Raising the Debt Ceiling

Debt ceiling fears push financial institutions to sell Treasuries

Sabri Ben-Achour Oct 11, 2013
Raising the Debt Ceiling

Debt ceiling fears push financial institutions to sell Treasuries

Sabri Ben-Achour Oct 11, 2013

A number of big institutions, including Fidelity Investment and investment banking giant JPMorgan Chase, have ditched their short-term U.S. government debt. Specifically, they’ve sold off their debt that would mature in October and early November — right around the time the debt ceiling insanity could come to a head.

Hong Kong’s futures and options market is no longer considering U.S. Treasuries as credible, and says it will treat them as if they were below their face value.  

Basically, people are getting a little antsy about short-term U.S. government debt.

Why is this something to care about? 

Because “it signals the lighting of the fuse of a real potential debacle,” says Marc Spindel, chief investment officer at Potomac River Capital.

Remember when you went to the ATM the other day? Or when you paid that electric bill?  Or when you basically did anything ever with money?

Well you, my friend, are why banks need that short-term debt. 

With all of us out here doing things with our money — and taking it out of our bank accounts, banks have to keep up! We might think our cash is in the vault downtown, but really most of it is being invested — that’s how banks make money. So if the bank doesn’t have my money in its coffers, what does it do when I ask for it?

It borrows it. From another bank, for super-low interest.

This happens every day. It’s pretty normal.

Now guess what they use as collateral? Short-term U.S. government debt.

A T-Bill. You can think of it as a itty-bitty bond, with an interest rate of some tiny fraction of a percent. It’s usually pretty reliable (who doesn’t think the U.S. government would make good on a three-week loan?…), so they’re usually treated almost like cash.

This system of banks borrowing from one another lets me do my shopping, but it also lets my boss make payroll or you get a mortgage. It’s a huge, vital part of the global banking system.

“The market provides all sorts of liquidity and grease for much larger, much longer term transactions,” says Spindel.  

So what happens if the U.S. government really screws up and can’t pay back those short-term Treasuries? Well, then banks can’t use short-term U.S. Treasury debt. The grease in the financial engine starts to run out and, as Spindel says “it ripples throughout the entire credit system.”

First off, says Eric Parnell, founder of Gerring Wealth Management, interest rates would rise.

That’s because banks would have to work harder to borrow money. And, of course, they will pass those higher rates right on down to us, in the form of fees and other charges.

Second, banks might have to sell off other assets to get cash.

“It could be short-term corporate paper, longer term bonds, it could even be stocks or precious metals,” says Parnell.

And here’s the kicker. If all the banks sell off short term assets, then those assets fall in price.

Which means the banks’ books start to look real bad. Which means they won’t want to lend. Not to each other, and not to me and you.

Now, there is a silver lining to this story for now

Banks happen to have an enormous amount of cash on hand (around $3 trillion) because of the Federal Reserve’s policy of quantitative easing. So for the moment, the banks can afford to proactively get out of using short term debt for the period that ends around the debt ceiling deadline.

But that doesn’t mean an actual default will be any less nasty.

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