What Happens to Treasury Bills If the US Defaults?

A Treasury Bill (T-bill) is a short-term debt obligation issued by the U.S. Department of the Treasury. Considered secure, they are backed by the full faith and credit of the U.S. government, assuring repayment. T-bills are sold at a discount and mature at face value; the difference is the interest earned. Maturities range from days to 52 weeks, playing a significant role in government short-term funding.

Defining a US Default Scenario

A U.S. government default involves failing to meet financial obligations, particularly on debt instruments like Treasury Bills. This occurs if the government cannot pay principal or interest on time. The primary mechanism for default is reaching the statutory debt ceiling, which limits federal borrowing for operations and existing commitments.

When the debt ceiling is reached without an increase, the Treasury Department must resort to “extraordinary measures” to manage cash flow and continue paying obligations. These measures are temporary, and if exhausted, the government would lack legal authority to borrow, potentially leading to default. A distinction exists between a technical default (a temporary delay in payments due to administrative issues or hitting the debt ceiling) and an outright repudiation (a deliberate refusal to pay, which has never occurred in U.S. history regarding Treasury securities).

Treasury Bills are part of the national debt, representing money borrowed by the government to fund its expenses. If the government cannot borrow new funds or generate sufficient revenue, it may be unable to repay maturing T-bills or their interest.

A default means the government would lack resources to pay principal or interest on its securities when due. This inability could force the government to prioritize payments. Even if debt payments were prioritized, credit rating agencies and investors might view delayed payments to other creditors as a default, damaging U.S. creditworthiness. Such an event would transform the world’s safest investments into instruments with impaired repayment certainty.

Immediate Consequences for Treasury Bills

A U.S. government default would have immediate financial consequences for Treasury Bill holders. The primary concern is delayed or missed payments. T-bills are sold at a discount and mature at face value, with the difference constituting the investor’s return. A default would mean the government might fail to pay the full face value at maturity, or delay payment.

Investors would face direct financial loss or significant disruption to cash flows. Money market funds, banks, and corporations holding T-bills for cash management would be affected by delayed principal repayment.

A default would affect the market value of existing Treasury Bills. T-bills are liquid and tradable, but a default would erode investor confidence. The perceived risk of holding U.S. government debt, previously considered risk-free, would increase, leading to sharp declines in T-bill prices. This price collapse would result in mark-to-market losses for investors, impacting portfolios globally.

Loss of liquidity would be another immediate consequence. Normally, T-bills are readily bought and sold, providing investors easy access to funds. During a default, the market for these securities would become impaired, making it difficult to sell holdings quickly or at a reasonable price. This illiquidity would trap capital, preventing investors from reallocating funds or meeting financial commitments, potentially cascading into broader financial instability.

Operational Challenges of Default

A U.S. government default would create unprecedented challenges for the Treasury Department in managing its obligations, including Treasury Bills. There is no established playbook or legal authority for the Treasury to prioritize payments. While some suggest prioritizing debt payments, this approach is considered unworkable and would likely be perceived as a default by credit rating agencies and investors, damaging the nation’s financial standing.

Making payments would become complex, as the government collects daily revenue but faces obligations due at different times and amounts. If cash flow is insufficient, the Treasury would decide which bills to pay and which to skip, a process without clear guidance or a technological system.

A default would impact the Treasury’s ability to issue new Treasury Bills, a fundamental aspect of government financing and debt management. Regular T-bill auctions are for refinancing maturing debt and raising funds for government operations. A default would cause investors to demand higher interest rates to compensate for increased risk, making new borrowing expensive. This would exacerbate the government’s financial woes, potentially leading to a prolonged inability to meet spending obligations and a deeper fiscal crisis.

Functioning of Treasury Bill Markets During Default

A U.S. default would disrupt the Treasury Bill market, altering their role in the financial system. Market liquidity, typically high for T-bills, would collapse as buyers become scarce and sellers offload holdings, leading to wide bid-ask spreads and price volatility. The absence of a reliable market would impair financial institutions’ ability to manage short-term cash needs and collateral requirements.

T-bill pricing mechanisms, normally driven by supply and demand, would cease to function. The relationship between T-bill yields and other interest rates would break down, introducing uncertainty into financial valuations. This breakdown would undermine their use as a benchmark for short-term interest rates and a reference point for pricing other financial products. Lack of clear pricing would create confusion and hesitation among market participants.

Financial institutions, including banks and money market funds, rely on T-bills as a safe, liquid asset for collateral and short-term financing. A default would render this collateral questionable, forcing institutions to find alternative assets or face capital shortfalls. Inability to use T-bills as reliable collateral would disrupt repurchase agreements (repos) and short-term funding markets, potentially triggering a credit crunch across the financial system.

Treasury Bills hold status as global benchmarks and reserve assets, underpinning confidence in the U.S. dollar and the international financial system. A default would undermine this role, eroding global trust in U.S. government debt reliability. This loss of credibility could lead to U.S. dollar depreciation and a global reevaluation of risk, impacting international trade and finance.