Last week I spoke with two people on Wall Street who are planning what to do in case Congress and the White House can’t reach a deal on raising or suspending the debt ceiling. They told me that it’s not clear how well the contingency plan for a default by the federal government would work, because it’s never been tested. Even if it did work exactly as conceived, they said, a default would still damage the economy.
Even the best-case scenario isn’t good. Let’s say Wall Street somehow managed to minimize the harm done by a brief default. That could cause some politicians to 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 the co-head of the Global Financing Group at Goldman Sachs, leads a group governed by federal statute called the Treasury Borrowing Advisory Committee, which meets with the Treasury Department once a quarter to advise it on how it raises money through sales of bonds, notes and bills.
“The U.S. government not making a payment is existential for financial markets,” Hammack told me. “We’re talking about a piece of paper that the world holds out to be risk-free or nearly risk-free.”
I asked her how confident she was in the contingency plan for a default that’s been developed by the Treasury Market Practices Group (more on that later). “It’s never been tested,” she said. “Nobody knows if it’s going to work. So, no, it’s not a great workaround.”
As for the possibility that the contingency plans might work almost too well, lulling Washington into a false sense of security, she said it’s wrong to think that no damage is done if a default is brief and the government quickly catches up on all its payments. Damage is already being done, she said, pointing to the spike in interest rates on Treasury securities that mature around the time the Treasury is expected to run out of ways to delay hitting the debt ceiling.
“The U.S. is afforded a very unique place in financial markets,” Hammack said. “People flock to our products in times of uncertainty because they believe in the U.S. government. If we don’t pay our debt we are jeopardizing the dollar dominance that gives the U.S. a material economic advantage on the world stage.”
I heard a similar message from Robert Toomey, who is a managing director, the 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 the least disruption to the market.”
SIFMA has written a playbook for what do in case of a disruption in Treasury payments. It doesn’t cite the debt ceiling as a trigger, perhaps out of a desire to appear nonpolitical, instead mentioning “systems failures, natural disaster, terrorist acts or other reasons.” There’s a schedule for meetings in case of a notification from Treasury that payments will be missed on a certain date. Two occur the evening before that date, at 6:45 p.m. and 10:15 p.m. The next three occur on the day that payments were scheduled to occur, 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 it. Like the organization Hammack leads now, it is made up of private-sector executives. Its mission is “supporting the integrity and efficiency of the Treasury, agency debt and agency mortgage-backed securities markets.”
The Treasury Market Practices Group has a seven-page contingency plan, updated most recently in December 2021, that is coordinated with SIFMA’s. “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 changing the operation of the Fedwire Securities Service, which buyers and sellers of Treasury securities use to transfer securities. It’s ordinarily open until 7 p.m. Eastern time on weekdays. When a Treasury security reaches its maturity date, the person who receives the principal is the one who held it as of 7 p.m. the day before, when the Fedwire Securities Service closed. The security becomes frozen — or nontransferable — at that time. This strict rule avoids confusion over who is entitled to be paid.
The rule that works well in ordinary times would be disastrous in case of a default. Every Treasury that reached maturity would become frozen, meaning it could not be sold or used as collateral for a loan. Treasury securities are the building blocks of Wall Street, so freezing maturing ones would disrupt how high finance is conducted. That would soon spill over to the real economy.
The Treasury Market Practices Group’s solution is to have the Treasury notify the Fed at least a day ahead that it will not make scheduled payments. That would allow the Fedwire Securities Service to change its normal practice and extend the “operational” maturity 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 work for only one day, “This practice could be repeated each day until the principal payment is made,” the group says in its contingency plan.
It’s hardly a complete fix. As the Treasury Market Practices Group puts it: “Some participants might not be able to implement these practices, and others could do so only with substantial manual intervention in their trading and settlement processes, which itself would pose significant operational risk. Other operational difficulties would also likely arise that could be severe and cannot currently be foreseen.”
In short, there is a Plan B. But Plan A — raising the debt ceiling — is a thousand times better.
Outlook: Preston Mui
The U.S. labor market is softening, but there’s little evidence that unemployment will rise a lot this year, Preston Mui, a senior economist at Employ America, a research and advocacy organization that supports full employment, wrote in a report on Friday. One sign of continued strength, he wrote, is that the Black unemployment rate was just 1.6 percentage points higher than the white unemployment rate in April. That’s the lowest in Bureau of Labor Statistics records going back to 1972. The gap tends to narrow when demand for labor is strong. “At this point, the Fed’s projections for 4.5 percent unemployment by the end of this year look implausible,” Mui wrote. “Getting there would require an extremely rapid increase in the unemployment rate.”
Quote of the Day
“To sell a thing for more than its worth, or to buy it for less than its worth, is in itself unjust and unlawful.”
— St. Thomas Aquinas, “Summa Theologica,” “Of Cheating Which Is Committed in Buying and Selling,” Objection 3 (1265-1274)
