How Treasury Can Benefit from the Government Threatening to Default
Corporate treasury teams can leverage the recent debt-ceiling standoff to improve their preparedness for future crises.
One of the most important lessons learned from the recent debt-ceiling standoff is that the U.S. government is capable of having cash flow problems. Obviously, U.S. Treasury Secretary Janet Yellen faced a very different situation than the typical corporate treasurer trying to overcome a temporary cash crunch. Still, the threat of running out of cash struck a nerve with many treasurers.
The federal government was able to solve its recent liquidity challenge by raising more debt—extending the borrowing ceiling and kicking the proverbial can down the road for another two years. That’s where any analogy with corporate America stops, as companies’ treasury and finance leaders operate within a very different playbook than Janet Yellen does. But the narrowly averted crisis does offer some important takeaways for CFOs and treasury teams, strategies and tactics they can apply to their own cash, liquidity, and risk management practices.
Redefining Risk-Free
There was a moment when U.S. Treasury securities, particularly Treasury bills (T-bills), looked like they might default. No one in the finance community really expected that to happen, but as the probability increased, that affected the yields of U.S. government debt. In fact, for companies looking to pick up short-term yield, the Treasury issued one-day T-bills for the first time in over a decade. In select cases, Treasury bills temporarily yielded more than 6 percent, a higher-than-normal return.
Some corporates chose to take advantage of the higher interest rates, investing in Treasuries as allowed by their investment policy. But in that scenario, with the government threatening to default, were U.S. Treasury bills, notes, or bonds actually risk-free? And now that normalcy has returned, do companies need to redefine their investment policies to consider not only the types of instruments that they can invest in, but also the scenarios in which those instruments are risk-free and meet investment policies?
Consider, for example, that some U.S. corporates which are permitted to invest in government money-market funds (MMFs) draw the line at investing in prime MMFs—which hold more corporate paper—due to their marginally higher risk of default. Perhaps corporates need to change their understanding of what conditions qualify as “risk-free” and what risk tolerance, in different scenarios, they are willing to accept. Having such flexible thinking built-in would improve the resilience of investment policies in future debt-ceiling crises.
Cash Forecast Scenarios
In the past three years, since the outset of the pandemic, many treasury teams have had to modernize their forecasting by injecting data into their forecast scenarios. To prepare for the unpredictability of Covid-19 markets, CEOs and boards demanded real-time scenario planning—exploring what if this happened, or what if that happened instead—to demonstrate the impact of different external circumstances on cash and liquidity.
The concerns during the pandemic revolved around business viability—e.g., “What if our customers stop paying us?” Over the past year, the same scenario planning techniques have helped treasury teams prepare for potential impacts of unprecedented currency volatility and the fastest interest rate increases in recent history. Even more recently, forecasts have had to react rapidly to bank failures and, of course, the prospect of a default on U.S. Treasuries. Now many companies are adjusting cash forecasts to account for the potential tightening of credit, as banks will have more capital requirements thrust on them by regulators in the coming months.
When the prospect of a debt-ceiling crisis was looming, those treasurers who had responded to Covid by building multiple what-if scenarios into their cash forecasts were able to easily demonstrate to their CFOs and other executives what the impact would be on cash balances and liquidity levers if the U.S. government did, in fact, default on its obligations. Unfortunately, though, most treasurers do not have this level of forecasting automated within their accounting or treasury systems.
The debt-ceiling standoff intensified the interest among treasury leaders in making liquidity decisions faster and moving to real-time–everything treasury operations. Treasury teams have been headed in that direction for quite some time, spurred on by the soon-to-be launched FedNow instant payments in the United States. Instant payments demand payment processing and governance to operate at “machine speed.” The debt-ceiling crisis offered an opportunity for treasury teams to test their preparedness for real-time payments by responding to executives’ requests for on-demand cash forecasting and liquidity planning updates, hardened by data-driven scenario analyses.
These scenario analyses must continue to evolve in order to predict the next crisis that might impact future cash flows—not the least of which is the looming threat of recession and the tightening of credit availability and borrowing capacity. Most especially with longer-term liquidity planning practices, treasury professionals and their corporate finance colleagues must steer their data insights like a cruise ship rather than a sports car, so that they can continue to deliver predictable revenue, earnings, and cash flow guidance to communicate a message of stability to investors and analysts.
Adapt Processes to Demonstrate Learning
The debt-ceiling agreement provides an opportunity for treasurers to showcase the resilience of their forecasts and the evolution of their liquidity planning practices to offer better forecast predictability and more data-driven financial decisions.
Conversely, treasury teams that lack scenario planning capabilities are likely to suffer from inadequate decision-making. They are forced to constantly react to news, events, and last-minute information much like a city driver navigating an unfamiliar, pothole-filled country road. Spoiler alert: It doesn’t end well.
Fortunately, there are better avenues in the form of advanced scenario-based forecasting processes and systems that leverage artificial intelligence (AI) and analytics to harness enriched data and incorporate real-time updates into on-demand liquidity planning. A treasury organization that taps into these pathways will be better able to see crises well in advance and to plan for them before being dropped into the high-stress pressure cooker of a crisis situation.