Last week I spoke with two people on Wall Street who are planning what to do if Congress and the White House can’t come to an agreement to raise or suspend the debt ceiling. I’m told it’s unclear how well the federal government’s default contingency plan would work, because it’s never been tested. Even if it worked exactly as envisioned, they said, a default would still hurt the economy.
Even the best of cases is not good. Let’s just say that Wall Street somehow managed to minimize the damage caused by a brief default. That could make some politicians think the warnings were overblown, making them more willing to risk another default, which could inflict more damage. Once broken, a taboo loses its power.
Beth Hammack, who is co-head of the Global Finance Group at Goldman Sachs, leads a federally statutory group called the Treasury Loan Advisory Committee, which meets with the Treasury Department once a quarter to advise it on how to raise money from through the sale of bonds, promissory notes and bills.
“The US government not making a payment is existential for financial markets,” Hammack told me. “We’re talking about a piece of paper that the world considers risk-free or nearly risk-free.”
I asked him how confident he was of the contingency plan for a default developed by Treasury’s Business Practices Group (more on that later). “It’s never been tested,” he said. “No one knows if it will work. So, no, it’s not a great solution.”
As for the possibility that contingency plans work almost too well, lulling Washington into a false sense of security, he said it’s a mistake to think that no harm is done if a default is brief and the government quickly catches up. day with all your payments. The damage is already being done, he said, pointing to rising interest rates on Treasury securities due around the time the Treasury is expected to run out of ways to delay the debt ceiling.
“The United States has a unique place in the financial markets,” Hammack said. “People flock to our products in uncertain times because they believe in the United States government. If we don’t pay our debt, we are jeopardizing the dominance of the dollar that gives the US a material economic advantage on the world stage.”
I heard a similar message from Robert Toomey, who is a managing director, associate general counsel, and head of the capital markets practice at SIFMA, an influential trade group for the securities industry. “We don’t know what will happen,” he said. “We have absolutely no precedent. You try to prepare because you want to create as little disruption to the market.”
SIFMA has written a Playbook what to do in the event of a break in Treasury payments. He doesn’t cite the debt ceiling as a trigger, perhaps out of a desire to appear apolitical, instead mentioning “system failures, natural disasters, terrorist acts or other reasons.” There is a schedule of meetings in case of a notification from the Treasury that payments will not be made by a certain date. Two occur the night before that date, at 6:45 p.m. and 10:15 p.m. The next three occur on the day payments were scheduled to be made, at 7:30 a.m., 11 a.m., and 2 p.m.
If there is a default, another key player will be the Treasury Market Practices Group, which is sponsored by the Federal Reserve Bank of New York. Hammack used to belong to her. Like the organization Hammack now runs, it is made up of private sector executives. Its mission is to “support the integrity and efficiency of the Treasury, agency debt, and agency mortgage-backed securities markets.”
Treasury’s Business Practices Group has a seven-page contingency plan, most recently updated in December 2021, which is coordinated with SIFMA. “It should be emphasized that the practices described here, if implemented, would only modestly reduce, not eliminate, the operational difficulties posed by untimely payments on Treasury debt,” the plan says.
A key part of the plan is to change the operation of the Fedwire Securities Service, which buyers and sellers of Treasury securities use to transfer securities. It’s usually open until 7 pm Eastern time, Monday through Friday. When a Treasury security reaches its maturity date, the person who receives the principal is the person who had it at 7 pm the day before, when the Fedwire Securities Service closed. The value is frozen, or cannot be transferred, at that time. This strict rule prevents confusion about who is entitled to receive the payment.
The rule that works well in normal times would be disastrous if breached. Each Treasury that reached maturity would be frozen, meaning it could not be sold or used as collateral for a loan. Treasuries are the building blocks of Wall Street, so freezing those that mature would alter the way finances are conducted. That would soon spill over into the real economy.
The Treasury’s Business Practice Group’s solution is for the Treasury to notify the Federal Reserve at least one day in advance that it will not make scheduled payments. That would allow Fedwire’s Securities Service to change its normal practice and extend the “operational” expiration date by one day. That, in turn, would give the holder one more day to sell the security or borrow against it. While the stopgap measure would only work for one day, “This practice could be repeated every day until the principal payment is made,” the group says in its contingency plan.
It is hardly a complete solution. As the Treasury Market Practices Group puts it: “Some participants may not be able to implement these practices, and others might be able to do so only with substantial manual intervention in their trading and settlement processes, which in itself would represent operational risk.” significant. It is also likely that other operational difficulties will arise that could be serious and cannot currently be foreseen.”
In short, there is a Plan B. But Plan A, raising the debt ceiling, is a thousand times better.
Perspective: Preston Mui
The US job market is weakening, but there is little evidence that unemployment will rise much this year, Preston Mui, a senior economist at Employ America, a research and advocacy organization that supports full employment, wrote in an article. report on Friday. A sign of continued strength, he wrote, is that the unemployment rate for blacks was only 1.6 percentage points higher than the unemployment rate for whites in April. That’s the lowest on record from the Bureau of Labor Statistics since 1972. The gap tends to narrow when demand for labor is strong. “At this point, the Fed’s projections of 4.5 percent unemployment by the end of this year seem far-fetched,” Mui wrote. “Getting there would require an extremely rapid increase in the unemployment rate.”
quote of the day
“Selling a thing for more than its value, or buying it for less than its value, is in itself unfair and illegal.”
— Saint Thomas Aquinas, “Summa Theologica,” “Of Deceptions Committed in Buying and Selling,” Objection 3 (1265-1274)