ICI Concerned About Default Effect on Treasuries

October 14, 2013 (PLANSPONSOR.com) - Investment management firm members the Investment Company Institute (ICI) are “deeply concerned” about the potential of a federal government default.

Those with significant exposure to U.S. Treasuries and the markets affected by their pricing are especially concerned, according to a message delivered by ICI President and CEO Paul Schott Stevens in recent testimony to the U.S. Senate Committee on Banking, Housing and Urban Affairs. During his address, Stevens pointed to a number of harmful, domino-like effects that could result from the U.S. failing to make interest or maturity payments on Treasury securities.  

“U.S. Treasuries trade in the deepest, most liquid market in the world,” Stevens said. “Their interest rates set the benchmark for other debt issuers—and as the ‘risk-free rate of return,’ these rates factor into the pricing of a wide range of other assets, including stocks and real estate.”

During the talk, Stevens pointed to the fact that ICI members hold more than $1.7 trillion in securities issued by the Treasury and other U.S. government agencies, accounting for more than 10% of their total assets. But the risks to financial markets are not limited to those directly holding Treasuries and government debt products, because, as Stevens put it, “the health of the Treasury market underpins all financial markets.”

This means that the $15 trillion in assets ICI members manage in total on behalf of more than 90 million shareholders could also fall significantly in value should Congress and the President fail to reach agreement over extending the nation’s borrowing authority. That authority could reach its $16.7 trillion limit as early as October 17. 

A lesson that cannot be unlearned

“Once the treasury has exercised the option to delay payments, investors will learn a lesson that cannot and will not be unlearned—even after all missed or delayed payments have been made good,” Stevens said. “That lesson is simple: Treasury securities are no longer as good as cash—they carry a future risk of further missed payments.”

Such a risk will have to be priced into the interest rate investors demand, Stevens said.

What’s more worrying is that investors are already seeing the early signs of these effects as the October 17 deadline approaches. For instance, rates of the Treasury securities most at risk have already risen sharply, with yields on Treasuries maturing between October 17 and October 31 rising from around two basis points on September 24 to between 20 and 25 basis points on October 8.

Another example: The price of credit default swaps on six-month and one-year Treasuries—basically the premium for insurance against default on those securities—hovered between $11,000 and $12,000 per $10 million of coverage in mid-September. Now those premiums are over $50,000.

A full transcript of Stevens’ speech can be found here