Treasury bills, also called T-bills, are government issued debt that investors can buy, hold onto, and earn a profit on. In a stable country, this is one of the safest places to put your money, which is why the interest paid to you for owning such debt is lower than if you owned a corporate bond. The biggest risk is that governments will default, which might lead to certain problems with your treasury bills as well as the economy and the government's ability to function properly.
When a government defaults it is not quite the same as an individual declaring bankruptcy. Governments will usually still be forced to repay debts. However, the debts wll be restructured so the government can meet its obligations. When debts such as T-bills are restructured, investors might have to wait longer than the original terms specified to receive the full amount they are owed. Investors might also be required to take a partial payment, losing some interest or principle on their investment.
When a government defaults it must still run the country, which means a continual need for more funds. New T-bills will still be issued, although investors are likely to be wary of investing. Investors will therefore demand higher yields to compensate them for the risk of lending to the financial strapped government. If the situation worsens, rates will continue to rise, forcing the government to pay higher interest on the money it receives through loans.
Credit Rating Revision
A default of any kind, such as not being able to meet obligations on time, will likely have a negative affect on the country's credit rating. In 1979 the U.S. government briefly defaulted on a small number of T-bills due to a back office issue. Since the situation was rectified quickly, with all investors being paid, the incident did not affect the governments credit rating. If multiple payments are missed or delayed, though, it will have a negative affect on the government's credit rating. Rating agencies will view the T-bills as a higher risk asset than before and adjust the credit rating accordingly.
A side effect of the government defaulting on T-bills is that banks may also become insolvent. Since banks are a large purchaser of T-bills, being forced to wait for T-bill payments from the government -- or taking a loss on significant quantities of T-bills -- could cause cash flow problems for many banks. These cash flow problems might mean depositors wouldn't be able to access funds and the bank might not be able to make payments on its own obligations.
Following a government default, the international financial community tries to come to an agreement on the course of action the defaulting government must take. Often this agreement involves an increase in taxes, spending cuts and a reduction in government sponsored programs. This resolution allows the government and country to regain economic footing and hopefully bring stability back to the financial markets.
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