Expanding the default: An overview

Lawmakers in the United States are currently debating how to raise the $31.4 trillion debt ceiling, a move that has increased concerns about the potential for a disaster and what will happen if the borrowing limit isn’t raised by the deadline. With major companies preparing for the potential scenario, it’s important to consider what could happen if the Treasury fails to pay its lenders.

While there is no certainty about how this situation will play out, investors and policy makers are actively updating their strategies to anticipate how it may unfold. Negotiators are currently appearing to move towards a resolution, but with time running out, there are concerns that the debt limit may not be lifted by the deadline.

The Treasury Department estimates that the government will reach the “X date” on June 1, meaning that it will run out of cash to pay all bills on time. There are still many questions surrounding what could happen in the market and how the government will react.

Although the Treasury is still selling bonds, it’s uncertain whether it will be able to fully repay its maturing debt, as opposed to just making interest payments. This is because once bonds are sold, the Treasury receives newly borrowed cash, but this doesn’t allow them to reduce the outstanding debt.

As the situation becomes more difficult, the Treasury may have to defer additional funding, as it did during the 2015 debt limit stalemate. If the debt ceiling is not raised, there is concern that the Treasury may not be able to make interest payments on other debt, which could lead to default.

To avoid default, the Treasury may choose to postpone the maturity date of the loan, notifying Fedwire by 7:30 a.m. that the payments are not yet ready. If this happens, it will take until 4:30 p.m. to make the payment and avoid default.

The potential for a default has sparked speculation about how the Treasury Department will prioritize payments to bondholders over other bills. If bondholders receive their payments and others don’t, rating agencies are likely to rule that the U.S. avoided default. However, if late payments are seen as default, it could lead to a downgrade of U.S. debt.

The possibility of a default is concerning for many, and economists, politicians, and central bankers warn that it could lead to a recession and a range of related problems. With the situation in uncharted waters, it’s difficult to predict what may happen or how it can be avoided.

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