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Debt ceiling impasse? Fed’s ‘loathsome’ game plan for the ‘unthinkable’ By Reuters


© Reuters. FILE PHOTO: U.S. Treasury secretary Janet Yellen responds to questions at the hearing of the Senate Appropriations Subcommittee, which examined the FY22 budget request by the Treasury Department, Capitol Hill, Washington, DC. June 23rd, 2021. Greg Nash/Pool


By Ann Saphir

(Reuters) – Treasury Secretary Janet Yellen says failure to raise the U.S. debt limit could lead to the unthinkable: a default on government payment obligations. This is the outcome that the White House warned would plunge the economy into financial crisis.

What would the Federal Reserve, the Federal Reserve which acts as the lender last resort and backstop to the U.S. financial market, do if Congress doesn’t resolve the $28.5 trillion limit on debt before October?

It turns out that Fed Chair Jerome Powell might already have a plan. In 2011, the country was faced with a similar debt crisis. Two years later, Fed Chair Jerome Powell had to rethink his strategy.

Plan included procedures for managing payments to government. This was in response to the Fed’s belief that Treasury would prioritise principal and interests, while making day-to-day decisions regarding whether or not they would be covered by other obligations.

There were plans to make changes in the Fed’s oversight of banks. The Fed would allow banks to include defaulted Treasuries in their risk-capital requirements. Supervisors will work with any bank that experiences a temporary drop in regulatory capital ratio. A U.S. central banking would direct banks to allow stressed borrowers leeway.

A plan was also developed by policymakers to address market tensions and the financial stability risk resulting from technical defaults.

The policymakers agreed to certain measures including the expansion of ongoing bond purchases in order to cover defaulted Treasuries as well as lending to defaulted securities through the Fed’s emergency lending window and conducting repurchase operations that stabilize short-term financial market.

Others actions discussed during the meeting and in briefing notes were controversial. They included direct support for money markets through buying defaulted Treasury bill or selling Treasuries in default while simultaneously buying Treasuries in default.

Powell called these methods “loathsome.”

Powell described these approaches as “loathsome.”

Powell stated that he didn’t rule it out in a dire situation. He was supported by his fellow colleagues John Williams and Yellen, both of whom were at the time presidents of San Francisco Fed. Williams is currently head of New York Fed.

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