More Signs Wall Street Is Preparing For Debt Ceiling-Related Problems
It was hard not to notice this story by Michael Mackenzie and Aline van Duyn in yesterday's Financial Times about how Wall Street is planning to deal with the situation if the federal debt ceiling isn't raised by August 2, the date the U.S. Treasury says the federal government's cash situation will become critical.
Here's the money quote:
One strategy, which bank executives only agreed to discuss without attribution due to the political sensitivities related to discussing Treasury debt, is to have more cash on hand to put up as collateral against derivatives and other transactions, decreasing the financial system’s reliance on Treasurys.
“We’re planning to lower our reliance on the use of Treasurys in early August and have more cash on hand as a contingency measure,” said a U.S. bank chief.
The fact that plans are being made isn't surprising, but the fact that Wall Street sees a need to make and is making contingency plans is definitely newsworthy. Up to now, congressional Republicans (and some commenters here at CG&G) have been denying that Wall Street cares if the debt ceiling isn't raised, or have been insisting that it will have little effect. Combine this story with my post from last Tuesday and it's clear that just the opposite is true.
As Ronald Reagan said, "This
As Ronald Reagan said, "This country now possesses the strongest credit in the world. The full consequences of a default -- or even the serious prospect of default -- by the United States are impossible to predict and awesome to contemplate. Denigration of the full faith and credit of the United States would have substantial effects on the domestic financial markets and on the value of the dollar in exchange markets. The Nation can ill afford to allow such a result. The risks, the costs, the disruptions, and the incalculable damage lead me to but one conclusion: the Senate must pass this legislation before the Congress adjourns."
-- November 16, 1983 letter to Senate Majority Leader Howard Baker
The FT article goes on to
The FT article goes on to discuss default, as if that is somehow the premise for plans to curtail the use of Treasuries as collateral. In fact, it does not. Rather, it assumes greater scarcity of Treasuries, as net new issuance falls to zero.
Default on Treasury securities is a real possibility, but it is far from the only possibility. Treasury could, and probably would, default on other obligations first. That would tend to slow the economy, boosting demand for Treasuries and making them even scarcer, relative to demand. Too bad the FT writer (editor?) couldn't see past the default craze. Otherwise, the topic of the article is worth reporting on, but is pretty mechanical. Of course the use of Treasuries as collateral would be curtailed if net Treasury debt outstanding were to stop rising.
No, it's about default
A failure to raise the debt ceiling would have only a small effect on the total number of Treasuries outstanding, so I don't think this is about scarcity. The net issuance of new Treasuries was negative during the final years of the Clinton Administration, and I don't recall any move away from using Treasuries as collateral back then.
Treasuries are used as collateral because they are perceived as risk free. The article suggests that that perception hasn't changed yet, but that people are preparing for the possibility that the perception could change.
Debt Ceiling
Please keep telling the politicians: "This is reality!"