Dead end for the US debt ceiling? The Fed’s “hateful” game plan for the “unthinkable”

Treasury Secretary Janet Yellen said failure to raise the US debt limit could lead to the unthinkable: a default on government payment obligations. It’s an outcome the White House warned on Friday could plunge the economy into recession.

If the deadlock in Congress over the $ 28.5 trillion debt limit is not resolved by the October deadline, what would the Federal Reserve be – the backstop of U.S. financial markets as a lender in? last resort – would she be prepared to do so?

Turns out Fed Chairman Jerome Powell may already have a game plan. The country faced a similar debt ceiling crisis in 2011 and again two years later, and at an unscheduled meeting in October 2013, Fed policymakers – including Powell, who was then governor of the Fed, and Yellen, who was the vice chairman of the Fed – debated possible actions in response.

“Disgusting” was how Powell described some of the more aggressive options considered, as the transcripts show, though he was among those who said they might be needed in the face of what could be a disaster of the world. drastic market.

“GET OUT IN SWINGING”
The plan included a process for managing government payments, as the Fed expected the Treasury to prioritize principal and interest, but make day-to-day decisions on whether to hedge debt. other obligations.

Changes in the supervision of banks by the Fed were also expected. Banks would be allowed to count defaulted treasury bills as part of the risk capital requirements, and supervisors would work directly with any bank experiencing a “temporary decline in its regulatory capital ratio.” The US central bank is also reportedly ordering lenders to give stressed borrowers wiggle room.

Policymakers have also defined approaches to manage market tensions and financial stability risks resulting from a technical default.

They readily agreed to some measures, including expanding outstanding bond purchases to include defaulted treasury bills, lending against defaulted securities and through the Fed’s emergency lending window, and driving buyback operations to stabilize the financial markets in the short term.

Other actions outlined in the briefing notes and during the meeting were more controversial, including direct support for financial markets buying defaulted Treasury securities, or simultaneously selling non-defaulting Treasury securities. default and the purchase of those that are.

It was these latter actions that Powell described as “loathsome” while others called them “loathsome” and “beyond the pale”. The problem, the transcripts suggest, was the concern that such purchases might be seen as crossing a line in direct government funding.

“The economics are good, but you would step into this tough political world and look like you made the problem go away,†Powell said at the time.

More policymakers, including Yellen and John Williams, who was then chairman of the San Francisco Fed and now head of the New York Fed, felt that such an intervention should be part of the response of the US central bank if necessary. Even Powell agreed that it might have to be “under certain circumstances”.

Congress resolved the debt ceiling deadlock in 2013 and the Fed never had to activate its game plan. Since then, he has gone through a number of crises, including the coronavirus pandemic, to which he has responded aggressively and with tools never used before like municipal debt purchases. “We’ve crossed a lot of red lines that had never been crossed before,†Powell said in an interview in May 2020.

Analysts say the Fed has helped avert an even worse financial crisis and economic downturn.

Christopher Russo, a postgraduate researcher at the Mercatus Center at George Mason University, said the Fed’s experience could influence how it responds to future crises.

“The lesson learned is, if they want to do something, swing out,†he said.