A crisis-management playbook Federal Reserve officials created years ago could guide their response this fall if the federal government can’t pay all its bills because of a political standoff over raising the federal debt limit.
The options include the Fed buying Treasury securities in default on the open market and selling Treasurys owned by the Fed to counteract potentially severe strains in financial markets, according to the transcript of an October 2013 conference call.
Among the officials who said those steps shouldn’t be ruled out were Jerome Powell —the central bank’s current chairman who was then a Fed governor—and Janet Yellen —the current Treasury secretary who was then Fed vice chairwoman.
Powell called some measures "loathsome" and others called them "repugnant" or "beyond the pale" for two main reasons. First, they would pierce the Fed’s institutional preference to avoid directly financing the government, often referred to as its independence from fiscal policy. Second, Fed officials worried if such contingency planning became public, elected officials might feel less urgency to raise the debt limit.
"These are decisions you really, really don’t ever want to have to make," Powell said on the call. "The institutional risk would be huge. The economics of it are right, but you’d be stepping into this difficult political world and looking like you are making the problem go away."
Yellen said, "I wouldn’t be eager to do them, but I wouldn’t say, ‘never.’"
Congress faces another political standoff over how to raise the debt ceiling before the Treasury Department is unable to pay bills over the next month or so. Lawmakers agreed in August 2019 to suspend the borrowing limit for two years, and it took effect again last month at around $28.5 trillion. The Treasury has been relying on cash-conservation measures since then to manage payments.
Similar standoffs in the past have often been resolved after going down to the wire, and some analysts say that has bred complacency that obscures the growing risks of a misjudgment this fall. One worry this time is a game of chicken in which markets stay placid because they assume Congress will act, and lawmakers don’t act because they see no alarm in markets. Top Republicans have said they won’t help Democrats raise the limit this year.
Powell declined at a press conference last week to elaborate on the Fed’s contingency plans, but he warned of severe damage to the economy and financial markets if Congress waits too long to act. "It’s just not something we should contemplate," he said. "No one should assume the Fed or anyone else can fully protect the markets or the economy in the event of a failure."
In 2011, Standard & Poor’s downgraded the U.S. triple-A credit rating for the first time ever, after the Treasury came within days of being unable to pay certain benefits such as Social Security. In 2013, during another standoff, the U.S. government shut down for 16 days until Congress passed a bill funding the government and raising the debt limit.
Both times, Fed policymakers debated behind closed doors what they would do if the gridlock led to the government defaulting on its debt payments or to broader financial-market instability, according to transcripts released with the usual five-year lag. A Fed spokeswoman declined to comment.
Powell, a Republican who oversaw debt-management policy as a top Treasury Department official in the early 1990s, made his return to public service in 2011 by warning against the consequences of default to Republicans who used it as leverage to seek spending cuts from President Barack Obama. As an unpaid analyst at a Washington think tank called the Bipartisan Policy Center, Powell modeled government cash flows to produce a so-called "X Date" after which the Treasury would run out of money to pay bills as they came due.
After that standoff was resolved, Obama’s advisers recommended Powell’s nomination to the Fed’s board of governors, and he was confirmed in 2012. He became Fed chairman in 2018.
Last week, the think tank’s director of economic policy, Shai Akabas, released projections showing the "X Date" would fall between Oct. 15 and Nov. 4. Friday could be a particularly difficult date for federal finances, he said, because of a large payment owed to a trust fund for veterans’ retirement benefits. Financial and economic risks could accelerate from that point, he wrote.
Fed officials agreed in 2011 on a process for managing government payments that would allow the Treasury to give priority to paying principal and interest on government debt ahead of other obligations, the transcripts show. They were also prepared to tell banks that they could count defaulted Treasurys toward their regulatory capital buffers and that they wouldn’t necessarily penalize banks that faced a drop in capital ratios due to unusual cash demands from customers.
On Oct. 16, 2013, then-Fed Chairman Ben Bernanke convened a conference call for officials to review potential options as the Treasury Department neared the exhaustion of its emergency borrowing authority, according to a transcript of the call.
Fed staff economists had prepared a memo outlining nine steps the central bank could consider to manage the fallout from any missed payments.
Officials broadly agreed on several measures, including lending against defaulted Treasurys at their emergency borrowing window and accepting defaulted Treasurys in a separate bond-buying stimulus program—albeit at potentially reduced market prices, so long as it was certain that the government would quickly make full payments after the debt ceiling was lifted.
Bernanke warned the Fed wouldn’t be able to remove defaulted securities from the market "in any kind of comprehensive way given the size of the Treasury market."
They also agreed to steps that could flood lending markets with cash, including by extending very short-term loans made between financial institutions called repurchase agreements, which could also relieve pressures on money-market mutual funds.
Many officials expressed concern that financial markets might face a severe disruption even before the Treasury stopped paying all its bills if the U.S. government failed to find enough buyers in an auction of Treasury debt to replace maturing securities with new ones.
Powell pointed to the risk of a failure of the Treasury to sell short-term bills that would mature at a point where the government’s borrowing authority might be exhausted. "The real risk is of a failed auction—a loss of market access at any price," he said.
Powell worried that the ideas with the broadest support were ineffective to address that problem. He later agreed that in an extreme crisis, the most unappetizing measures shouldn’t be ruled out. "I don’t want to say today what I would and wouldn’t do if we actually deal with a catastrophe on this," he said.
Bernanke said only Congress could fully resolve any impasse. "What we are talking about…are steps that the Federal Reserve could take to mitigate on the margin the potential effect of such a default, but obviously, this is not a problem that we could eliminate, by any means," he said.