The Debt Ceiling, T-Bills, & Your Managed Futures Account

We’ve been putting the following simple question to some higher ups at the FCMs we work with this week:

What would happen to client Tbill holdings should Congress not pass the debt ceiling legislation and the FCM can’t get redeem Tbills held in client accounts ?

While this was at one time unthinkable and essentially not possible… the stalemate on the debt ceiling now makes it a non zero probability at this point.

For background, the US borrows money  (billions and billions worth) every day in order to bring in cash to pay out monies it owes, like Federal employees paychecks, gas to put in our fighter jets, your Grandpa’s medicine through Medicare, and the interest on the mountain of debt the US owes.  Most of this borrowing is done through T-Bills and longer term T-Bonds.

In a nod to fiscal responsibility, the U.S. has a self-imposed limit on how much debt the government can take on. That limit, historically, has been raised whenever we’ve gotten close to hitting it. Think about it like raising the limit on your credit card every time you get close to maxing out. Financially sound? Probably not, but when you’re a geopolitical powerhouse, no one asks questions.

Today, we are only a couple of weeks away from hitting our debt ceiling, and without a law raising it, the US may be unable to take on more debt to pay its bills (see here).  Now, the one item we’re concerned with in the short term as it relates to managed futures accounts is the repayment of T-Bills.

T-Bills are zero coupon bonds which are bought at a discount and redeemed for face value upon maturity. IN the good old days, that would look like buying a $100,000 T-Bill for $97,500, and then in 3 months getting $100,000 back from the government (recently, with Tbills at just 0.10%, it looks more like pay $99,995 and get back $100,000).

Part of the benefit of futures accounts is that T-Bill holdings can be used to margin positions. So you can hold that $100K T-Bill in your account, and the FCM (via the exchanges) will treat $95,000 or so of it as cash in your account.

This is all fine and good when the world is normal, and there is zero risk of T-Bills not being repaid (which the FCMs translate into a 5% risk via the T-Bill only counting as 95% of its value for margins). But what happens if the T-Bill comes due and the US government doesn’t pay the FCM what they are owed for it?  They aren’t likely to never pay what is owed, but they could delay it for a day, or a week or two while lawmakers scramble to find a solution.

If there is even the threat of a delay in getting the full value of the T-Bill from the US government, what will the FCMs do? Will they continue to let T-Bills be treated as 95% margin?  Will they cut the value they will give Tbills for margin to 50% or less? Will they consider it worthless until there is a resolution?

These are all serious questions that nobody in the futures industry seems to be talking about in public, beyond the rhetoric that not raising the ceiling would be catastrophic.  A worst case scenario could see FCMs treat T-Bills as worthless during any sort of payment delay, which could in turn likely put accounts holding them on margin calls for additional equity, which could lead to mass exiting of positions.

That could wreak havoc on a portfolio not looking to exit positions, and/or create some odd market movements based on mass selling which trigger additional trades from systematic programs. All in all, it doesn’t seem that it would be a great thing.

So, after that lengthy explanation…. We’re back to our question: What would happen to client Tbill holdings should Congress not pass the debt ceiling legislation and the FCM can’t get redeem Tbills held in client accounts ?

Here’s what we heard from FCM higher ups ‘off the record’

  1.       I don’t see a default happening, they will get the ceiling raised. And even if it did happen they would not pay some other part of government before they didn’t pay off Tbills.

 

  1.      The answers are only theoretical and speculative, but my best educated guess is that in practice the T Bills would be cashed out at the current going discount rate (essentially whatever someone else would pay for them).  The regulators would most likely be forced to reduce the margin haircut or deem the instruments as not available for collateral. 

 

  1.     Good questions, we’re going to have a meeting on that next week.

How likely is it we’ll see anything happen?  If you believe the bond market, very unlikely…  People keep buying up US bonds with no fear of not getting paid (see here), and T-Bill rates remain essentially zero, telling us that people aren’t selling them en masse to guard against the possibility of not getting their principal back at maturity.

Stay tuned next week….

Speak Your Mind

*

Interested in distributing or reprinting this content? Check out our reprint policy here.

DISCLAIMER

Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.

The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex, and is not intended as investment advice, or an offer or solicitation for the purchase or sale of any financial instrument. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts. Opinions expressed are that of the author.

*The mention of specific asset class performance (i.e. +3.2%, -4.6%) is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.), and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.

The mention of general asset class performance (i.e. managed futures did well, stocks were down, bonds were up) is based on Attain’s direct experience in those asset classes, estimates of performance of dozens of CTAs followed by Attain, and averaging of various indices designed to track said asset classes.

It should be noted that past market performance is not indicative of future market movement.No market data or other information is warranted by Attain Capital Management as to completeness or accuracy, express or implied, and is subject to change without notice.

Managed Futures Disclaimer:

Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.