The Fed's Response to a Debt Default: "Not Much"

  • Not much: Jerome Powell responded by saying that there’s “little the central bank could do to prevent an economic meltdown” if the US did not pay its bills.
  • He continued: “No one should assume that the Fed can really protect the economy and the financial system and our reputation globally from the damage that such an event might inflict.”

Following the March 10th failure of Silicon Valley Bank the Fed took steps that resembled what it might also do with defaulted US debt—agreeing to accept impaired securities, at face value, as collateral on loans to banks.

  • Accepting defaulted securities as collateral for Fed loans—essentially swapping “good” debt for bad debt—would be an extreme variation on the theme.
  • The alternative, however, could also be an economic collapse that would follow a default.

To a bank, carrying “underwater” investments can be catastrophic, as the recent collapse of Silicon Valley Bank demonstrated.

  • To a central bank, with no budget constraint and an elastic time horizon, it’s just a matter of waiting out the politicians.

Go deeper and read the full piece here.