About That Debt Ceiling Crisis...

With just one month left until the "X Date", better known as the first day on which Treasury has exhausted its borrowing authority and no longer has sufficient funds to pay all of its bills in full and on time, and also known as the date the US is technically in default on its debt obligations and would be forced to prioritize debt payments according to that infamous 2011 Fed transcript...

... traders were hoping if not for resolution, then at least a modest dose of optimism in the days ahead: after all with Houston reeling, the last thing the US needs is a full government shutdown in addition to the emergency crisis in Texas.

Alas, that"s precisely the opposite of what is taking place in the market, where the September/October Bill Spread has again blown out to record levels...

... making the October T-Bill "hump" the worst it has been yet.

One potential catalyst for the spike in odds of an adverse outcome is that earlier today, the chairman of the conservative House Freedom Caucus said aid for victims of Hurricane Harvey should not be part of a vehicle to raise the debt ceiling.

Quoted by The Hill, Rep. Mark Meadows (R-N.C.), a Trump ally who leads the conservative caucus, said disaster aid should pass on its own, apart from separate measures the government must pick up in September to raise the nation"s borrowing limit and fund the government.

“The Harvey relief would pass on its own, and to use that as a vehicle to get people to vote for a debt ceiling is not appropriate,” he said an interview with The Washington Post, signaling agreement with Trump on the approach. It would “send the wrong message” to add $15 to $20 billion of spending while increasing the debt ceiling, Meadows added.

Ironically, it was precisely the Harvey disaster that prompted Goldman yesterday to lower its odds of a debt ceiling crisis from 50% to 33%, on the assumption that it would make conseratives more agreeable to a compromise, when in fact precisely the opposite appears to have happened, and the new dynamic is now playing out in the market where the odds of a government shutdown have never been greater.

So what does it mean for the US if the T-Bill market is correct and a debt ceiling deal is not reached in time over the next 30 or so days? For an unpleasant perspective on what may happen next, here is Deutsche Bank"s preview of what a debt ceiling crisis would look like:

Guide to a Debt Ceiling Crisis

If Congress doesn’t act in time and the above fallbacks are deemed untenable, the Treasuries with affected principal or coupon payments would likely be handled in two ways, according to scenarios considered by SIFMA. The first option would extend maturity and coupon payments, where payment decisions are explicitly announced by Treasury one day at a time, and both coupon and principal payments are ultimately made in full once the debt limit is raised. These securities would be able to be transferred normally, and a market for them would develop. While the security is not “defaulted” as its maturity date has been extended in systems, the extension would likely constitute a change in terms that triggers CDS.

The other outcome would a failure pay , where Treasury does not set a date for future payment, and there is no pre-announcement (or it comes last minute). A failure to pay would mean the affected securities drop off the Fed system and cannot be transferred normally. A market would eventually develop, but once there is a failure to pay and the securities are not extended in systems, they cannot be “unmatured” and maturity extended.

Regardless of whether it is a payment extension or a failure to pay, the longer Treasury remains in default, the worse the situation for financial markets. Market reactions and market functioning might be comparatively stable at first, but the concern is of widespread panic and systemic market disruptions.

As for immediate ramifications, noted that CDS would likely triggered either default scenario , as sovereign CDS is triggered by either a failure to pay, repudiation/moratorium, or a restructuring. A failure to pay occurs when a sovereign doesn’t pay principal or interest when due, with a 3 day grace period applying to that due date in the case of the US. In our view, a CDS trigger would apply to all debt obligations backed by the full faith and credit of the US government (including GNMA, FHA securities, etc.). A CDS event is unlikely to have much direct market impact, however, as net CDS exposure is a modest $1bn as of the end of July, down from about $4bn in 2013 and its peak near $6bn in 2011. As long there is no one particular bank that is overly short protection, we do not expect any knock-on CDS event. 5y CDS is currently suggesting no real concern, sitting at the bottom end of its 19-24bp ytd range. While the supply of deliverable securities is more than adequate to satisfy the outstanding contracts, demand deliverable bonds may cause distortions . The 2.25% Aug 2046 bonds are currently the cheapest-to-deliver into the CDS, and would likely trade upward in price towards recovery value.

Among Treasury market investors, money market funds are a key group possible propagation risk . Even after money fund reform, government funds continue to be quoted at a stable $1 NAV, leaving them vulnerable to perceptions around “breaking the buck,” and therefore large scale investor redemptions in an extreme scenario. Treasuries accounted for $678bn of money funds $2.7tn AUM as of the end of July, while Treasury repo makes up another $595bn (with about $150bn of that made up by RRP’s with the Fed). Money funds’ Treasury holdings tend to be concentrated in securities maturing in the first month – more than 40% of their Treasuries held at the end of July matured in August. This suggests that the bias will be for money funds to accumulate more securities maturing around the debt ceiling, though they may be cautious around specific issues. However, it’s worth noting that they then owned over $40bn combined in the October 5 bills, October 12 bills, and October 15 coupon maturities – more than 20% of the amount  outstanding. Of the $1.3tn of Treasuries (bills and coupons) that mature between October and mid-January, money funds own about 19% - potentially an important factor in the event that a default drags out. Also note that maturing notes and bill holdings are concentrated in a relatively few fund families.

Potential outflows from money funds has implications repo market . Possible forced selling of Treasuries, money funds would likely cut back on their provision of financing to banks through repo. While reforms have reduced banks’ reliance on short term funding and put them in a place to better withstand a significant reduction in availability of things like repo funding, a sharp contraction in overall repo financing would likely have ramifications for market functioning and liquidity.

In terms of market plumbing, given the reliance Treasuries managing credit risk derivatives , a default event could spread quickly to derivatives market via a sudden drop in the valuation of UST collateral. This loss in value would trigger calls for additional collateral, and given the widespread use of UST’s, it is possible that a number of market participants fail to post sufficient collateral; this would constitute a default in a centrally cleared trade. The requirement that the surviving counterparty replace the risk of that trade could subsequently result in a major revaluation of all related trades, triggering new collateral calls, and potentially create a vicious cycle.

How might the Fed might react to a major disruption?

The question is complicated by a possible reinvestment decision in the September meeting, but extracting that for the time being, there is nothing immediately apparent in the Federal Reserve Act that would preclude the Fed from purchasing defaulted Treasury securities. This would likely not be a proactive step, as the Fed would not want to be seen “bailing out” the Treasury, but given the extremity of a default situation, the Fed would be governed by its financial stability mandate.

The Fed could intervene by removing defaulted securities from the market and sell or repo non-defaulted issues to provide the market with good collateral. Additional emergency facilities similar to those seen in 2008 are another option wherein the Fed could support money funds by accepting their assets and providing liquidity. To the extent that liquidity concerns became extreme the Fed could obviously move to add further monetary accommodation especially if it perceived knock on effects to the growth and inflation outlook.

3-Month Treasury-Bill Auction Prices At Highest Yield Since Lehman On Debt-Ceiling Concerns

It seems Morgan Stanley was right when they said "the debt ceiling worries us most," as today"s 3-month T-Bill auction surprised the market with its highest yield since the fall of 2008, as investors continue to price concerns that the U.S. government will exhaust its borrowing authority around mid-October.

As SMRA details:

The 3-month bill auction stopped at 1.180%, with a 67.70% allocation at the high yield. The 3-month auction bid/cover ratio was 2.87. The average 3-month bid/cover over the past three months was 3.13. The WI was last trading at 1.165% at 11:30 AM. Indirect bidders took down 38.44% of the 3-month bill auction and Direct bidders took down 5.61%.

The 6-month bill auction stopped at 1.130%, with a 34.87% allocation at the high yield. The 6-month auction bid/cover ratio was 2.91. The average 6-month bid/cover over the past three months was 3.30. The WI was last trading at 1.115% at 11:30AM. Indirect bidders took down 40.66% of the 6-month bill auction and Direct bidders took down 2.69%.

So the 3-month bill is priced 5bps cheaper than the 6-month bill and both dramatically tailed.

As BofA noted, the early pricing of debt limit concerns may reflect overhang from this week’s bill auctions and the "greater influence" of government money market funds following October"s reforms.

But, Morgan Stanley recently warned that the biggest immediate risk to the market is:

The debt ceiling worries us most, given that action may need to be taken within as little as seven weeks. But on the other issues, we’re more relaxed. The Senate’s Healthcare bill had an approval rating of 17%, so we doubt its failure would be a hit to consumer confidence. The Special Counsel’s investigation, whatever the outcome, will likely take considerable time. Our economic baseline was already cautious with regard to fiscal stimulus, a long-held view of our policy team. And while tax cuts could boost the market temporarily, they could also lead to a more hawkish Fed, a classic ‘be careful what you wish for.’

As the 3mo6mo yield curve inverts dramatically...

Inflecting right around the mid-October date of today"s auction...

What Form Will The Great Confiscation Take - And How Can We Prepare?

Submitted by John Rubino via DollarCollapse.com,

For what seems like decades, people have been warning that the next time some over-leveraged corner of the financial system implodes, bank and brokerage accounts will be either confiscated by desperate governments or lost during the resulting chaos.

Here, from 2012, is a representative warning from gold mining eminence grise Jim Sinclair:

My Dear Extended Family,

In bankruptcy of your bank, broker or fund, you can find your assets in the majority of cases are backing the liabilities of the entity in front of yourselves. This is why you must act to protect yourself.

No one in this financial world is going to do it for you, and few will have the courage to recommend you escape Street Name. You can wake up one day and find out that your investments are gone.

The insurance programs will function as long as the incidents of bankruptcy are isolated events.

In a systemic collapse the insurance funds are not capitalized to meet the potential obligations. The guarantor you are relying on will have to be bailed out.

For securities there are only three ways to hold them:

1. Street name.
2. Direct registration.
3. Certificate form.

Anyone advising you to stay with the Street Name option is a babbling idiot not interested at all in your welfare.

In street name the inferred ownership is the broker or bank, not you. In Direct Registrationand Certificate form, the distinct ownership is you.

In 99.9% of the cases of retirement accounts the answer is you are in Street Name.

How are your securities held? Do you even know? I dare you to ask!

Do you know what your broker’s capital ratio is? Find out as that number is the order of magnitude at which your broker is gambling on with primarily your money. I dare you to ask.

This time around those investors that are too lazy to consider protecting themselves will be demolished.

How would you like your gold shares at $3500 gold, outperforming gold, and one morning you wake up to having nothing anymore? You now are behind the back burner in a bankruptcy situation with any fiduciary.

The system and their minions will do everything to keep you trapped in Street Name. Articles will be published trying to put you back to sleep on this issue.

Wake up, please.

The fact that this mass confiscation hasn’t yet happened doesn’t mean it won’t, says Jim Rickards, whose previous bestsellers Currency Wars and The Death of Money were already pretty apocalyptic. He believes that a coordinated closure/restructuring/confiscation of the banking/brokerage industry is imminent. Here’s an excerpt from a recent column:

In that interim period between the crisis and the time the IMF can react, central banks will be paralyzed. They’re likely going to lock down the system.

When I say lock down, they’ll start with money market funds. I can’t think of a greater misnomer than the money market funds. People think that money market funds are money. They’re not money; they’re mutual funds regulated by the SEC. People think they can just call up their broker, sell to the money market fund and the money’s in my bank the next day.

That will not be true in this crisis because everyone will be doing the same thing. That is what happened in 2008 when Ben Bernanke and Hank Paulson went to the White House and said to the President that the system’s melting down and he must act.

That was such a shock then, that when it happens again they’re not going to give you your money. They’re going to lock it down. The problem is that when it is spreading you can’t just lock down part of the system.

If you lock down money market funds, people are just going to take their money out of the banks. Then you’re going to have to close the banks. Then people are going to sell their stocks, then you’re going to have to close the stock market. Every time you shut one path to liquidity, people are going to turn to another path.

It happened in part in 1914, 1931, 1933 and to gold in 1971. There’s no precedent for a total freeze but we’re getting closer to that point.

The question is, how do you protect yourself against that? There’s only so much you can do.

I don’t recommend running down and pulling all your money out of the bank. I would not have more than the insured amount, which in the U.S. is $250,000. You can spread it between your selected banks so that each is backed and insured up to the limit.

Rickard’s solution is right out of the stacker playbook:

In the world described, the dollar price of gold will approach the $10,000-level if not much higher. But when all of this begins to play out, you’re not going to be able to get gold.

Because of this, gold and silver need to be in physical form, in safe storage, and a non-bank. Putting it in a safety deposit box in a bank is troublesome because by the time you want it the most, that will be when the banks are going to be closed.

Charles Hugh Smith offers some other possible responses:

So what’s difficult to expropriate? It’s impossible to expropriate one’s skills, experience and social capital. These are intangible forms of capital and so they cannot be confiscated like gold, currency, land, etc.

Land and homes are difficult to expropriate for two reasons: private property is the backbone of capitalism and democracy, and the state confiscating private property would very likely spark a political insurrection that would diminish or threaten the power and wealth of the privileged Elites.

Secondly, it’s very costly for the state to maintain the productive output of real property it has confiscated. Guards must be posted, sabotage repaired, and the immense difficulties of coercing a rebellious populace to continue working what they once owned for the benefit of the state and its privileged Elites must be solved and paid for.

The state can expropriate farms, orchards and workshops for back taxes (or some similar extra-legal methodology), but how do you force people to work these properties productively?

As a general rule, whatever the super-wealthy own will be protected from expropriation. Private real property is the foundation of the Elites’ wealth, and while the land of debt-serfs may well be confiscated for back taxes (the wealthy will buy exemptions from rising taxes), those who own land and buildings free and clear constitute a political force to be reckoned with.

The state will also have difficulty confiscating assets that are outside its reach.This explains the popularity of owning assets in other nations, and the debate over cryptocurrencies: will states be able to confiscate all cryptocurrencies at will, or is that technically unfeasible?

The main takeaway is this: your skills, knowledge and social capital will emerge unscathed on the other side of the re-set wormhole. Land and real property you own free and clear (no debt) is likely to remain in your possession, as long as you can pay soaring taxes/junk fees during the crisis phase. Your financial assets held in centrally controlled institutions will not make it through unscathed; they are simply too easy for central authorities to expropriate.

It’s easy, as the world’s zombie economies just keep shuffling along, to start assuming that the current system will endure forever. That would be wrong, and almost certainly the above warnings will someday seem prescient. All the more reason to forget about timing, and keep buying real assets.