Major banks and financial regulators in the United States are preparing for the potential default on U.S. debt amid a lack of progress in talks between President Joe Biden and House Republicans over raising the debt ceiling. The failure to increase the debt limit means the U.S. cannot borrow more money to cover its bills, which have already been approved by Congress. Economists anticipate financial chaos, a rise in borrowing costs, and a severe global economic recession if a default occurs.
Bank of America CEO Brian Moynihan emphasized the importance of preparing for such an event, stating that hope is not a strategy. JPMorgan Chase CEO Jamie Dimon has been convening a weekly war room to discuss the bank’s response to a potential default. The discussions encompass a wide range of economic and financial effects, including contracts, collateral, clearing houses, and clients both domestically and internationally.
Banks can prepare for default by reducing exposure to Treasury securities, which could be considered in default once the U.S. exhausts its ability to pay its bills. The value of Treasurys is likely to plummet in the event of a default, weakening bank balance sheets. Buying credit default swaps, which offset credit risk, is another strategy banks can use to hedge their exposure. Data suggests that banks are already engaging in this practice as the cost to protect U.S. government debt from default is higher than that of countries with lower credit ratings that have defaulted multiple times.
Financial industry groups and regulators are also planning for a potential default to ensure the continued functioning of the financial system. The Securities Industry and Financial Markets Association has updated its playbook to govern communication among participants in the Treasurys market during a default. The Federal Reserve, responsible for financial stability, has been considering the possibility of a U.S. default for over a decade. In the event of a default, the Fed could act as a buyer of last resort for Treasurys, lower lending rates, and provide the necessary funding to prevent financial contagion and collapse.
Ultimately, it is hoped that Congress will raise the debt ceiling, as it has done in previous instances. Banks are speaking out about the serious damage that would result from not raising the ceiling, adding pressure on political leaders to reach a deal. The debates over raising the debt ceiling have become too frequent, and the risk of a default underscores the need for a resolution to ensure financial stability and avoid catastrophic consequences.
