By Kate Davidson
Federal Reserve and Treasury Department officials in August 2011 had privately formalized a plan to make on-time payments on Treasury debt and delay paying other government bills if Congress and the White House failed to reach an agreement to raise the federal borrowing limit, according to transcripts of a central bank meeting released Thursday.
The transcripts provide the most detailed description yet from any government agency of what officials were prepared to do in the event of a debt-limit breach.
At the time, Obama administration officials were warning the Treasury would run out of cash to pay all the government's bills if Congress failedto lift the debt ceiling.
Republicans were pressing the Treasury to prioritize payments to bondholders to avoid a default on U.S. government securities, a linchpin of global markets. But Treasury officials said prioritizing principal and interest payments while missing payments on other obligations -- such as Social Security checks, veteran benefits and other vendor bills -- was "simply default by another name," and thus an "unacceptable outcome."
The issue was of great concern then to investors around the world, and could be again this year as Congress faces another debt ceiling deadline on March 15.
The prospect that the U.S. government might fail to make bond payments had roiled financial markets when Fed officials held an emergency conference call on Aug. 1, 2011, just after congressional leaders announced a deal to raise the debt limit.
Transcripts from the call show the Fed -- acting as the Treasury's fiscal agentand at its direction -- was prepared to keep making principal and interest payments on time, and delay other payments as necessary, if the deal fell through and the debt limit wasn't raised in time.
Louise Roseman, the director of the Fed's division of reserve bank operations and payment systems at the time, told Fed officials that the central bank, its regional reserve banks and the Treasury had jointly developed and codified the procedures into a "special operating circular, " which it planned to issue to banks if Congress failed to strike a timely agreement. The plan was "approved by the Treasury as reflecting what it would like the Reserve Banks to do as its fiscal agents if it ever came to that," she said.
The Fed released the transcripts from its 2011 meetings on Thursday under its customary five-year lag.
Ms. Roseman said the Treasury planned to ensure it would be able to make the interest payments "by holding back othergovernment payments and accumulating sufficient cash balances in its Fed account to pay upcoming coupon payments."
Janet Yellen, the Fed's vice chairman at the time, said she came away from the debt ceiling episode "quite concerned" about the vulnerability of market infrastructure in the event of an actual default, which she said could have had "catastrophic market consequences."
"Given that we could face a similar situation somewhere down the road, I think it's important for us to think about lessons learned so that we and markets will be better prepared if we face such a situation again," Ms. Yellen said, according to the transcript.
Fed officials also discussed ways they might respond in the event of a default or renewed market turbulence. Those options included valuing defaulted securities at their own market prices, conducting reverse repurchase operations to address strains in money markets, providing emergency liquidityto money market mutual funds and buying defaulted Treasury securities outright.
Some officials worried that emergency lending to money markets could generate moral hazard, and that buying defaulted Treasuries could be seen as financing the public debt. Ms. Yellen said those options "seem to be possible to me" if such a situation were to arise in the future and default seemed to be a possibility, "but whether or not I would endorse them would depend on the actual circumstances were this to arise."
"The implication of this approach would be that the Treasury would be delaying non-[principal and interest] payments even on days when it may have ample balances in its Fed account to have been able to make those payments if it had so chosen," she said. "Instead, the Treasury would be conserving that cash to be able to ensure that it would be able to pay future-dated interest payments."
Ms. Roseman said the Treasury wouldn't submit any payments to the Fed's regional reserve banks unless it was sure it would have sufficient balances to settle the transactions on the settlement dates.
The release of the transcripts could complicate efforts to negotiate the next debt-limit increase ahead of the March 15 deadline. Congressional Republicans had repeatedly called on the Treasury to prioritize payments ahead of the 2011 deadline, as well as other categories of federal spending.
In the years since the showdown, administration officials have acknowledged that they conferred with the New York Fed and determined that prioritizing such payments was technologically possible. But they warned such a move "would be entirely experimental and create unacceptable risk to both domestic and global financial markets."
Treasury officials told government watchdogs that they determined the "least harmful option" available in 2011 was to delay all payments until they could all be made on a day-by-day basis.
According to the inspector general's report, the Treasury said that, because Congress has never provided guidance on how to prioritize payments, its systems are designed to make each payment in the order it comes due.
"Treasury officials determined that there is no fair or sensible way to pick and choose among the many bills that come due every day," the report said.
The Fed transcripts released Thursday suggest that, at the end of the day, officials were prepared to prioritize principal and interest payments on bonds, though Ms. Roseman acknowledged the plans were fluid and had only been finalized the prior Friday, July 29.
"That would be a comfort if we find ourselves in another debt ceiling event, although we view that as less likely this time around," said Ian Lyngen, head of U.S. rates strategy at Bank of Montreal, said after the transcripts were released Thursday.
Contingency planningfor such a default "had been under way for months," she said, but the plan had changed substantially over the previous week or two, in part because "it was only recently that senior policymakers, here at the board and at the Treasury and elsewhere, paid very serious attention to what the procedures would be, and questioned, perhaps, whether that was the appropriate approach."
She said the plan she was outlining would "provide a higher degree of certainty" to payment recipients.
Then-Fed Chairman Ben Bernanke asked whether the Fed would have been able to prioritize payments for other major categories of federal spending, in addition to payments on Treasury debt, as envisioned under a bill that had been proposed by Sen. Pat Toomey (R., Pa.).
Ms. Roseman said the challenge "would be more on the Treasury side," adding that the department had concerns about its ability to send certain types of payments to the Fed while withholdingothers.
"But frankly, the Treasury had concerns about some of the approaches we've ultimately adopted...in the past week or so that it has now decided it would be able to do after all," she said. "So I suspect that it would, with sufficient lead time -- at least in weeks, not days -- be able to accommodate that."
"But it's something that, until you have developed the procedures and tested the procedures, your comfort level is pretty low," she added.
Ms. Roseman also said the Fed system would have been capable of handling delayed coupon payments or delayed redemption of matured securities if the Treasury changed its mind again and decided not to prioritize payments. But she said it could create "very big operational challenges and probably a lot of disruption" for other market participants, who never anticipated the possibility of the government missing a debt payment.
Katy Burne contributed to this article.
Write to Kate Davidson at firstname.lastname@example.org
(END) Dow Jones Newswires
January 12, 2017 17:31 ET (22:31 GMT)
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