http://www.zerohedge.com/news/2013-10-05/what-impact-technical-treasury-default
Submitted by Tyler Durden on 10/05/2013 15:11 -0400
Submitted by Tyler Durden on 10/04/2013 18:33 -0400
Submitted by Tyler Durden on 10/04/2013 09:40 -0400
Submitted by Tyler Durden on 10/04/2013 08:39 -0400
What Is The Impact Of A Technical Treasury Default?
Yesterday we described the various scenarios available to Treasury in the next few weeks should the shutdown and debt ceiling debacle carry on longer than the equity markets believe possible. As BofAML notes, however, the most plausible option for the Treasury could be implementing a delayed payment regime. In such a scenario, the Treasury would wait until it has enough cash to pay off an entire day’s obligations and then make those payments on a day-to-day basis. Given the lack of a precedent, it is hard to quantify the impact on the financial markets in the event that the Treasury was to miss payment on a UST; but the following looks at the impact on a market by market basis.
Via BofAML,
Impact of going past the X date
Given the lack of a precedent, it is hard to quantify the impact on the financial markets in the event that the Treasury was to miss payment on a UST. In 1979, the Treasury did delay payments on $122mn worth of bills maturing on April 26, May 3 and May 10, 1979. However, the Treasury blamed the delay on an unprecedented volume of participation by small investors and the unanticipated failure of word-processing equipment used to prepare schedules needed to cut them individual paper checks. The problem was cleared up within three weeks, and investors holding T-bills maturing on May 17, 1979, were paid on time. The late bill payments were also made, with interest.
In contrast, any debt ceiling breach today will be seen as a willful default by Congress on the country’s debt obligations and will have greater consequences. The economic effects will be felt via declining consumer and business confidence, reduced availability of credit and higher private borrowing costs.
Technical aspect of a treasury default
Treasury auctions: If the debt ceiling is not raised by October 17, we expect the Treasury to postpone the announcement of the 30-Year TIPS auction (scheduled for 11am on October 17) and the 2s,5s, 7s announcement (scheduled for 11am on October 24). With respect to the auctions, the debt ceiling allows the Treasury to issue new debt to replace maturing debt, as this does not add to the total debt outstanding. The problem would be any increase in net issuance, which ordinarily helps fund the deficit. In this scenario, our best estimate is that the Treasury would suspend coupon auctions and issue cash management bills (CMBs) totaling the size of the maturing debt. There is no guarantee, however, that the proceeds of the auction would be used to pay off the maturing debt – technically, they can be used to pay off obligations of a previous day under the delayed payment regime.
Bill rollover: Although Treasury can roll over maturities, bills are a little more complicated because they are issued at a discount to par. When Treasury issues new bills at a positive yield, the proceeds of the auction would be slightly less than what the Treasury will need to pay down the maturing bills. Once Treasury runs out of cash, the issue of prioritization would become relevant because it will need to scrape up some extra cash to make up for the discount factor on the new bills.
Repo market eligibility: In our view, Treasuries for which a coupon payment has been missed will continue to be eligible for repo market transactions. However, cash lenders in tri-party may ask to not be delivered the specific defaulted CUSIPs. Securities that are past their maturity date without the principal being paid cease to exist as securities. Instead, they will be considered IOUs between the Treasury and the holder. Such IOUs cannot be used in the securities market unless such a market develops separately for trading these issues.
If the Treasury were able to provide advance guidance that a principal payment will not be met, the security’s maturity date could be modified in advance in order to help systems maintain their classification as a security (instead of an IOU). Treasury repo rates would likely rise as liquidity in the repo market deteriorates. In late July 2011 Treasury GC rates rose by nearly 30bp and MBS repo increased by 35bp as the X” date approached, though this was exacerbated by heavy money fund outflows.
Repo haircuts and exchange collateral:During the debt ceiling standoff in 2011 there was some concern that repo haircuts on Treasuries could increase in the event of a US government default or ratings downgrade. A ratings downgrade alone would not be sufficient to cause an increase in haircuts since haircut levels are not linked to ratings. Rather, cash lenders seek to maintain haircuts large enough to protect themselves from an adverse market move over the time period required to liquidate the collateral in the event of a counterparty default. Significant deterioration in market liquidity would be a more serious threat to existing repo haircut conventions than a ratings downgrade. Going past the X date has the potential to trigger an increase in haircuts if liquidity were to deteriorate sufficiently.
Money fund holdings: SEC Rule 2a-7 does not require that fund managers liquidate their Treasury, agency, or repo holdings in the event of a US government downgrade or default, though there is some ambiguity about how defaulted securities would be treated. In our view, the bigger risk could come from investor outflows, though we expect MMF cash to be “stickier” than in 2011.
Fed purchases: In our view, the Fed can continue to buy Treasury securities even if a payment were to be missed. The Federal Reserve act does not explicitly have any qualifications around default, and permits the Fed to buy any direct obligation of the United States. In 2008-2009, the Fed purchased agency debt as a part of QE1 well after the CDS on Fannie Mae and Freddie Mac were triggered.
Rating agencies: In the case of a missed payment, we believe that S&P would move the sovereign rating to Selective Default (SD). If multiple payments were to be missed, Fitch would also move the rating to Restrictive Default (RD)”. In our view, there is no concept of default by a specific CUSIP or cross-default for USTs. Further, there is no prospectus document with a Treasury offering defining default and the rating agencies would move the sovereign rating (not issue specific rating) to SD/RD. In all cases, even after the default is cured, we think all three rating agencies are likely to downgrade their current ratings by a notch.
Index eligibility: The eligibility of Treasuries with respect to any of the BofA Merrill Lynch US Fixed income indices will be unaffected, irrespective of rating changes. Sovereigns are exempt from rating criteria in single currency indices (Except Euro Broad Market). In the case of global indices, Treasuries are unlikely to fall out unless the average of the 3 ratings goes below investment grade.
CDS: We believe the contract would be triggered after a three-day grace period (since no grace period is defined, ISDA default is likely three days). It is important to remember that US CDS contracts are rather illiquid despite the recent spike in volumes and spreads (Chart 4). There is less than $5bn in outstanding notional and will likely traded by only non US counterparties (payout in euros).
http://www.zerohedge.com/news/2013-10-04/what-if-we-go-past-x-date
What If We Go Past The "X" Date?
What if the Treasury were to go over the X date (date beyond which the Treasury cannot honor all its payments) without the debt ceiling being raised? As BofAML notes, the Treasury estimates the X date to be October 17, though they believe that the Treasury may have enough cash and incoming tax receipts to last a few more days. In either case, the date is not too far out. Market concerns over possible postponed payment have been rising as indicated by the performance of October and November bills. What are the options of for the Treasury?
Via BofAML,
In our view, most options are unviable – the most fair and sensible option would be to implement a delayed payment regime where no payments would be made until they could all be made on a day-by-day basis.
1. 14th Amendment will not be used
The White House has ruled out raising the debt ceiling using the 14th amendment (which states that the validity of the public debt of the United States cannot be questioned). National Economic Council Director Gene Sperling and Presidential Adviser Dan Pfeiffer have both rejected using this option this week. Also, earlier this year, the White House press secretary emphasized that the Administration did not believe that the 14th Amendment gives the president the power to ignore the debt ceiling.
2. Trillion dollar coins will not be minted
We do not believe the Treasury will even consider minting coins (which are not subject to debt ceiling) and asking the Fed to purchase them to temporarily get over the debt ceiling. The legality of this is questionable, and it would further deepen the distrust between the two political parties. It would also risk being the first step down a slippery slope of debt monetization. We believe it would be extremely unlikely the Fed would agree to accept platinum coins in return for making Treasury’s payments, as it would politicize the Fed and put its independence at risk.
3. Asset sales are unlikely
During the 2011 debt ceiling debate, Treasury officials rejected the option of selling gold reserves as it would undercut confidence in the US and destabilize the world financial system. Treasury officials determined that a “fire sale” of other assets like TARP assets would not maximize value for taxpayer and could be detrimental. These asset sales would also buy very little time. Since then, the Treasury has completely wound down its MBS portfolio and TARP assets now total less than $25bn.
4. Prioritization of payments: Treasury will be unwilling
Another option in case of a breach of the ceiling would be the prioritization of debt service payments by the Treasury. The idea of issuing scrips or IOUs to claimants (other than those who hold US Treasury debt) would be another manifestation of the same idea, wherein debt payments are deemed superior. However, this may be impossible from an operational standpoint. The Treasury makes 80-100 million payments per month, and modifying systems to pick and choose would be an operational nightmare. The administration would be accused of picking winners and losers and become the center of intense media and public scrutiny. In 2011 when a bill to prioritize debt payments was introduced, the proponents were accused of paying China instead of federal workers. In 2011, Treasury officials reportedly determined that there was no fair or sensible way to pick and choose among the many bills that are due every day.
5. Delayed payment regime most likely
We believe the most plausible option for the Treasury could be implementing a delayed payment regime. In such a scenario, the Treasury would wait until it has enough cash to pay off an entire day’s obligations and then make those payments on a day-to-day basis. For example, if the Treasury did not have enough cash to pay all of its obligations on November 1, 2013, it would wait until enough receipts flow in (perhaps not until November 3 or 4) and then make good on all payments for the 1st. Given that the US has a sizable monthly deficit, the delay would worsen by the day, but at least the Treasury would not have to pick winners and losers.
http://www.zerohedge.com/news/2013-10-04/debt-ceiling-fight-stretching-november-bond-traders-increasingly-say-yes
A Debt Ceiling Fight Stretching Into November? Bond Traders Increasingly Say Yes
Until yesterday, all the action in T-Bills - that was creating anxiety in the credit markets - was focused on the end-of-October bills. But now, despite the Boehner restatement of his desire not to end-the-world yesterday that realistically said nothing new, the mid-November Bills are starting to blow higher in yield. It seems confidence in a short-term solution to the shutdown/CR/Debt-Ceiling debacle is not expected. The 11/14/13 bill is up 8.5bps to 13.5bps this morning...
http://www.zerohedge.com/news/2013-10-04/someone-getting-nervous-er-er
Someone Is Getting Nervous-est
Another day, another shut government and 1-month T-Bills have surged another 6bps to 18.5bps. Those who read our suggestion from Sept 26 to hedge the political stupidity and debt ceiling debate and put on the 1M1Y flattener have seen the fastest plunge and inversion (to negative!) in the curve since early 2009. Despite the relative calm in repo markets, which is likely due to expectations that any technical default will be for a minim al length, the short-term bills most likely to be affected (the 10/31/13 T-Bills) are seeing thelargest daily deterioration yet as traders exit and price in the possibility of missed payment.1Y USA CDS has spiked by a massive 26bps to 65bps, higher than during the Lehman crisis and second only to Summer 2011.
Putting the 1M1Y move in perspective: fastest flattening since March 2009!
And since the September 26 reco:
Charts: Bloomberg
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