- The Washington Times - Tuesday, July 26, 2011

Global markets recently fixated on the budget fight in Washington, but have remained mostly calm, in part because many investors think the Treasury Department will be able to avoid default for at least a week or two beyond the Aug. 2 “drop dead” deadline touted by the White House.

The additional elbow room that Treasury has — though the White House insisted again Tuesday that it has no “wiggle room” — comes from a variety of sources, according to Wall Street analysts. For one, federal revenues came in stronger than expected in recent weeks, giving the Treasury an extra $14 billion in cash to spend on Social Security and other payments after Aug. 2, one analysis found.

Also, the Treasury can rejuggle its scheduled bond and bill auctions to buy additional time as it has during past debt-limit fights, and the Federal Reserve could come to the Treasury’s rescue, freeing up additional borrowing room and buying additional time through back-room maneuvers, the analysts say.

“There’s lots of discussion in the financial markets that Treasury has enough cash flow and the Fed can sell bonds to extend the deadline to mid-August,” said John Silvia, chief economist at Wells Fargo Securities.

The market’s lack of concern about an imminent default was on exhibit Tuesday, when investors showed a strong appetite for $35 billion in two-year notes sold by Treasury. The price for the securities actually rose rather than declined, as would be expected if investors were bracing for a default next week.

Analysts say the Treasury has enough cash on hand to get by for another week beyond Aug. 2, even without resorting to extraordinary maneuvers.

“We now believe that August 10 is a more realistic deadline for the Treasury to run out of cash,” based on stronger than expected receipts in July, said Anshul Pradhan, analyst at Barclays Capital.

According to Barclays’ analysis, the Treasury will have enough cash on hand to make $22 billion of Social Security payments on Aug. 3, as well as pay other bills until another round of Social Security payments comes due on Aug. 10. It estimates that Treasury is most likely to run out of cash on or around the second Social Security payment date, and would be in danger of defaulting on debt-interest payments coming due on Aug. 15 without an increase in borrowing authority.

Jefferies & Co. also expects that Treasury can avoid a “drop dead” cash crunch on Aug. 2 and muddle through until mid-August.

“The case for an Aug. 2 ‘drop dead’ date is not very compelling,” said Ward McCarthy, managing director at Jefferies. “After cranking through the numbers, we think that Aug. 15 will be a crisis date and that the ultimate ‘drop dead’ date is actually Aug. 18.”

Jefferies estimates that Treasury will be flush with $85 billion in cash on Aug. 2, and it could gain additional flexibility by reducing the size of some upcoming auctions of Treasury bills. With some juggling, Treasury would retain enough cash and tax receipts to have $50 billion on hand on Aug. 15. But it would likely be unable to settle a bond refunding on Aug. 15 without an increase in borrowing authority or some more heavy-duty maneuvering, he said.

From the perspective of bond investors, some of the Treasury’s maneuvering around bond auctions could get ugly and disruptive in coming days, and present some “nightmarish flashbacks” to past budget fights in the 1980s and 1990s that roiled the markets, Mr. McCarthy said.

“We simply cannot know with any degree of confidence if Secretary [Timothy F.] Geithner has any more options than he has acknowledged publicly,” Mr. McCarthy said. “Treasury Secretary [Robert] Rubin did when he outfoxed Newt Gingrich in 1995. Given the financial, economic and political importance of avoiding default, it would be unwise and surprising if Secretary Geithner has no other options.”

Other analysts expect the Treasury to take a different path, with the Fed coming to the rescue.

Mr. Geithner on Friday met with Fed Chairman Ben S. Bernanke as well as his own predecessor, Henry M. Paulson Jr., to discuss the debt ceiling and budget impasse, among other topics. The three financial heavyweights are the same troika that orchestrated the government’s extraordinary and controversial financial maneuvers during the September-October 2008 financial crisis.

The Fed is ordinarily heavily involved in the government’s day-to-day finances, and has increased its involvement exponentially in the last year. It now holds $1.6 trillion of Treasury securities, most of which it purchased since last fall under a controversial easing program that ended in June. All of those bonds are covered by the current $14.3 trillion debt limit.

Analysts speculate that the Fed could sell some of its bonds to public investors to raise cash, and through various maneuvers, transfer the cash to the Treasury — all without violating the Treasury’s current debt ceiling.

Since the Fed has so many Treasury securities in its portfolio, “this drill could keep the government going and all creditors paid for another 18 months,” said Peter Morici, business professor at the University of Maryland.

“In the end, the Federal Reserve and Treasury have potent options at their disposal to head off an immediate bond rout and keep the government going until Republicans and Democrats agree on a combination of tax and spending reforms to strengthen federal finances,” he said.

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