Default Poses Operations Risk Even With Planning, Fed Group SaysCaroline Salas Gage and Liz Capo McCormick
An industry group sponsored by the Federal Reserve Bank of New York that advises on transactions in U.S. securities said members’ contingency planning wouldn’t eliminate the operational risk posed in case of delayed payments on government debt.
The Treasury Market Practices Group, whose members represent firms including Morgan Stanley and BlackRock Inc., held a regularly scheduled meeting on Sept. 25 and went over plans for how the industry would handle a U.S. government debt default threatened within weeks if Congress fails to raise the debt ceiling.
“The discussion emphasized these contingency actions, if implemented, would only mitigate, not eliminate, expected operational difficulties in the event of delayed payments on Treasury debt,” according to the minutes of the meeting, posted on the New York Fed’s website.
The TMPG, as the group is known, discussed contingency plans throughout 2012 after disruptions in the markets occurred ahead of a looming debt-ceiling deadline in August 2011. The group said Sept. 25 that the previously proposed plans remain relevant, including one that calls for eventual principal payments for securities with delayed maturities to be made to the final holder of the debt once the debt limit is raised. The group cautioned more work still needed to be done.
“Members also highlighted uncertainty of some market participants about whether the Treasury securities with delayed payments would be eligible for the Discount Window and in Open Market Operations,” referring to the Fed’s emergency loan facility and debt it purchases or sells as part of its monetary policy.
The TMPG also questioned whether services providing bond-market prices had “robust contingency plans in place” as well as the risk that planning overall in the industry was not uniform.
“Members expressed concerns that contingency planning was uneven across market participants,” the minutes said. Still, “members recognized that efforts by industry trade organizations, to coordinate operational efforts and identify recommended actions, in response to a contingency event were more advanced than in prior years.”
A delay in payments by the Treasury on its obligations could be deemed a technical default, because the government would have the ability to pay, yet would choose not to, according to JPMorgan Chase & Co. In such a case, prices of Treasuries that mature or have coupon payments due during that time would likely undergo the greatest negative reaction.
Two years ago, one-month bill rates climbed to a 29-month high of 0.18 percent as the Aug. 2, 2011, deadline set by Treasury to avoid a default approached. They traded at 0.015 percent in December 2012 before a year-end trigger would force automatic spending cuts and tax increases.
One-month Treasury bill yields traded at 0.1572 percent yesterday, up from negative 0.0051 percent on Sept. 17, before the government shut down after Republicans and Democrats in Congress failed to agree on funding for the new fiscal year that began this month.