We’ve been putting the following simple question to some higher ups at the FCMs we work with this week:
What would happen to client Tbill holdings should Congress not pass the debt ceiling legislation and the FCM can’t get redeem Tbills held in client accounts ?
While this was at one time unthinkable and essentially not possible… the stalemate on the debt ceiling now makes it a non zero probability at this point.
For background, the US borrows money (billions and billions worth) every day in order to bring in cash to pay out monies it owes, like Federal employees paychecks, gas to put in our fighter jets, your Grandpa’s medicine through Medicare, and the interest on the mountain of debt the US owes. Most of this borrowing is done through T-Bills and longer term T-Bonds.
In a nod to fiscal responsibility, the U.S. has a self-imposed limit on how much debt the government can take on. That limit, historically, has been raised whenever we’ve gotten close to hitting it. Think about it like raising the limit on your credit card every time you get close to maxing out. Financially sound? Probably not, but when you’re a geopolitical powerhouse, no one asks questions.
Today, we are only a couple of weeks away from hitting our debt ceiling, and without a law raising it, the US may be unable to take on more debt to pay its bills (see here). Now, the one item we’re concerned with in the short term as it relates to managed futures accounts is the repayment of T-Bills.
T-Bills are zero coupon bonds which are bought at a discount and redeemed for face value upon maturity. IN the good old days, that would look like buying a $100,000 T-Bill for $97,500, and then in 3 months getting $100,000 back from the government (recently, with Tbills at just 0.10%, it looks more like pay $99,995 and get back $100,000).
Part of the benefit of futures accounts is that T-Bill holdings can be used to margin positions. So you can hold that $100K T-Bill in your account, and the FCM (via the exchanges) will treat $95,000 or so of it as cash in your account.
This is all fine and good when the world is normal, and there is zero risk of T-Bills not being repaid (which the FCMs translate into a 5% risk via the T-Bill only counting as 95% of its value for margins). But what happens if the T-Bill comes due and the US government doesn’t pay the FCM what they are owed for it? They aren’t likely to never pay what is owed, but they could delay it for a day, or a week or two while lawmakers scramble to find a solution.
If there is even the threat of a delay in getting the full value of the T-Bill from the US government, what will the FCMs do? Will they continue to let T-Bills be treated as 95% margin? Will they cut the value they will give Tbills for margin to 50% or less? Will they consider it worthless until there is a resolution?
These are all serious questions that nobody in the futures industry seems to be talking about in public, beyond the rhetoric that not raising the ceiling would be catastrophic. A worst case scenario could see FCMs treat T-Bills as worthless during any sort of payment delay, which could in turn likely put accounts holding them on margin calls for additional equity, which could lead to mass exiting of positions.
That could wreak havoc on a portfolio not looking to exit positions, and/or create some odd market movements based on mass selling which trigger additional trades from systematic programs. All in all, it doesn’t seem that it would be a great thing.
So, after that lengthy explanation…. We’re back to our question: What would happen to client Tbill holdings should Congress not pass the debt ceiling legislation and the FCM can’t get redeem Tbills held in client accounts ?
Here’s what we heard from FCM higher ups ‘off the record’
- I don’t see a default happening, they will get the ceiling raised. And even if it did happen they would not pay some other part of government before they didn’t pay off Tbills.
- The answers are only theoretical and speculative, but my best educated guess is that in practice the T Bills would be cashed out at the current going discount rate (essentially whatever someone else would pay for them). The regulators would most likely be forced to reduce the margin haircut or deem the instruments as not available for collateral.
- Good questions, we’re going to have a meeting on that next week.
How likely is it we’ll see anything happen? If you believe the bond market, very unlikely… People keep buying up US bonds with no fear of not getting paid (see here), and T-Bill rates remain essentially zero, telling us that people aren’t selling them en masse to guard against the possibility of not getting their principal back at maturity.
Stay tuned next week….