Today the US Federal Reserve released the minutes of its October rate-setting meeting, and they shed light on a worrisome subject: What would the central bank do if Congress, in all its wisdom, forced the Treasury to miss a payment on the national debt?
This isn’t just a historical curiosity. The US government dallied with hitting its debt ceiling last month, and could do so again as soon as March unless lawmakers in Congress reach a compromise. The Fed held a conference call to discuss the question on October 16—the same day that legislators resolved the debt-ceiling deadlock that had kept the government largely shut down for over two weeks. Here are the official minutes, with some interesting parts bolded:
Videoconference meeting of October 16
On October 16, 2013, the Committee met by video-conference to discuss issues associated with contingencies in the event that the Treasury was temporarily unable to meet its obligations because the statutory federal debt limit was not raised. [...] Meeting participants saw no legal or operational need in the event of delayed payments on Treasury securities to make changes to the conduct or procedures employed in currently authorized Desk operations, such as open market operations, large-scale asset purchases, or securities lending, or to the operation of the discount window. They also generally agreed that the Federal Reserve would continue to employ prevailing market values of securities in all its transactions and operations, under the usual terms. [...] Under certain circumstances, the Desk might act to facilitate the smooth transmission of monetary policy through money markets and to address disruptions in market functioning and liquidity. Supervisory policy would take into account and make appropriate allowance for unusual market conditions. The need to maintain the traditional separation of the Federal Reserve’s actions from the Treasury’s debt management decisions was noted. Participants agreed that while the Federal Reserve should take whatever steps it could, the risks posed to the financial system and to the broader economy by a delay in payments on Treasury securities would be potentially catastrophic, and thus such a situation should be avoided at all costs.
What does all that mean? “I think this is Fed-speak for ‘we’re not going to make things worse, we’ll even try to make things better, but there is not a whole lot we can do to make it better,’” Joseph Gagnon, an economist and former Federal Reserve official, told Quartz.
One way the Fed might be able to make it better is, in effect, to pretend that the default hadn’t happened—at least for the purpose of one of its key jobs, which is to keep liquidity in the banking system from drying up. There is a hint at this in the references to maintaining the “operation of the discount window” (the system whereby the Fed lends banks cash for short periods in exchange for collateral like Treasury bonds) and addressing “disruptions in market functioning and liquidity.”
Such disruptions would occur if, after the Treasury defaulted on its debt, banks stopped trusting that debt as collateral. In a worst-case scenario, this could lead to 2008-style market freezes. If the Fed continues, as the minutes suggest, to accept even defaulted Treasury debt as collateral at the discount window, and to purchase it through its bond-buying programs, it might underpin the market. Analysts at Deutsche Bank and Nomura had wondered if the Fed would use such tools when the debt ceiling was approaching. Now we have something of an answer.
But all that is still uncertain and politically tenuous. And there’s no institution more averse to politics than the Federal Reserve—hence the focus on avoiding the debt ceiling “at all costs.”
And we still have no word on whether or not the Fed would accept a trillion-dollar platinum coin as collateral.