The United States is inching closer to disaster as lawmakers continue to debate what it will take to raise the nation’s $31.4 trillion debt limit.
That raised questions about what would happen if the United States did not raise its debt ceiling in time to avoid default, along with how key players are preparing for that scenario and what would actually happen if the Department of finance fails to repay its lenders.
Such a situation would be unprecedented, so it is difficult to say for sure how it will play out. But it’s not the first time investors and policymakers have had to consider what if, and they’ve been busy updating their plans for how they think things might play out this time around.
While negotiators appear to be moving toward an agreement, time is running out. There is no certainty that the debt limit will be lifted before June 5, when the Treasury now estimates the government will run out of money to pay all its bills on time, a point known as the “X date”.
“We have to be in the closing hours because of the schedule,” said Congressman Patrick McHenry, Republican of North Carolina, who participated in the negotiations. “I don’t know if it’s in the next day or two or three, but it should come together.”
Big questions remain, including what might happen in the markets, how the government plans for bankruptcy and what will happen if the United States runs out of money. Here’s how things could play out.
Before the X date
Financial markets have become more jittery as the United States approaches Date X. While a flurry of expectations for increased earnings from artificial intelligence helped the stock market recover, fears about the debt limit persist. On Friday, the S&P 500 rose 1.3 percent, a modest gain of 0.3 percent for the week.
This week, Fitch Ratings said it was putting the nation’s top AAA credit rating on review for a possible downgrade. DBRS Morningstar, another ratings firm, did the same on Thursday.
For now, the Treasury is still selling debt and making payments to its creditors.
This helped alleviate some concerns that the Treasury would not be able to repay the outstanding debt in full, as opposed to simply paying interest. That’s because the government has a regular schedule of new Treasury auctions, where it sells bonds to raise fresh money. The trades are planned in such a way that the treasury receives its new borrowed money at the same time as paying off its old debts.
That allows the Treasury Department to avoid adding much to its $31.4 trillion in outstanding debt, something it can’t do now because it took emergency measures after approaching the limit on Jan. 19. long. And it should give the Treasury the cash it needs to avoid any disruptions in payments, at least for now.
This week, for example, the government sold two-year, five-year and seven-year bonds. However, that debt is not “settled” — meaning the money is delivered to the Treasury and the securities are delivered to the buyers at the auction — until May 31, which coincides with the maturity of three other securities.
More precisely, the new cash being borrowed is slightly more than the amount owed, with the difficult balancing act of all the money coming in and going out pointing to the Treasury’s challenge in the coming days and weeks.
When all the payments are added up, the government ends up with just over $20 billion in extra cash, according to TD Securities.
Some of that could go toward $12 billion in interest payments that the Treasury is also due that day. But as time goes on and the debt limit becomes harder to avoid, the Treasury may have to delay any further fundraising, as it did during the 2015 debt limit impasse.
After the X date, before default
The US Treasury pays its debts through a federal payment system called Fedwire. The big banks hold Fedwire accounts, and the Treasury Department credits those accounts with payments on its debt. These banks then move the payments through the market pipeline and through clearing houses such as the Fixed Income Clearing Corporation, with the money eventually landing in the accounts of domestic pension holders at foreign central banks.
The Treasury may try to stave off default by extending the maturity of the debt that is about to mature. Because of the way Fedwire is set up, in the unlikely event that the Treasury chooses to draw down its debt maturity, it would have to do so before 10:00 p.m. at the latest on the day before the debt matures, according to the intended plans to contingency action by the trade group Securities Industry and Financial Markets Association, or SIFMA. The group expects that if this is done, the maturity will be extended by only one day.
Investors are more nervous that if the government runs out of cash it could miss an interest payment on its other debt. The first big test of that will come on June 15, when interest payments on bonds and notes with original maturities of more than a year come due.
Moody’s, the ratings agency, said it was most concerned about June 15 as the possible day the government could default. However, it could be helped by the corporate taxes that will hit its coffers next month.
The Treasury cannot delay an interest payment without being in arrears, according to SIFMA, but it can notify Fedwire by 7:30 a.m. that the payment will not be ready for the morning. It will then have until 16:30 to make the payment and avoid default.
If there are concerns about a default, SIFMA — along with representatives from Fedwire, the banks and other industry players — has plans to convene up to two calls the day before a default could occur and three additional calls on the day payment is due. owes, with each call after such a script to update, assess and plan what may develop.
“In terms of settlement, infrastructure and plumbing, I think we have a good idea of what could happen,” said Rob Toomey, head of capital markets at SIFMA. “This is the best we can do. As for the long-term effects, we don’t know. What we’re trying to do is minimize disruption in what will be a disruptive situation.
Default and then
One big question is how the United States will determine whether it has actually defaulted on its debt.
There are two main ways in which the Treasury can default: by failing to pay interest on its debt or by defaulting on its loans when the full amount becomes due.
This has sparked speculation that the Treasury may prioritize payments to bondholders over other accounts. If bondholders are paid but others are not, rating agencies will likely decide that the United States has avoided bankruptcy.
But Treasury Secretary Janet L. Yellen suggested that any missed payment would essentially amount to a default.
Shai Akabas, director of economic policy at the Bipartisan Policy Center, said an early warning sign that bankruptcy is coming could come in the form of a failed Treasury bid. The Treasury will also keep a close eye on its spending and incoming tax revenue to predict when a missed payment might occur.
At that point, Mr. Akabas said, Ms. Yellen is likely to issue a warning with the exact time she predicts the United States will not be able to make all of its payments on time and announce the contingency plans she intends to follow.
For investors, they will also receive updates through industry groups tracking key deadlines for the Treasury Department to notify Fedwire that it will not make a scheduled payment.
Default will then cause a cascade of potential problems.
Ratings firms said a missed payment would merit a downgrade of U.S. debt — and Moody’s said it would not restore its Aaa rating until the debt ceiling was no longer subject to political conflict.
International leaders question whether the world should continue to tolerate recurring debt ceiling crises given the integral role the United States plays in the global economy. Central bankers, policymakers and economists warned that the bankruptcy would most likely send America into recession, leading to ripple effects from corporate bankruptcies to rising unemployment.
But these are only some of the risks known to lurk.
“These are all uncharted waters,” Mr Akabas said. “There is no playbook to use.”
Luke Broadwater contributed reporting.