Wall Street banks along with asset managers have started preparing for the effects of a potential default as discussions over raising the astounding $31.4 trillion debt ceiling for the United States government become more heated.
A recent preparation for such a disaster was made by the financial sector in September 2021. But this time around, a senior industry insider claimed, the narrow window for finding a solution has bankers on edge.
Jane Fraser, CEO of Citigroup (C.N), stated that this debt ceiling dispute is more concerning than past ones. Jamie Dimon, CEO of JPMorgan Chase & CO (JPM.N), stated that the bank is holding weekly meetings to discuss the consequences.
It is difficult to properly assess the harm that a default would cause because U.S. govt bonds support the whole worldwide financial system, but executives anticipate extreme volatility in the debt, equity, and similar markets.
It would be very difficult to buy and sell Treasury holdings on the secondary sector.
Wall Street officials who supervised the Treasury’s debt programmes cautioned that since Treasuries are frequently used as protection for trades and loans, any breakdown in the Treasury area would swiftly extend to the mortgage, derivative, and the commodity markets.
Analysts said that financial institutions should ask the counterparties to properly replace the bonds impacted by late payments.
Even a brief overdraft could trigger an increase in interest rates, a drop in stock prices, and covenant violations in agreements for loans and leverage contracts.
The Treasury market turmoil as well as general volatility are being prepared for by brokers, banks, and trading platforms.
This often entails scenario planning for how transactions on Treasury securities ought to be handled, the reaction of crucial funding markets, the availability of adequate technology, human resources, and cash to manage high trading volumes, as well as assessing any potential effects on client contracts.
To avoid selling at the weakest possible time and to be able to sustain potentially dramatic asset price movements, large bond investors have emphasised that keeping high levels of liquidity is crucial.
Tradeweb, an emerging platform for trading bonds, reported that it was in talks regarding backup plans with customers, business associations, and similar market participants.
the Fixed Income Clearing Corporation (FICC), the Federal Reserve Bank of New York, several clearing banks, and Treasury market participants would express in advance of and during the days of possible missed Treasury payments, according to a playbook developed by the Securities Industry & Financial Markets Association (SIFMA), who happens to be a leading industry association.
SIFMA has thought about various possibilities. The more likely scenario would be for the Treasury to announce ahead of a transaction that it might likely roll those maturing notes over, prolonging them one day at a time, in order to gain time to repay bondholders.
That would enable the marketplace to continue operating, but interest for the postponed payment would probably not accumulate.
The Treasury is likely not the one to reimburse the principal or the coupon and does not postpone maturities in the most worst-case scenario. Meanwhile, the Fedwire Securities Service, one that is used to retain, transfer, and settle Treasury securities, would no longer allow the trading and transfer of the unpaid bonds.
Each scenario would probably cause serious operational issues and call for daily human adjustments to the trading and settlement procedures.
Meeting minutes posted on its website on November 29, showed the Treasury Market Practises Group (TMPG), a business association supported by the New York Fed, also has a strategy for trading in defaulted Treasury bonds.
This strategy will be evaluated at the close of the year. The New York Fed chose not to make any more comments.
Additionally, Fed staff along with policymakers had sincerely developed a playbook during previous debt-capping standoffs in 2011 – 2013, which would probably serve as a starting point.
The final and most delicate stage would be to eliminate defaulted securities from the financial system.
FICC’s owner, the Depository Trust, plus Clearing Corporation, declared that it was keeping an eye on the situation and that it had created a number of scenarios based on SIFMA playbook.