As US debt default looms, Yellen faces her biggest test yet

WASHINGTON (NYTIMES) – When Janet Yellen was Federal Reserve chair in 2014, she faced a grilling from Republicans about whether the federal government had a plan if the nation’s borrowing limit was breached and measures to keep paying the country’s bills were exhausted.

Ms Yellen, appearing at a congressional hearing, outlined a dire scenario in which financial institutions might try to make payments that they could not cover, because the Treasury Department was out of money, leading to a cascade of bounced checks. She pushed back against the notion held by some Republicans that an economic meltdown could be averted, warning that there was no secret contingency plan.

“To the best of my knowledge, there is no written-down plan,” Ms Yellen said at the time, adding that it was beyond her remit at the Fed. “That’s a matter that is entirely up to the Treasury.”

Fending off such a calamity is now squarely the responsibility of Ms Yellen, who is confronting the biggest test she has faced in her eight months as US President Joe Biden’s treasury secretary. Mr Biden chose Ms Yellen to help steer the economy out of the pandemic downturn. But in the face of congressional dysfunction, she has been thrust into a political role, trying to convince reticent Republican lawmakers that their refusal to lift the debt cap – which limits the government’s ability to borrow money – could lead to a financial collapse.

It is not a comfortable spot for Ms Yellen, an economist by training who is now trying to navigate the rough political waters that she tends to avoid by countering legislative gamesmanship with economic logic.

Over the past month, Ms Yellen has reached out to Democrats and top Republican leaders, including Sen. Mitch McConnell of Kentucky, the minority leader, and Rep. Kevin Brady of Texas, the top Republican on the Ways and Means Committee. She has used those calls to convey the economic risks, warning that Treasury’s ability to stave off default is limited and that failure to lift or suspend the debt cap by sometime next month would be “catastrophic.”

Ms Yellen has reminded Republicans in the calls that they have been willing to join Democrats in lifting the debt ceiling in the past, and that raising the cap allows the US to pay its existing bills and does not authorize new spending.

Thus far, Republicans seem unmoved by Ms Yellen’s overtures.

In a call with Ms Yellen last week, Mr Brady said he told the secretary that he would be happy to work with her on a bipartisan framework focused on financial stability and curbing government spending but, barring that, Democrats should not expect Republicans to help them address the debt limit.

“They are playing a dangerous political game with our economy and it’s absolutely unnecessary,” Mr Brady said Wednesday.

Mr McConnell conveyed a similar message during a telephone conversation with Ms Yellen last week, his spokesman said. Mr McConnell’s former chief of staff, Brian McGuire, said the Kentucky Republican would not be persuaded by pressure tactics and suggested that the Treasury secretary should direct her economic warnings at Democrats.

On Thursday, Ms Yellen appeared at a news conference with Speaker Nancy Pelosi of California and Senate majority leader Chuck Schumer of New York. Ms Pelosi assailed Republicans for refusing to join Democrats in covering costs that both parties have incurred, including the US$1.5 trillion (S$2 trillion) tax cuts that Republicans passed during the Trump administration.

“This is a credit-card bill that we owe,” Ms Pelosi said.

Democrats wanted to pair the federal debt limit increase with legislation to keep the government funded through early December, which would require Republican support in the Senate. With no such agreement in sight, the White House’s Office of Management and Budget on Thursday alerted federal agencies to review their shutdown plans, given funding is scheduled to lapse next week.

Democrats do have another legislative option for raising the borrowing cap – they could pair it with the US$3.5 trillion spending bill that they are aiming to pass along party lines using a fast-track process known as budget reconciliation. However, that would impose procedural hurdles they are trying to avoid, and Democrats have yet to agree on what the spending bill should include or how to pay for it. Party leaders claimed progress toward a deal on Thursday, saying they had agreed upon an array of possible ways to pay for it. But they offered no details about what programmes would be included or what the total cost would eventually be, and what they called a “framework agreement” appeared to be modest.

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Ms Yellen, who has kept a low public profile in the last month, did not make a statement at the news conference and took no questions.

In private, she has tried to amp up the pressure. Ms Yellen has personally warned the chief executives of the nation’s largest banks and financial institutions about the very real risk of default. Over the past several days she has spoken to Jamie Dimon of JPMorgan Chase, David Solomon of Goldman Sachs, Brian Moynihan of Bank of America and Laurence Fink of BlackRock, telling them about the disastrous impact a default would have, according to people familiar with the calls.

The banking industry traditionally wields significant influence with Republicans; the biggest financial services lobbying groups wrote a letter to top lawmakers earlier this month urging them to take action.

“Any default would negatively impact the general economy, disrupt the operations of our financial markets, undermine confidence, and raise funding costs in the future,” they wrote.

Republicans, including Mr McConnell, have insisted that if Democrats want to pass a big spending bill, then they should bear responsibility for raising the borrowing limit. Democrats call that position nonsense, noting that the debt limit needs to be raised because of spending that lawmakers, including Republicans, have already approved.

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“This seems to be some sort of high-stakes partisan poker on Capitol Hill, and that’s not what her background is,” said David Wessel, a senior economic fellow at the Brookings Institution who worked with Ms Yellen at Brookings.

A new report from the Bipartisan Policy Center underscored the fact that if Congress fails to address the debt limit, Ms Yellen will be left with no good options. If the true deadline is Oct 15, for example, the Treasury Department would be approximately US$265 billion short of paying all of its bills through mid-November. About 40 per cent of the funds that are owed would go unpaid.

“Realistically, on a day-to-day basis, fulfilling all payments for important and popular programmes would quickly become impossible,” the report said, pointing to Social Security, Medicare, Medicaid, defense and military active duty pay.

Tony Fratto, a Treasury official during the Bush administration, lamented that Ms Yellen is operating without any leverage. Democrats, he said, appeared to have miscalculated when they thought that Republicans would be too ashamed to block a debt limit vote after supporting a suspension of the borrowing cap when former President Donald Trump was in office.

“I think that was in the ‘hope’ category,” Mr Fratto said. “This is Washington in 2021 – your hopes will be dashed.”

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