By Karen Brettell
NEW YORK, Oct 15 (Reuters) - Banks and investors arefine-tuning plans to try to reduce the risk that operationalfailures will disturb crucial short-term lending markets if theU.S. Treasury is late in making its debt payments, though manyare skeptical that any U.S. default could be managed smoothly.
Anxiety over the lack of agreement in Washington to raisethe U.S. debt ceiling has risen. U.S. Senate negotiations weresuspended on Tuesday until House Speaker John Boehner can workout a plan that can pass the House of Representatives.
The U.S. is still seen as very unlikely to default on itsdebt, but the impasse has left nerves increasingly frayed.Short-term Treasuries bill yields have surged as banks andinvestors shun the debt, while the cost of borrowing in the $5trillion repurchase agreement market has also jumped.
"You've already seen significant disruptions, even thoughwe're a long way away from any of the really risky dates. Peopleare preparing earlier this time around," said Michael Cloherty,an interest rate strategist at RBC Capital Markets in New York.
A key concern by market participants is that a delay inmaking Treasuries payments could disrupt operational systems atthe center of short-term lending markets. This could add toconfusion and a likely pullback in lending as investors worryover how many other issues are at risk of missed payments.
"Operationally, it's going to be a mess to clear it up,"said Bret Barker, portfolio manager at TCW in Los Angeles.
The New York Fed's Fedwire Securities Service, which is usedto hold, transfer and settle Treasuries pledged to back repoloans, would need some manual daily adjustments to ensure thatdefaulted debt can continue to be transferred.
Traders said that they will be able to extend the maturitiesof affected Treasuries if they receive enough notice from theTreasury, which will allow the debt to continue to circulate.The maturities of affected securities may be able to be extendedas late as midnight, or slightly after, on the day before thepayments are due, these people said.
The Treasury, however, is seen as unlikely to make such anannouncement until the last possible minute, as it would want todelay any potential default on hopes that Congress would reach adeal on the ceiling. That would complicate any contingencyplanning, traders said.
Spokespeople for the Treasury and the New York Fed declinedcomment.
U.S. Treasury Secretary Jack Lew has warned Congress theUnited States would exhaust its borrowing capacity no later thanThursday, though many market participants see the government aslikely to be able to fund itself until late October, with a keydate being Oct. 31 when around $150 billion in debt payments aredue.
Others warned that planning for a default is uneven acrossfirms, and that preparations including maturity extensions onthe Fedwire may still not resolve all operational risks.
"These contingency actions, if implemented, would onlymitigate, not eliminate, expected operational difficulties inthe event of delayed payments on Treasury debt," the TreasuryMarket Practices Group (TMPG) said in meeting minutes from lastmonth.
The group, which includes representatives from GoldmanSachs, Morgan Stanley, JPMorgan Chase,Citadel Investments, BlackRock, Fidelity Investments and others,added that there were concerns "that contingency planning wasuneven across market participants."
Lew also warned on Thursday that the nation's paymentsystems are not set up to allow officials to pick and choosebroadly between its payment obligations if Congress does notincrease the government's borrowing authority and allows it todefault.
"Anyone who thinks it can be done just doesn't know thearchitecture of our multiple payment systems. They are verycomplex. They were designed properly to pay our bills. They werenot designed to not pay our bills," he said.
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