Behind scenes, Fed preps for worst in US debt fight

Analysis: The deadlock in Washington has gotten so bad that the nation's central bank is getting ready for what might happen after Uncle Sam bounces his checks.

By InvestorPlace Jul 21, 2011 9:52AM

By Jeff Reeves, Editor,

Reports emerged last night that the Federal Reserve is actively preparing for a government debt default. With negotiations over the debt ceiling still going nowhere, it's clear that Fed Chairman Ben Bernanke and his fellow central bankers don't want to be caught without a plan.

There are just 12 days to go until the Aug. 2 deadline set by the Treasury, when the government will run out of money and stop paying some bills. And, barring a last-minute compromise, the U.S. will face at least a credit downgrade and at worst the label of outright default on its debts.

Yes, it has gotten this bad. And the Fed is preparing for the worst.

How did we get from the idea or threat of default to the point where the Fed is actually expecting such a disaster to occur?

There are a few reasons, but let's cover the most pernicious: The political brinksmanship in Washington, D.C., has reached a new low. Yes, fiscal conservatives are correct when they say our massive government debts must change. And, yes, social-minded liberals are right to protect the poorest and the oldest Americans who need government assistance most. We should all agree on that.

The hard part is finding a reasonable place to meet in the middle, where those competing interests can be balanced. But as we so often see in Congress, many spineless politicians have decided to take the easy way out by being stubborn and acting like it's the other guy who's being unreasonable -- all so they can please their bases and hopefully get re-elected in 2012.

So the Fed, not surprisingly, is making contingency plans. Some are just logistics -- for example, how to communicate with the Treasury and federal departments on which checks will bounce and which ones won't if the debt debate isn't resolved. The Treasury, after all, is just a department itself. The Federal Reserve actually clears the millions of Social Security payouts and government employee paychecks that get written each month.

But some Fed plans are downright scary if they become necessary. For instance, the Federal Reserve plays a crucial role in short-term lending to massive financial institutions. Fed "discount window" loans are offered to banks that hold Treasury bills as collateral. But in the event of a default or credit downgrade, those U.S. Treasury securities won't have as much weight as a guarantee that the borrower is good for the loan.

"Do we treat (the T-bills offered as collateral) as if they didn't default, in which case we would be saying we are pretending it never happened?" Charles Plosser, the president of the Philadelphia Federal Reserve Bank, wonders in Reuters' report. "Or do we treat them as if they defaulted and don't lend against them?"

These are the serious and scary questions the Fed is facing, all because Congress can't get its act together. The Treasury repeatedly has said default was unthinkable, but top policymakers clearly have begun thinking about it.

Jeff ReevesI don't pretend to have an easy solution to our massive government debts, anemic economic growth and federal budget problems. But here's the reality: This mess was created through shenanigans by Democrats and Republicans alike over decades. And while some folks believe the Treasury could make ends meet beyond Aug. 2, the bottom line is that, without a compromise, we assuredly will face a downgrade to America's credit rating in the short term and a default sometime down the road. Maybe not on Aug. 2 but eventually.

President Barack Obama has tried to express the importance of shared sacrifice and compromise in negotiations. It's a noble idea and one that our politicians should embrace.

But frankly, with each passing day, the most realistic outcome of the current politicking in D.C. seems to be a downgrade or default for federal debt.

Jeff Reeves is the editor of Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.

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Jul 21, 2011 12:48PM

Suspend Congress and Presidential pay until crisis is solved

Pull all troops out of all countries other than allies under threat

Suspend all foreign aid until crisis is solved

Cut 20% out of every budget except Social Security and Medicare


All money saved go directly to pay down debt and keep SS and MC solvent until an appropriate reform can be implemented

Jul 21, 2011 11:46AM
If congress causes a default  do they still get paid?
Jul 21, 2011 12:48PM
Hey, they need to CUT the pay of these politicians!!
Jul 21, 2011 12:46PM
Jul 21, 2011 12:11PM
They seem to tell us all about doom and gloom, They are all telling us exactly what they want us to hear. Democrat, Republican, it doesn't matter, they have been pointing this country in this direction for decades. taking more and more of our rights away from us, making it harder and harder to just live, and make a decent living.
Jul 21, 2011 12:17PM
I have said it before and will say again.

These idiots that we elect have lost sight of the real reason why you are supposed to go in to politics.

This is so you can be a representative of your people around you for their beliefs and yours. And for the greater good of all.

You are supposed to fill your term and GO HOME. These were NEVER meant for a career. You are supposed stop and go back to society and CONTRIBUTE. You are supposed to go back to your community and HELP them. THEY put you there to start! You do not deserve to be re-elected. NONE of you have done ANYTHING in the tenure you've had to justify your re-elections.

GO HOME. Give back what you are taking from the people who put you there in the first place. Stop stealing our Social Security!  It's not yours! It's mine you @ssholes! I'm so ticked that you make me pay in to a system that you steal from and tell me won't be there when I retire.


Jul 21, 2011 11:53AM
I hope voters will remember in 2012 the ones screwing around today.
Jul 21, 2011 1:43PM
First kill ALL Foreigh Aid of ANY kind. The rest of the world despise us anyway. Second kill all subsidies to oil companies - Their profits are obscene. . Third, implement a work for welfare program - WPA and CCC did great things for this country after the depression. Oh yeah and here is a real goodie. Repeal the loophole that allows taxes paid by a company to a foreigh government to be deducted from their US taxes. Now all we have to do is elect honest politicians to implement these changes. 
Jul 21, 2011 1:19PM

I am NOT a political person, but if we default and Social Security, Medicare, Government  pay checks, Military checks bounce or worse yet don't get paid.  I think we need to have a huge lawsuit against every elected official in Washington.  All parties have caused this, all parties and their people need to suffer if they don't get it together.


I would love to see all of the House, Congress, Senate and White House elected officials loose their paychecks FIRST, before the regular people.  Then we should fire them all at election time.  i'm convinced you could pluck anyone off the street to run this corrupt government and they would do a better job of making things right!


Too many special interest groups running the show, politicians with no backbone bowing down because they do not want to loose their hoity tioty positions in politics!

 They have ruined the United States, and "We the people" have let them.

Jul 21, 2011 3:10PM

Easiest ways to curb the debt is

1. Congress should have to pay for their health coverage like everyone else.  How can the vote rationally on subjects that don't affect them.

2. Limit elected congress to 2 terms, then they can go back to their professions and contribute to the economy.  Reasonable salaries can be maintained.  This is how it used to be, and how it was meant to be.

3. eliminate servants and maintenance at the white house or make the incumbent pay for it out of his pocket.  If you can't maintain it, you shouldn't live there.

3. No elected official should receive a pension of any sort.  They asked for the job...not the other way around.

Jul 21, 2011 1:13PM
Here is a thought.. First, we stop paying other countries money that they use to spend on weapons to kill us. Second, we stop spending money to train foreign militants on how better to kill us. Third, we become neutral, feed and educate our people, re-grow America, and use the money we save to pay back our debt and clean up our streets. Maybe we should start a war with ourselves and then apply for aid.
Jul 21, 2011 2:20PM
How about instead of social security recipients, military, etc not getting paid how about we not pay the President and members of Congress? They're the ones NOT doing their job so THEY should be the ones not getting paid.
Jul 21, 2011 12:38PM

Im not up on the politics, but history tells me we have built, supported and donated to many countries around the world.  Wouldnt it be a simple solution if we just stop pouring money out to others ?

We also need to reform the NAFTA trade agreements.  We Americans are getting screwed.

No jobs, no money and big debt.

Im no politician but this sounds like the solid way too go.

Jul 21, 2011 1:10PM

 Stop social security for anyone who has not paid into it.  Stop medicare for anyone but the elderly and disabled. Stop paying for illegals and giving them free healthcare ect. 


Cut all President, Congress pay, and make them pay for their health care and everything we have to pay for let them see how the other half live, if they want to support people who want a free ride then let them do it, not the people who go to work every day to support the people too lazy to work.

Jul 21, 2011 12:39PM

WHAT DEFAULT?  Why is no one pointing out that the interest on the national debt is roughly 14 billion per month and we have roughly 200 billion per month coming in in revenue?   Even if we don't raise the debt ceiling, the revenue is there to pay the interest (service the debt), pay social security, medicare, medicaid, Military pay (retiree's too), ALL department of defense bills, Indian health care, temporary aid to families(welfare), all gov't employee salaries, etc., etc.

The people left out would be the subsidies to other countries, to farmers like al gore who get paid to not produce, the oil company subsidies (we give them billions to blend food [ethanol] into our gas!) etc. 

Why are we paying any of that anyway!

Jul 21, 2011 12:55PM

I say to cut the pay of the law makers in the house and the senate who make 6+ figures a year.  Make them fly coach, stay in modest hotels, and drive modest cars.  If they have to have all the luxury, they should pay out of their own pockets.  They should not be allowed to decide to give themselves raises, but rather it should be an unbiased-committee or the American people who decide that.  And like any other job, if they are not doing their job, they should be fired and replaced.  How can they ask the American people to make sacrifices if they are not willing to themselves.  Stop cutting the taxes of the rich and expecting the middle class to pick up the slack.  That's just my opinion, though.

Jul 21, 2011 12:46PM
I have had it with those politicians. All they really care for is the best interest of their agendas. To "pretend" that social security is talking the bulk of the monies or is to blame is ludicrious. Even if it were true, we need to take care of "our" ailing American's and not some punk from a third world country (case in point: Pakistan 1,000,000 aide). That money should be spend back here helping our American's. I'm at a point of wanting to move out of this country. My six figure income is a thing of the past thanks to this stale ecomomy. Funny thing is, these wall street types, including Paulson are still make seven figures. What ****s!!!!!!!!
Jul 21, 2011 2:22PM
Instead of not sending social security checks, I think the first checks the fed govt should stop sending is the paychecks of these ridiculous "lawmakers" who are too stupid and stubborn to negotiate a deal.
Jul 21, 2011 12:35PM
Maybe our government should take a look at how much money they are paying all those White House employees and cut their wages. The Soldiers who defend this country do not make 1/8th the money that those White House employees make, just sitting on their butts doing nothing. A 10 year old can use a calculator and make better decisions then those egg heads. This country should start collecting on debt owed to us from other countries. Collect on the banks who needed to pulled out, they are past due on payment.
Jul 21, 2011 12:04PM

 It's time to make REAL cuts. We CANNOT afford to keep our entitlements in their current form. Even if you raise taxes to 100% on the rich it would not come anywhere near solving the trouble we're in. The presidents "plan" if you can call it that is nothing more then a bunch of rhetoric mixed in with tax hikes.The cuts he alleges will be made are spread much too thin across too long of a time period and won't even compensate for growth. This country is being run in to the ground with it's spending habits. The old habits of shifting debt around, printing more money, and highere taxes aren't working anymore. It's clear the country is living far beyond it's means.

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