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Fed plan for U.S. default would be step into abyss

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A pedestrian walks past the Federal Reserve Board building on Constitution Avenue in Washington, March 19, 2019. REUTERS/Leah Millis

WASHINGTON, Sept 22 (Reuters Breakingviews) - The Federal Reserve could do without the latest arguments in Washington about the U.S. government’s borrowing limit. Failure to agree could leave Uncle Sam unable to pay its bills. If lawmakers allow any debt to go unpaid, the central bank would be in a seriously tough spot.

Congress is once again playing a game of chicken. The $28 trillion borrowing limit went back into effect in August. If lawmakers don’t increase it soon, the government won’t be able to pay its bills starting sometime in October. Eventually, that could result in an actual debt default. The U.S. House of Representatives on Tuesday approved a measure to suspend the debt ceiling again through 2022. But that plan would require support from Senate Republicans, who have vowed to reject it.

The worst-case scenario is something the Fed has considered before. To contain a default, the central bank discussed accepting delinquent Treasuries as collateral for loans or even buying them in 2011 and 2013, when the debt limit was also in limbo, according to Reuters. Such measures would amount to enabling the government’s default while also, in effect, bailing out reckless lawmakers. That would make the Fed’s claim of political independence almost untenable. Back in 2013, then-Governor Jerome Powell, now the Fed chair, summed it up when he said the options were “loathsome.”

Even if the standoff gets nowhere near a default, the central bank could still be in an awkward spot. The Treasury would have to stop paying bills, including perhaps Social Security payments to retirees. The fiscal tensions could also bring a spike in interest rates, which would make mortgages and car loans more expensive. Meanwhile, the economic recovery from Covid-19 still faces speed bumps and the central bank is trying to gauge when to scale back its ongoing support, with the latest policy update expected on Wednesday.

The debt ceiling has already become a political football. It was a key reason why Standard & Poor’s downgraded the U.S. credit rating in 2011. It makes no sense for lawmakers to try to block already agreed spending by limiting the borrowing to pay for it. Yet some might be willing to take the risk of provoking a default. That would be potentially catastrophic for the U.S. economy – and also for the Fed.

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CONTEXT NEWS

- The U.S. central bank’s Federal Open Market Committee is set to announce its latest monetary policy moves on Sept. 22. One area of focus is when the committee will reduce its purchases of $120 billion in Treasury and mortgage-backed securities each month, a program that began in 2020 in response to the economic effects of the pandemic.

- Separately, the House of Representatives on Sept. 21 approved a measure to suspend the federal government’s borrowing limit until the end of 2022. The ceiling, suspended since 2019, went back into effect on Aug. 1, and a failure to increase it will leave the federal government unable to pay all of its bills starting sometime in October. The plan moves to the Senate, where Republicans have vowed to block it.

- U.S. Treasury Secretary Janet Yellen said that a government default on its debt obligations would result in a “permanently weaker nation.” In an opinion piece in the Wall Street Journal on Sept. 19, she urged Congress to raise or suspend the current borrowing limit of about $28.4 trillion.

Editing by Richard Beales and Amanda Gomez

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