A deal required before an Asian markets drop on Monday. Bankers summoned to a joint meeting with officials in New York. Congress paralysed. Despite our continuing optimism and markets’ relative insouciance, it all sounds worryingly familiar.
Bloomberg reports on Friday morning that the Federal Reserve is preparing to issue guidance to banks should Congress fail to raise the debt ceiling and that the US treasury has invited all 20 primary dealers to a contingency briefing in New York.
Not that bondholders should worry too much it seems, with reports they will be prioiritised if August 2 passes without a deal. The US treasury on Thursday also announced the refinancing of the T-bill that would have broke America‘s credit.
Nevertheless, questions remain about what the US government would do should its legislative branch continue its best impression of an Ionesco play. Five questions, at least. The FT’s Gillian Tett says that the Fed and the US Treasury still need to answer the following:
— What might the US government do to support the US money market funds if American debt is downgraded, or suffers a technical default?
— Will the US authorities step into the markets and act as the dealer or financier of last resort, if parts of the market freeze up?
— What will regulators do about capital standards if some banks’ balance sheets balloon?
— How will regulators and risk managers respond if the “risk-free” status of US debt starts to crumble?
— What rules will apply for paying interest, accrued interest and principal on Treasury bonds, if a technical default [occurs]
Excellent questions, and ones we assume were recently repeated in a downtown conference room. There’s a fine balance of course between calming and causing panic, and until recently the agencies were probably right to keep mum, but it’s getting to the point where a lack of communication only stokes concern.
We do have some intelligence, however. Officials have — as they do regularly — been speaking with individual banks and sometimes the latter share the points raised in these meetings. A note from RBC’s Foreign Exchange team includes these details gleaned from “a number of conversations with government officials over recent weeks” (emphasis ours).
On ratings agencies
Treasury appears to be working under the assumption that there is a high probability that S&P will cut the US rating. They are effectively working under the assumption that there will be split ratings since they also believe Moody’s and Fitch are not on the same page as S&P. In other words, they are taking a less extreme view than S&P.
A split rating seems to be an outcome they are willing to accept. On this point, when asked about the impact of a downgrade in general, they believe it’s hard to tell, particularly if it’s a split rating. They also highlighted that a split rating would likely not have any major implications for repo markets.
On the legislative process
Things may look messy in the media, but the differences between the two parties are not as significant as the media would lead one to believe. However, they had been working under the assumption that this would go into early next week. They are confident a bill could be passed in short order (one person explicitly said 10 minutes) once a deal is struck. Timing is the biggest difference. We were explicitly told that a two-step plan (short-term plan bridging the gap to a long-term plan) does not make sense – but they acknowledged this was a growing possibility.
They are telling Congress that August 2 is a hard deadline. This is something Geithner has mentioned recently as well. They seem unlikely to acknowledge that there is more wiggle room. However, they did acknowledge that the Treasury can still pay bills beyond that date. They just don’t want Congress to be able to latch on to something that can be used to extend the debate any further.
On contingency plans
In terms of contingency plans, they highlighted the Fed and that they don’t want to put them in a position to “monetize the debt.” They also stressed that the Fed lending money to the Treasury is against its charter.
Regarding the 14th amendment, this was all but ruled out. Officials highlighted this was uncharted territory and not something they want to explore.
On prioritizing payments (in the event the ceiling is not raised and they run into cash-flow issues), the officials noted that debt payments come first. They also highlighted that their systems are not set up for this type of event. It was also interesting that they view a missed payment on any obligation (such as Social Security) as inconsistent with the behavior of AAA credit. They said a missed payment would warrant a downgrade.
On foreign debt holders
They are in constant contact with our foreign creditors. They explicitly said they speak with our largest debt holders regularly, and while they acknowledge they are concerned, they said they are reasonably sanguine about the situation.
And at pixel time, the first readouts of the meeting were being reported by Reuters. The two interesting aspects are reports of discussions of delaying refunding (a European solution) and of issuing cash management bills (a Californian solution).
Friday, July 29, 2011 1:43:59 PM RTRS – U.S. TREASURY DISCUSSED DELAYING OR CUTTING SIZE OF QUARTERLY REFUNDING WITH PRIMARY DEALERS-SOURCES
Friday, July 29, 2011 1:46:28 PM RTRS – MOST PRIMARY DEALERS PREFERRED TO SEE TREASURY DELAY REFUNDING IF U.S. DOES NOT RAISE DEBT CEILING-SOURCES
Friday, July 29, 2011 1:47:56 PM RTRS – NO FORMAL DECISION TAKEN ON CHANGES TO QUARTERLY REFUNDING AT TREASURY’S MEETING WITH DEALERS-SOURCES
Friday, July 29, 2011 1:49:16 PM RTRS – TREASURY, DEALERS ALSO DISCUSSED DELAYING REFUNDING ANNOUNCEMENT SCHEDULED FOR THURS-SOURCES
Friday, July 29, 2011 1:50:41 PM RTRS – TREASURY, DEALERS DISCUSSED ISSUING CASH-MGMT BILLS TO REPLACE MATURING SECURITIES INSTEAD OF FULL REFUNDING-SOURCES
More details should be expected throughout the day and throughout the weekend.
U.S. Contingency Plan Gives Bondholders Priority – Bloomberg