Wall Street

Wall Street gets ready to trade defaulted US debt

A trader works on the floor of the New York Stock Exchange.
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While most on Wall Street continue to believe it very unlikely the United States will default on its debt later this month, banks and securities firms are already gearing up for how to handle any U.S. Treasuries tainted by missed payments.

The Securities Industry and Financial Markets Association, a trade group that represents hundreds of securities firms, banks and asset managers, has drawn up plans so that trading platforms can still process deals involving defaulted U.S. Treasuries, SIFMA Managing Director Rob Toomey said on Friday.

Political dysfunction in Washington has raised the possibility of the once unthinkable: a default that could potentially trigger financial and economic mayhem.

Washington could start missing payments on its debt if Congress and the White House fail to reach a deal soon to raise the nation's $16.7 trillion cap on government borrowing.

SIFMA is counting on an announcement by the Treasury Department the day before it misses payment on a bill, note or bond. That would allow the financial world to calibrate systems to recognize instruments in default.

"Protocols are being put into place," Toomey said in a conference call with reporters.

Banks have been working intensely on their plans to deal with a potential default.

(Watch: Are default warnings just political provocation?)

"We're so focused on the plumbing on this, and have been for awhile," a source at a major bank said of the contingency planning underway. "We're dealing with the key people in IT, financing, and risk management to make sure it's all working. But the environment will be tricky."

Will the government default?
Will the government default?

Toomey said SIFMA's working presumption was that the Treasury, the night before it believed it would miss a payment, would announce that it would pay creditors one day late.

A missed payment would constitute a default. But if the Treasury fails to communicate its plans, the world's trading systems would act on the assumption that the security was paid.

In that case, the security would disappear from traders' systems and would no longer be able to be bought, sold or used as collateral in other deals, Toomey said.

However, were default to occur, the world would be a very different place.


Borrowing costs could surge for businesses and consumers and the stock market could plunge. The Treasury warned on Thursday that a default could trigger a financial crisis and the worst recession since the Great Depression.

SIFMA will be on high alert for a default beginning on October 16, the day before the Treasury says it might be forced to stop adding to the national debt.

(Read more: Obama expected Congress to raise debt ceiling)

Wall Street not listening to default warnings
Wall Street not listening to default warnings

The next day, the Treasury must make principal and interest payments. Debt payments are also due on October 24 and October 31. The Congressional Budget Office has forecast that the nation would not start defaulting on its obligations, which include everything from debts to Social Security checks, until October 22.

If the government knew it was going to miss payments on any of its debts, SIFMA thinks dealers would have to know about it well before 8 p.m. eastern time the previous night in order to have time to adjust their systems. Trading of Treasuries gets going in Tokyo around that time.

SIFMA thinks if the Treasury cannot make investors whole the day after payments were due, it would continue issuing one-day extensions to maturity dates.

"So long as timely notification is given, systems can be adjusted to take that (Treasury) security," Toomey said.

No amount of planning, however, will be able to answer the most important question for the market in the event of a U.S. default: What's the price?

"The market will have to find a price for defaulted securities," the bank source said.