What Is The Impact Of A Technical Treasury Default?

Tyler Durden's picture

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).

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CPL's picture

Nothing.  Everyone is making up their own rules without thinking too much.


nope-1004's picture

So Hussein Soetoro could have signed any number of these, without the publics' knowledge, for a variety of gov't departments.  No?


Renewable Life's picture

Oh we can only dream of such things as default!  We have been in default for decades, if you want to call it by its definition!  But who needs that when we can just run a ponzi scheme and print fake money to replace more fake money!  

Man I should do that myself, if the Federal government can do it, right? ohhhh it's ilegal and you'll be arrested by Federal agents and thrown in Federal prison!!!!!!!! Ohhhhh the fucking IRONY!!!!!!

DoChenRollingBearing's picture

There's plenty of money flowing in to pay our Treasury debts.  

Almost everything else is just fluff we don't need.

knukles's picture

He can just say; "Take a hike.  I did."

Sudden Debt's picture

true,normally the shutdown should have created enoughh savings for the rest to continue like the payouts without the debtceiling to be broken.
Debt repayment can be done by paying and taking on a new loan without taking a loan on the interest.
What are the actual savings done by the shutdown?
Why doesn't anybody calculate this? and put it on paper?

A shutdown should be about savings and there's nothing to back it up.
If the US defaults it's just saying, how briefly it may be: we're fucked.
No 10yr will be sold to a sane person and anything larger than a 2 yr will need to be picked up by the FED... a private entity... who will own more than 30% of America by the end of next year....

1 COMPANY OWNS 30%!!!!!



brettd's picture

Jamie Dimon:  I'd like the Grand Canyon and Bakken fields please.

Moyanahan:  I'll take the Gulf waters and Hattaras National Seashore....

N2OJoe's picture

And you'll be fed and clothed by the very Federal funny money you were competing against!

Kirk2NCC1701's picture

Today is one of those days that I like to fast-forward to the heart of the issue:

The ONLY frikin thing that REALLY matters, is if it results in the Dollar losing its RESERVE status. If that happens, no amount of Blue Pills will help. Unless you're an Elite, who has already taken the appropriate measures for what's coming*.

K out.

* Since the USD and its Reserve status is backed by OIL, TPTB are drilling and mother-fracking everywhere they can. These Vampire Squids don't give a sh!t about any "environmental" effects of fracking, since they don't live anywhere near there. As long as they can use the Dollar's Reserve status to create more fiat/confetti-debt which they then use to buy other real assets, they're all in.

IOW: SOP for ongoing Largest Transfer of Wealth in Human History.

Fuck me, are sheeple stupid!

WallowaMountainMan's picture


agreed in part.

the flow of algo driven decisions have already established a world currency. it just has no name.



max2205's picture

Its hard to find buyers of bonds when you can't redeem the ones coming due....oh wait that's what Ben for.....

WillyGroper's picture

"Civilian Employees" ---Pay Our Military Act

CogDis---this sets my hair on fire. Doesn't apply to VN vets.

Bastards, all of 'em.

jabhagsb's picture

Paying government employees for time they didn't actually work?!?  Great way to address budget issues! Carry on. 


TeamDepends's picture

Ladies and Gentleman, this is your captain speaking.  Due to extreme circumstances, you will each be required to buy a Bloody Mary for $500.  Oh yeah, fasten your seatbelts...

lolmao500's picture

Ladies and Gentleman, this is your captain speaking.  Due to extreme circumstances, we'll seize your 401k to pay the debt to the banksters. It's all because of republicans of course. Now I suggest you go ask for your money personally. Good hunt!

kaiserhoff's picture

"Declining consumer and business confidence..."

  I didn't know that stuff could go below zero.

q99x2's picture

Use public banks those Washington D.C. banksters are out of money. Pretty much their system to take over the world is dead in the water. They have to beg Saudi terrorists for money and Al-Queda to protect them. We are close to winning the revolution.

virgilcaine's picture

Nothing is real, up is down, down up in this clown bux world they created. It appears to me they want an 'event'..  ex. a downgrade of the clown bux Tbills.

max2205's picture

Govt workers to get paid to be on vacation.....makes sense right

lolmao500's picture

Shutdown? What shutdown? The government is still kicking enough to fuck you over...


Massachusetts college student faces up to 10 years in prison for owning standard gun magazines


Priests threatened with arrest if they minister to military during shutdown http://www.breitbart.com/Big-Government/2013/10/05/Feds-Try-to-Close-the... Feds Try to Close the OCEAN Because of Shutdown

Pentagon ordering most of its furloughed civilian employees back to work.


Former Joint Chiefs chairman: Obama plotted to destabilize regimes in Bahrain, Egypt
Smegley Wanxalot's picture

Let It Burn.

I hope they default, finally, and get it over with.

NoWayJose's picture

The Treasury collects $2.5 trillion in taxes every year. At least for a few more years, taxes more than cover interest paid out. So technically they will not default on interest. The 'real' default will be the first week of November when the government writes out checks to Social Security and all the various monthly paychecks, EBT, welfare, unemployment, etc. If they cover interest, there will be no money for these programs. And that will definitely get some attention.

moneybots's picture

"The Treasury collects $2.5 trillion in taxes every year. At least for a few more years, taxes more than cover interest paid out. So technically they will not default on interest. The 'real' default will be the first week of November when the government writes out checks to Social Security and all the various monthly paychecks, EBT, welfare, unemployment, etc. If they cover interest, there will be no money for these programs. And that will definitely get some attention."


But those (Social Security, EBT) are promises, not debt obligations.  There is a difference.

Dr. No's picture

With the fed gov partially shut down, what is the burn rate? Are they still spending more than their tax income? If no, there should be no issue paying the debt interest while shut down.

If the shut down burn rate is more than revenue, then things are very sad.

moneybots's picture

"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"


Why would the government miss a payment on a UST?  The government takes in more tax revenue than treasury obligations.  

As Obama said, raising the debt ceiling does not raise the debt.  Neither does not raising the debt ceiling cause default.  Default is a choice.  The government can raise the debt ceiling and default if it so chooses.

lolmao500's picture

Why would the government miss a payment on a UST?

Because never waste a good crisis.

hardcleareye's picture

That is a very good question...  so I did a little research...  here is were the money goes as a percentage of what is spent in the year 2012...

(this is the source of the info below, seemed a neutral source at quick glance..http://www.cbpp.org/cms/?fa=view&id=1258)

-19 percent of the budget, or $689 billion, paid for defense and security-related international activities.

-22 percent of the budget, or $773 billion, paid for Social Security,

-21 percent of the budget in 2012, or $732 billion.Medicare, Medicaid, and the Children’s Health Insurance Program (CHIP)

-6 percent of the budget on interest payments claimed $220 billion,

And this is what I think the government has shut down....

-12 percent Safety net programs, or $411 billion

-7 percent Benefits for federal retirees and veterans: (maybe still funded ?)

-3 percent Transportation:

-2 percent Education

-1 percent Science and medical research:

-1 percent Non-security international

-5 percent All other

Roughly 30-40% of the total government expenditures more or less...

So the question remains is there enough cash flow, with the above expenses removed to pay the maturing debt to prevent a default?

Anyone have any thoughts on this?

Jim in MN's picture

Most of the debt is long term, and most long term debt is rolled over upon maturity.  So there would not be a whole lot coming due in any kind of near term time frame.

All of the 'consequences' have to do with expectations and dynamics--kind of like a market run or panic, do more folks sell or not roll over....etc.

But, considering the wet firecracker the bond vigilantes have become in the Fed Hegemony Era, even that might just be BS at this point.

0b1knob's picture

California has technically defaulted a couple of times.    Each time it pays for goods with notes that pay a moderate rate of interest but can't be cashed until the state says so.   

Some sharp operators bought up the notes at a big discount and made a killing.   Vendors were desperate for cash and had to sell them.   So I see the same happening is the US.  The top 1% makes big money while the 99% get screwed.   And don't forget that the government can FORCE vendors to take the notes.

N2OJoe's picture

Impact of going past the X date:


Benny boy adds another digit or two at the end of his QE. You're not suggesting that there could be negative consequences to such things, are you??? 

Steroid's picture

No bail-ins among the scenarios!

Why am I not surprised?

toadold's picture

The rating agencies  and foreign governments rating may diverge by quite a bit given both ideological and financial reasons for foreign powers to knock the US Dollar off of it Reserve Currency pedestal. 

involuntarilybirthed's picture

Never happen so we will never know.

Heroic Couplet's picture

Maybe the NSA is watching the offshore accounts. Republicans who voted with Bush for two unfunded wars and tax cuts for the wealthy can all write checks now to cover the debt.

buzzsaw99's picture

A technical Treasury default would be insanely bullish for everything except gold bitchez. :snark: (deep inside u know it's true)

Haager's picture

I've heard gold is already below 1300 again, does that mean a stampede in stocks?!

moonstears's picture

Turn 401ks to annuities paying $600 per annum, per $10K...now where have I heard that?


wisehiney's picture

I am trying to learn from the bastards. I do not want to let this crisis go to waste. I need to raise more funds to buy precious. Any of you smart ZH folks can tell me how this might affect Treasury ETF's, in particular TLT? 

venzen's picture

also thought of that, but figure it won't work: by the time the ETFs have significant value due to everything going belly-up, they will go off-line (circuit-breaker) or declare "indefinite delay in pay-out". Just admire the physical you have.

venzen's picture

it's weekend, i've had time to think: It's all a show and we choose to believe or invest emotion in the supposed "stakes". Wherever they take this thing (or this thing takes them) we're onboard by default. Yes, I'm concerned but there is fuck-all else you or I can do but become self-sufficient - in groups or man-vs-everything.