How Wall Street Prepares for Possible US Debt Repayment

NEW YORK/WASHINGTON, May 22 (Reuters) – As talks on raising the U.S. government’s $31.4 trillion debt ceiling go down to the wire, Wall Street banks and asset managers are bracing for the fallout from a possible default.

The financial sector has already prepared for such a crisis in September 2021. But this time, the relatively short time frame for reaching a compromise has put bankers on edge, said a senior industry official.

With less than two weeks to go until June 1, US Treasury Secretary Janet Yellen reaffirmed on Sunday that the federal government may not be able to pay off all of its debt, as the Treasury Department warned.

Citigroup ( CN ) CEO Jane Fraser said the debate over the debt ceiling was “more worrisome” than previous debates. JPMorgan Chase & CO ( JPM.N ) CEO Jamie Dimon said the bank was holding weekly meetings on the implications.

What happens if America fails?

U.S. government bonds underpin the global financial system, so it’s difficult to fully gauge the damage a default would create, but executives expect huge volatility in equity, debt and other markets.

The ability to trade in and out of Treasury positions in the secondary market will be severely affected.

Wall Street executives who have advised on Treasuries’ lending operations have warned that a Treasury market crash could soon spread to the derivatives, mortgage and commodity markets as investors question the validity of Treasuries, which are widely used to hedge trades and loans. Financial institutions may ask counterparties to replace securities affected by defaulted payments, analysts said.

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Even a small breach of the credit limit can lead to a rise in interest rates, a fall in stock prices and covenant violations in loan documents and leveraged agreements.

Short-term funding markets may also freeze, according to Moody’s Analytics.

How are companies preparing?

Banks, brokers and trading floors are bracing for disruption and broader volatility in the Treasury market.

This usually involves game-planning how payments on Treasury securities will be handled; how important financial markets operate; ensuring adequate technology, staffing capacity and cash to handle high trading volumes; and checking the potential impact on contracts with customers.

Large bond investors have warned that maintaining high levels of liquidity is important to withstand potentially violent asset price moves and avoid selling at bad times.

Securities trading platform TradeWeb said it is in discussions with clients, industry groups and other market participants about contingency plans.

What scenarios are considered?

The Securities Industry and Financial Markets Association (SIFMA), a leading industry group, Game book It describes how Treasury market participants – the Federal Reserve Bank of New York, the Fixed Income Clearing Corporation (FICC), settlement banks, and Treasury dealers – interact before and after potential Treasury payments.

SIFMA has considered several scenarios. By extending maturing bonds by one day and giving advance notice of payment, the Treasury buys time to repay bondholders.

This will allow the market to continue to operate but not incur interest on late payments.

In the most disruptive scenario, the Treasury defaults on both principal and coupon and does not extend maturities. Unpaid securities are no longer tradable and no longer transferable on the Fedwire Securities Service, which is used to hold, transfer and settle Treasuries.

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Each scenario can lead to significant operational issues and require daily manual adjustments to trading and settlement processes.

“It’s unprecedented because it’s difficult, but what we’re trying to do is make sure we work with our members to create a plan to help them navigate a disruptive situation,” said Rob Toomey, CIFMA’s managing director and associate general counsel. For capital markets.

The Treasury Markets Practices Committee — an industry group sponsored by the New York Federal Reserve — also has a plan for trading in defaulted Treasuries, which is under review by the end of 2022. Meeting minutes on its website dated November 29. The New York Fed declined to comment further.

Additionally, during the debt-ceiling stances of 2011 and 2013, Fed staff and policymakers created a playbook that could provide a starting point, the last and most important step being to completely remove defaulted bonds from the market.

FICC-owned Depository Trust & Clearing Corporation said it is monitoring the situation and has formulated various scenarios based on SIFMA’s playbook.

“We are working with our industry partners, regulators and participants to ensure coordination of activities,” it said.

Report by David Barbuccia; Editing by Megan Davis, Michael Price and David Gregorio

Our Standards: Thomson Reuters Trust Principles.

David Barbuccia

Thomson Reuters

Davide Barbuscia covers macro investing and trading from New York, focusing on fixed income markets. Based in Dubai, he was Reuters’ chief economic correspondent for the Gulf region and has written on a range of topics, including oil, Lebanon’s financial crisis and Saudi Arabia’s efforts to exit corporate and sovereign debt covenants. and restorative situations. Before joining Reuters in 2016 he worked as a journalist at Debtwire in London and based in Johannesburg.

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