WASHINGTON (Reuters) – Federal Reserve Chairman Jerome Powell on Thursday asked what the Fed would do if U.S. Treasuries defaulted, citing Fed leaders on the issue. reiterated the mantra of: default is unthinkable, the U.S. government had to pay its bills, and if the central bank did not, there was little it could do to prevent an economic meltdown.
“We should not think that the Fed can really protect our economy, our financial system or our global reputation from the damage that such an event could cause,” Powell said.
But what’s not said is that some seven weeks ago, Powell again signaled his willingness to race past central bank red flags if necessary.
As a member of the Fed’s board of directors a decade ago, Powell called certain possible default responses by the Fed “abhorrent.” However, following the failure of the Silicon Valley Bank on March 10, the Federal Reserve took similar action against defaulted U.S. Treasuries, accepting impaired securities at face value as collateral for loans to banks. Agreed.
The move broke the central bank’s long-standing maxim that collateral is only accepted at a reduced value to minimize the moral and financial risks of providing such loans. It also helped contain possible financial turmoil, based on the reasonable assumption that the U.S. government would eventually pay the full amount of its Treasury bills and bills, even if they temporarily traded below par.
Accepting defaulted securities as collateral for Fed loans, or exchanging “good” federal debt already held by the Fed for impaired debt held by private investors are extreme variations on the theme, but alternatives It could prove to be less “disgusting” than the draft. Some predict that an economic collapse will follow defaults.
As the recent failure of Silicon Valley Bank shows, investing “behind the scenes” can have disastrous consequences for banks. For central banks, there are no budget constraints and flexible timeframes, so all you have to do is wait and see what politicians do.
The program put in place by the Fed in response to the SVB’s failure blurs the line “pretty blurry” between defaulting bonds and other securities for which no payments were made, according to a former Fed official. Vincent Reinhart, Top Staff and now Chief Economist, said: Dreyfus and Mellon could theoretically use Treasury issues at face value to secure loans from the Fed.
“They test hypotheses they don’t want to consider, so I’m not going to say specifically what they do.
A lapsed centrist?
Powell joined the Fed in 2012 from a think tank that was working on debt and deficit issues. He initially argued for aggressive central bank forays into quantitative easing, massive purchases of government bonds and mortgage-backed securities that expanded the Federal Reserve’s balance sheet, and private sector investment to fight off 2007-09. He was a centrist who felt uncomfortable with his presence in the financial markets. economic crisis.
Quantitative easing was considered an “unconventional” policy at the time, and many believed it would one day be removed, shrinking the Fed’s balance sheet back to its previous levels.
But the 2023 Federal Reserve Board (post-pandemic, post-global financial crisis) will be a separate body from those overseen by chairs like Alan Greenspan and Paul Volcker, and the one Powell has joined. is also different.
Quantitative easing is now integral to the Fed’s strategy, and its $7.8 trillion balance sheet is central to how the Fed manages interest rates and monetary policy.
Powell, who has been chairman since February 2018 after being promoted to then-President Donald Trump, has repeatedly demonstrated his willingness to abandon old practices when necessary. For example, the traditional guardrails when the Federal Reserve agreed to intervene in private bond markets.
He may not, in theory, think central banks should buy bonds of private companies. But if the alternative is a deep economic recession, purity can wait.
In the summer of 2020, on the eve of a devastating outbreak of inflation, Powell adopted a long-standing effort to shift the Fed’s policy focus toward the goal of full employment rather than the price mandate. bottom. , fixing what he came to believe was a policy bias that put more people out of work than needed to keep inflation stable.
The ruling was controversial as inflation began to spike in 2021.
A default could pose another tough decision for the Fed chairman, whose motto is never say never.
Reported by Howard Schneider.Edited by Andrea Ricci
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