As negotiations continue over the US government’s $31.4 trillion debt ceiling, Wall Street banks and asset managers are preparing for the potential consequences of a default. The financial industry prepared for such a crisis last in September 2021. However, this time, the deadline for reaching a compromise has put bankers in a bind.
The deadline could come as early as 1 June, and the government may not be able to pay all its debts. The CEO of Citigroup (NYSE:C) sees more concern in the debt ceiling debates than in the previous ones. The CEO of JPMorgan Chase & CO is holding weekly meetings on the consequences of default.
Since the world’s financial system is based on US Treasury bills, it is difficult to determine the consequences of default. However, it is clear that there will be enormous volatility in the stock, bond, and other markets when trading in Treasury bonds on the secondary market is significantly limited.
Wall Street leaders have warned that dysfunction in the Treasury obligations market will quickly spread to derivatives, mortgage credit, and commodity markets. This is because there will be a general lack of confidence in the reality of Treasury obligations used as collateral to secure deals and loans.
Banks, brokers, and trading platforms are preparing for disruptions in the Treasury obligations market, as well as broader volatility. Many are already planning for possible processing of payments for Treasury bonds and ensuring they have adequate levels of technology, personnel, and funds to handle large trading volumes.
Maintaining a high level of liquidity is crucial for bankers to withstand sudden changes in asset prices and prevent selling them at the wrong time. The Securities Industry and Financial Markets Association (SIFMA) has created an action plan. This plan outlines how market participants of Treasury operations communicate before and during the possibility of payment defaults on Treasury obligations.
For now, it is most likely that the Treasury will buy time to pay bondholders by announcing that it will extend the maturity of these securities before the payment. In the most destructive scenario, the Treasury does not pay the principal or coupon and does not extend the maturity.