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Bernanke: US Will Keep Paying Bondholders After Aug. 2

Wednesday, 13 Jul 2011 12:59 PM

Federal Reserve Chairman Ben Bernanke Wednesday said the United States would keep paying interest on government debt if Congress failed to reach a deal to lift the debt ceiling by Aug. 2.

The central banker's comments offered the first public indication of how the Obama administration would prioritize its financial obligations after Aug. 2, when the U.S. Treasury says the government would run out of money to pay all its bills.

"The assumption is that as long as possible, the Treasury would want to try to make payments on the principal and interest to the government debt, because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy," Bernanke said.

Bernanke's testimony on Capitol Hill came as President Barack Obama and congressional leaders prepared for a fourth straight day of talks aimed at breaking a logjam over taxes and spending cuts. Talks have hit an impasse with lawmakers from both sides blaming each other for failure to compromise and reach a deal.

Treasury Secretary Timothy Geithner has warned of a catastrophic impact in the global financial system if the $14.3 trillion U.S. debt system is not raised in time.

Bernanke confirmed for the first time that the Obama administration is making contingency plans in case the debt talks fail to produce a deal. He said its top priority was to ensure that holders of U.S. bonds were paid on time.

However, prioritizing the debt would mean ordinary Americans would suffer.

"As a matter of arithmetic, fairly soon after that date there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money," Bernanke said, focusing on areas that could affect key voting blocs ahead of 2012 elections.

"If, in fact, we ended up defaulting up the debt — or even if we didn't ... it's possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive of course because that makes the deficit worse," he said.


Bernanke said if the United States defaults on its debt it would be a "major crisis" since the Treasury security is viewed as the safest and most liquid security in the world.

"It's the foundation for much of our financial system and the notion that it would become suddenly unreliable and illiquid would throw shockwaves through the entire global financial system."

Failure to seal a deal by Aug. 2 could spook investors globally, causing U.S. interest rates to surge and stock prices to plummet, putting the United States at risk of another recession, Treasury officials and economists have warned.

Obama's Democrats and Republican lawmakers are sharply divided over tax and spending issues as they try to meet the Aug. 2 deadline.

The president will host talks at the White House with Republican and Democratic leaders at 4 p.m. Wednesday, the fourth meeting in as many days.

This week's talks have been marked by acrimony on both sides and a lack of progress.

Democrats, who say any deficit reduction plan should include a mix of spending cuts and tax increases, have accused Republicans of intransigence for refusing to consider revenue increases. Republicans contend that Democratic insistence on tax increases would put the economy at risk.

© 2015 Thomson/Reuters. All rights reserved.

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