Normally, the bonds issued by the U.S. Treasury are considered the most liquid of investments. They earn interest but can be sold for their full market value in a matter of minutes if you find out you need the cash. In this role, they serve an important function in the financial world. All that is changing, though, now that the U.S. government is effectively bankrupt, having borrowed as much as the law allows. With the timing of August interest payments looking increasingly uncertain, treasuries can’t be used as the equivalent of cash for much longer.
Yesterday there was a report that banks are already adjusting their cash management strategies. From Reuters:
A number of Wall Street’s biggest banks are preparing to lower their use of U.S. Treasuries in August, the Financial Times reported on Sunday.
This is an issue that applies not just on Wall Street, but in every bank in the country. Banks will hold fewer treasuries and may have to hold more cash and make fewer new loans as they adjust their approach in order to make sure they have cash on hand when they need it.
The concern about the liquidity of treasuries is not limited to banks, either. Money market funds that might ordinarily hold more than half of their portfolios in treasuries will have to cut back more than banks will, spreading their holdings out among commercial paper, state and local government bonds, and possibly even a smattering of foreign assets. They do this to ensure that their portfolio is liquid enough to meet any flurry of redemption requests that might come in during August, or for as long as the U.S. government bankruptcy lasts. Foreign banks and investment funds too will have to cut back on treasuries, for similar reasons if not to the same degree.
There is no suggestion at this point that any bank or fund will be selling off all their treasuries at a loss. They may merely have to stop buying them. But with so many large institutions and funds having to cut back, the value of treasuries may decline ever so slightly, which also means the interest rate on them will be higher. If Congress does not act to take the U.S. government out of bankruptcy, this move will be only the beginning of a progression of higher interest rates, accompanied by the step-by-step downgrades from ratings bureaus. No ratings bureau has announced a downgrade yet, but among banks and mutual funds, treasuries are already not what they used to be.