Bernanke: Default Would Send 'Shock Waves' to Financial Markets

Fiscal Responsibility

Today, Federal Reserve Chairman warned of the “tremendous” consequences if Congress fails to ensure we pay America’s bills.

Key point: "It is a concern," he said before the House Financial Services Committee on Wednesday. He warned that a default on government bonds would send "shock waves through the entire global financial system.”

The Hill

Bernanke: Default would send 'shock waves' to financial markets

By Peter Schroeder - 07/13/11 10:16 AM ET

Federal Reserve Chairman Ben Bernanke said a failure to raise the debt limit would create "tremendous problems" for the economy.

"It is a concern," he said before the House Financial Services Committee on Wednesday. He warned that a default on government bonds would send "shock waves through the entire global financial system."

"There would have to be significant cuts to Social Security, Medicare, military pay, or some combination of those in order to avoid borrowing more money," he added.

However, he also maintained that over the long-term, the government needs to get its deficit under control, calling the current arrangement "unsustainable." But he also warned that extreme, immediate cuts could do more harm than good by imperiling the fragile economic recovery.

"It's important to address these long-term issues, I guess I would emphasize...that these are long-term issues. They don't have to be solved today or tomorrow...but we do have to take some steps," he said. "We do need to take some care that we don't, by excessive restriction in the short term, we don't already hamper what is already a slow recovery."
Bernanke in the past has scolded lawmakers, saying they should raise the debt ceiling to avoid further economic problems.

Bernanke told the congressional panel that several factors weighing down the economy are temporary, but acknowledged a continued weak labor market.

Slow-growing consumer spending, continued struggles in the housing market, less access to credit and the tightening of government spending all are "headwinds" slowing the recovery, Bernanke said in his prepared testimony.

Bernanke suggested the Fed is considering the pros and cons of further stimulus, echoing the minutes of the Federal Open Market Committee (FOMC) released Tuesday.
The Fed could be more explicit about its plans for interest rates, or purchase even more securities in a third "quantitative easing" effort — after wrapping up the second round of such an effort at the end of June. The Fed could also reduce the rate of interest it pays to banks on their reserves, which would put downward pressure on short-term interest rates.

However, Bernanke acknowledged that the Fed's experience with such moves is "relatively limited" and all those plans come with "risks and costs."

On the other hand, the economy could move in such a way that the Fed needs to tighten its policy, Bernanke said.

With that in mind, the Fed is also figuring out how best to exit from its current accommodative stance. Bernanke said Fed policymakers have broadly agreed that they would increase interest rates before beginning to slowly sell back into the market the $600 billion in Treasury bonds purchased during quantitative easing. Once those bonds have been sold back, the Fed would use interest rate adjustments as its "primary means" of conducting monetary policy, Bernanke said.

Bernanke is testifying amid growing concerns about the economic recovery, which some think is being held back in part by the uncertainty over the debt talks. The economy added only 18,000 jobs for the month of June.

Bernanke is also scheduled to testify to a Senate panel on Thursday.

Congressional leaders are headed back to the White House for a meeting with President Obama at 4 p.m.

Senate GOP Leader Mitch McConnell (Ky.) on Tuesday offered a new proposal to break the impasse that would essentially hand responsibility for raising the debt ceiling to Obama. McConnell's proposal would ask the president to recommend spending cuts, but it does not require that those cuts be made. It would require supermajority votes in the House and Senate to stop Obama from raising the debt ceiling.