Bernanke: US bond default would send 'shock waves' through financial markets

Federal Reserve Chairman Ben Bernanke painted a bleak picture Wednesday of the global economy if Congress fails to raise the $14.3 trillion debt limit.

In comments that led to a market rally, Bernanke also told lawmakers that the Fed was considering additional stimulus for the economy if the recovery continues to lag. 

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The central bank head walked a fine line in comments to a House panel, warning of “tremendous problems” for the economy if the ceiling is not raised, but also saying Congress must get the deficit under control. 

“The possibility remains that the recent economic weakness may prove more persistent than expected ... implying a need for additional policy support,” he said. “We have a number of ways in which we could act to ease financial conditions further.”

His comments echoed the minutes of the policy-setting Federal Open Market Committee, which were released Tuesday.

The Dow Jones Industrial Average  gained 44 points for the day. Another warning for the debt talks came after the markets closed. Moody’s Investors Service said it was putting the U.S. triple-A credit rating on review for a downgrade.

Bernanke told the House Financial Services Committee 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.

He also maintained that over the long term, the government needed to get its deficit under control, calling the current arrangement “unsustainable.” 

But he warned that extreme, immediate cuts would do more harm than good by imperiling the fragile economy’s 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, hamper what is already a slow recovery.”

Bernanke used the words “calamity” and “crisis” to describe what would happen if the debt ceiling is not raised, but was more reticent when it came to discussing specific details that lawmakers are haggling over in both public and private. 

He advocated for a broad plan that gradually reduces the deficit as well as reforms the tax code, but repeatedly dodged attempts by members of both parties to weigh in on the ongoing debate.

“I’m not going to get into the breakdown of a deal,” he told Rep. Sean Duffy (R-Wis.) when pressed on whether tax increases would create jobs. “I’m not taking sides on this issue.”

Asked by Rep. Ed Perlmutter (D-Colo.) if he agreed that revenue increases should be part of a broad deal alongside entitlement reform, Bernanke said: “It’s your job. That’s why you get the big bucks.”

Bernanke said he “wouldn’t rule out” a balanced-budget amendment. 

“What do you do during a recession? What do you do during a war? What do you do during a natural disaster?” he asked. “I wouldn’t rule out by any means that kind of approach, but it has to be written very carefully ... to deal with unforeseen circumstances.”

The Fed has a few additional options for stimulating the economy if it chooses. 

The Fed could be more explicit about its plans for interest rates or purchase even more securities in a third “quantitative easing” effort. The Fed also could reduce the rate of interest it pays to banks on their reserves, which would put downward pressure on short-term interest rates.

Bernanke acknowledged, however, 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 acknowledged that the economic recovery has hit some “headwinds” such as slow-growing consumer spending, continued struggles in the housing market, less access to credit and the tightening of government spending.

He acknowledged “continuing weakness” in the labor market, but maintained that most of the obstacles to the economic recovery are temporary and that economic growth should pick up in the next few quarters.

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

This story was originally posted at 10:16 a.m. and updated at 7:06 p.m.


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