Brookings Event on Debt Limit
The debt limit: What if…
Tuesday, October 5, 2021
Panel 1: The View from Wall Street
- Jay Barry, Managing Director, Interest Rate Strategy, J.P. Morgan
- Deirdre Dunn, Co-Head of Global Rates Managing Director, Citi
- Richard Chambers, Global Head of Short End Interest Rates Products, Goldman Sachs
- Matthew Hornbach, Managing Director and Global Head of Macro Strategy, Morgan Stanley
In her opening statement, Louise Sheiner, Robert S. Kerr Senior Fellow in Economic Studies and Policy Director for the Hutchins Center on Fiscal and Monetary Policy, summarized the consequences of failing to raise the debt limit and said there is a lack of clear answers around these consequences. David Wessel, Director of The Hutchins Center on Fiscal and Monetary Policy and Senior Fellow of Economic Studies, and Brian Sack, Director of Global Economics at D.E. Shaw Group, moderated the discussion, which highlighted uncertainty about what the U.S. Treasury Department and the Federal Reserve (Fed) will do in response to hitting the debt ceiling and whether the existing “plumbing” will adequately facilitate the Treasury and Fed’s response.
Sack explained what a technical default looks like, what happens if Treasury cannot pay debts the next day, how Treasuries would no longer be transferrable, and how the way around that is to change the maturity dates, even though that is a delicate procedure. He mentioned a number of systems tied to this including the Fixed Income Clearing Corporation (FICC), dealer systems, clearing banks, and other private sector systems that would have to adjust. Sack also said there is a considerable amount of uncertainty for what would happen as a result of a downgrade.
Barry said investors are taking active steps to mitigate the low probability, but there is a high risk associated with a technical default, adding that while investors expect Congress to work this out, people may react to a downgrade by buying long term treasury bonds despite the U.S. government being the cause of the disturbance. Concerning minting a trillion-dollar coin, Barry said he agrees with Yellen’s assessment.
Dunn stated that the broader Treasury market is functioning well but showing signs of stress, adding that the market is focused on the timing of the resolution. She outlined her expectation that the market will express skittishness without a resolution or meaningful change in tone from D.C. and stated that Democrats can solve the problem on their own but the process could take up to two weeks. She added that a higher reserve environment contributes to a false sense of complacency and discussed the repo market. She explained that if short term treasuries go down in volume, stressed institutions will have to come up with more cash to make their positions work but that it does not necessarily depend on treasuries and could also depend on price changes and market volatility. Regarding Fed repo facilities, she stated that if the Fed ensured that extended maturities are still eligible for heavily used clearing and settlement systems, and they accept it as collateral for cash, it would help sustain the market. When asked about the Treasury prioritizing interest and continuing to pay interest, Dunn said what has an impact on the broader economy is what they are not prioritizing if they prioritize debt and interest payments. She also said that within prioritization of interest payments, they will likely prioritize bill maturities.
Concerning the broad landscape of repo markets, Chambers said there are multiple debt limit scenarios, including 1) a last-minute debt ceiling agreement; 2) a technical default on select treasury securities while making investors whole on their investments; or 3) a technical default without making investors whole. He said markets believe the repo market is still on sound footing, based on excess liquidity in the system and other factors. Chambers further stated that if we get to a technical default, we can expect a considerable repricing of risk and also discussed sentiment and the uncertainty associated with that sentiment. Sack said it is likely that all debt payments get delayed after default, prompting Richard to agree, saying that there will be an extension on maturing securities and that from a treasury market standpoint, he expects coupons and principle to be all or none. Chamber expressed concerns about the credit worthiness of the U.S. government and the Treasury paying its debts, because failing to pay debts would encourage investors to reevaluate their models based on Treasury securities.
Hornbach said the facilities and front-end plumbing are different and the size and scope of the market is larger and more liquid today than it was in 2011 or 2013, which could help offset technical issues. He suggested that in the case of default or leading up a default, people who hold tainted treasuries could give them to the Fed for money and that this issue is also relevant to foreign investors, who are heavily invested in treasury bills. Sack asked if the market is more fragile in a general way that is particularly problematic, to which Hornbach said confidence in the government’s willingness to pay its debts is important, and policy makers need to respect the importance of confidence in our marketplace and do the right thing.