Does Treasury See Market Crisis Ahead?

Minutes of an obscure Treasury advisory committee discuss plans to raise cash in the short term, but also note a severe cash crunch two years hence

Treasury building. Treasury building.

Minutes of an obscure Treasury Department advisory committee has some market participants wondering about potential market risks for which the government is seeking to raise cash.

The Treasury Borrowing Advisory Committee, a group consisting of investment and banking industry representatives who meet quarterly with high-ranking Treasury officials, earlier this week discussed the possibility of raising cash to forestall against potential risks.

Said a deputy assistant secretary paraphrased in minutes released Wednesday: “Several events had made it clear that market access and settlement risks could also potentially impair Treasury’s ability to fund government expenditures for several business days.”

One official speaking a news conference cited 9/11 and superstorm Sandy as the sort of events that could disrupt the bond trading needed to fund government operations.

The official also announced a test — for the first time since 2002 — in the coming quarter to buy back debt to make sure that government  IT systems are adequate should the need arise.

Some on Wall Street and beyond are questioning what the Treasury official insists is a merely a prudent measure.

As Nomura Holdings strategist Stanley Sun, quoted by Bloomberg, put it:

“Treasury is likely thinking that they want to be ready if the day comes that they need to use them so they should do some testing. But people in the market tend to think that when the Treasury or Fed tests something, it ends up happening, as was the case with the Fed’s reverse-repo program.”

The Zero Hedge blog sounded a greater alarm, asking “do they know something we don’t” and “just what upcoming event” prompts Treasury worries about “losing market access?”

David Santschi of TrimTabs Investment Research, in a phone interview with ThinkAdvisor, professed ignorance of “Treasury plumbing” and therefore withheld comment on Treasury’s cash-raising operations. However, Santschi was far less sanguine and far more vocal about another aspect of the TBAC minutes.

Earlier in the meeting held Tuesday in Washington, after an upbeat discussion of current Treasury finances, including a strong pace of tax receipts through June, decelerating budget deficits and a projection that Treasury would end up “overfinanced by $24 billion through the end of September,” a Treasury official raised concern about future financing.

Specifically, while Treasury is funded “appropriately” for the current and next fiscal years, the official noted the government’s borrowing needs would “be impacted by the Federal Reserve’s decision to redeem or reinvest maturing securities” in its portfolio of Treasury debt.

If the Fed redeems, the government would be underfunded by $775 billion from 2016 to 2018; if it reinvests the portfolio, underfinancing would amount to $100 billion at that time.

“This [the Fed’s unwinding of its Treasury debt] should be of grave concern to everybody,” Santschi warned, adding that “nobody knows how this policy is reversed and if they can even do so without causing major problems.”

The TrimTabs exec says the Treasury bond market has “Ponzi-like characteristics,” in that it relies on a buyer [the Fed] which is willing to buy debt at low yields that would be less attractive to private investors.

As a result, today’s low bond yields are “artificially low,” he says, and the government can keep borrowing at extraordinarily low rates even though the size of its debt is almost continuously increasing.

(Technically, Santschi, clarifies, the government generates enough tax revenue each month to pay the interest on its debt without selling new debt, although if it didn’t sell new debt, it would  have to cut back in other areas.)

“So, if I were the government, I’d be worried about access to cash,” he says.

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