WASHINGTON -- Just as the threat of a debt-deal collapse has put a wobble into the economy, so has the talk of a potential deal brought euphoria to the stock market.
Over the past week the cost for the federal government to borrow on a short-term basis has tripled, Treasury Secretary Jacob Lew told the Senate Finance Committee in an unusual early-morning hearing Thursday that began before financial markets had opened.
Later in the day, stock markets later surged on news of a possible short-term debt-ceiling deal, with the Dow Jones industrial average gaining a whopping 323.09 points. The ying-and-yang response served to remind how closely the markets are watching the debt debate, and how failure to reach a deal could drive down prices.
Notwithstanding Thursday’s rollicking Dow response — resulting in its best day since Jan. 2 — there’s plenty of evidence that fear of what might happen next week is already roiling financial markets. Investors are demanding a premium to buy Treasury bills that mature in coming weeks.
They’re demanding a higher return on a short-term Treasury bill than what they demand for buying a Treasury bond that matures over a period of two years. That’s highly unusual, and the rate the government had to pay investors Tuesday on short-term bills that mature on Oct. 31 had reached its highest level since October 2008, the height of the brutal U.S. financial crisis.
The government hit the $16.67 trillion debt ceiling in May and has been moving money between accounts to ensure the bills are paid. Those measures run out around Oct. 17, and Lew told lawmakers they’re playing with fire if they don’t act before next week.
“I very much fear that a miscalculation ... could lead to an unintended but very severe consequence,” Lew said, noting that he has seen swings in daily incoming revenue and that the government could unintentionally default on some of its obligations before the Oct. 17 date, or after it.
Sen. Pat Toomey, R-Penn., asked Lew to publicly guarantee bondholders that the government won’t default on Treasury bonds. “Senator, all the options are bad,” said Lew.
If Congress doesn’t act before Oct. 17, he warned, “we’re going to be ... in uncharted territory.”
Lew suggested the closer the nation gets to the deadline the more risk of market panic that erases wealth and harms the economy. It was a warning echoed by Sen. Maria Cantwell, D-Wash., who noted a 20 percent drop in 2011 during the last protracted fight over the debt ceiling.
“By Friday or Monday you could see ... as much as a 25 percent drop in the stock market,” she said, citing discussions she had with market participants. “We don’t have to go to default. Just talk of default is causing the uncertainty we’re trying to avoid.”
There also are worries that a U.S. crisis could go global. At the start of International Monetary Fund meetings in Washington on Thursday, Managing Director Christine Lagarde warned of “spillover effects” should Democrats and Republicans push the United States into a default on some of its obligations.
Should the Oct. 17 deadline pass, there would be about $30 billion left on hand for the Treasury Department to pay the more than 80 million transactions it conducts on a monthly basis. Lew could expect to see $10 billion-$15 billion in revenue flowing into government coffers every day, but it would be enough to cover about 68 cents of every dollar owed to bond holders, Social Security recipients, military families, and so on.
The Treasury could try to prioritize who gets paid, but Lew frowned on that prospect.
“This system was not designed to be turned off selectively,” he said.
Lew repeatedly warned that it’s not just a matter of paying interest to bondholders to prevent a default on U.S. government bonds, but rather the hundreds of millions of dollars of bonds that roll over in coming weeks. These bonds are used as collateral in all sorts of financial transactions and if financial markets decide they won’t trade then until the government is funded it could cause financial markets to seize up.
The $2.6 trillion money market. a source of important overnight funds for financial companies, is already affected by the threat of a debt deal. Fidelity Investments, the nation’s largest money-market fund, confirmed Wednesday that it has been quietly selling off all its Treasury bills that mature between mid-October and early November. JP Morgan Investment Management said late Thursday it too has been doing the same.