The Debt Ceiling Is Breaking Ben Bernanke’s Heart

The cardiac Congress is undermining the Fed chairman’s economic crusade.

WASHINGTON, DC - SEPTEMBER 18: Federal Reserve Chairman Ben Bernanke pauses as he speaks during a news conference at the Federal Reserve, September 18, 2013 in Washington, DC. Chairman Bernanke spoke after a closed door meeting of the Federal Open Market Committee. The Federal Reserve announced today that it will not scale back the bond-buying program and continue buying bonds at $85 billion a month. 
National Journal
Patrick Reis and Catherine Hollander
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Patrick Reis and Catherine Hollander
Oct. 9, 2013, 2 a.m.

Ben Bernanke has spent half of a dec­ade try­ing to coax in­vestors out of their postre­ces­sion bunkers. Now, Con­gress is set to send them run­ning for cov­er again.

The gov­ern­ment may not de­fault on its loans in the com­ing weeks, but just by com­ing close to the edge, law­makers will pull mar­kets in the ex­act op­pos­ite dir­ec­tion from where the Fed­er­al Re­serve has been try­ing to push them.

Bernanke’s bid to re­sus­cit­ate the eco­nomy de­pends on per­suad­ing people to make two leaps of faith. First, busi­nesses re­quire enough con­fid­ence in the fu­ture to ask for the big loans they need to ex­pand their op­er­a­tions, in part by hir­ing some of the coun­try’s 11.3 mil­lion un­em­ployed work­ers. Second, lenders need to be­lieve that mak­ing those loans is the best use of their money.

The Fed’s quest to drive down in­terest rates tar­gets both goals. By keep­ing rates low, Bernanke makes it cheap­er for bor­row­ers to take out loans. And to per­suade lenders to take a risk on those loans, the Fed has bought up massive quant­it­ies of Treas­ury bonds — con­sidered the ul­ti­mate safe in­vest­ment — in an ef­fort to drive down the rate at which those bonds pay off to private in­vestors. The hope is that in­vestors, dis­sat­is­fied with the low rate of re­turn they get from the fed­er­al gov­ern­ment, will in­stead put their money in­to the private sec­tor.

That’s where Con­gress’s be­ha­vi­or is so dam­aging. By pre­cip­it­at­ing one crisis after an­oth­er, law­makers are send­ing in­vestors run­ning back to in­vest­ments like Treas­ury bonds — which keep their money safe but do pre­cious little in the way of stim­u­lus. If Con­gress wanted to spook lenders, it could hardly pick a bet­ter meth­od than flirt­ing with de­fault. “It would be the op­pos­ite of what the Fed’s wanted to do,” says Stu­art Hoff­man, chief eco­nom­ist at PNC Fin­an­cial Ser­vices. “It ba­sic­ally says something has happened out­side the Fed’s con­trol that could shock the eco­nomy in­to re­ces­sion.”

For Bernanke, the cur­rent debt-ceil­ing stan­doff may be all the more in­furi­at­ing be­cause he’s seen it, and its de­struct­ive ef­fects, play out be­fore. When the coun­try last brushed up against the debt ceil­ing in the sum­mer of 2011, in­vestors flocked to Treas­ury bonds, look­ing for a safe place to park their as­sets while they waited to see wheth­er Con­gress was go­ing to un­leash eco­nom­ic chaos.

As in­vestors sought refuge in bonds, they fled from stocks. The stock mar­ket — fa­cing a de­fault threat in the U.S. and a sov­er­eign-debt crisis in Europe — plunged as the Aug. 2 debt-ceil­ing dead­line ap­proached and con­gres­sion­al Re­pub­lic­ans, Demo­crats, and Pres­id­ent Obama re­mained dead­locked. The Dow Jones in­dus­tri­al av­er­age began slid­ing on Ju­ly 22, and the losses wer­en’t erased un­til Janu­ary of this year. A gov­ern­ment de­fault was aver­ted in the nick of time, but Stand­ard & Poor’s cut the coun­try’s AAA cred­it rat­ing.

His­tory ap­pears poised to re­peat it­self as bond in­terest rates are fall­ing sharply in the run-up to the new dead­line, Oct. 17. The yield on the 10-year Treas­ury bond, the mar­ket’s bench­mark, hit a two-month low on Oct. 3, sig­nal­ing that in­vestors are will­ing to swal­low lower pay­outs on their in­vest­ment in ex­change for safe har­bor. Yields on the one-month T-bill soared Tues­day; the high­er short-term fed­er­al bor­row­ing costs re­flec­ted in­vestors’ con­cerns about a de­fault in the com­ing weeks. Stocks have slipped in re­cent weeks, too, as a gov­ern­ment shut­down stretches on and the bor­row­ing-lim­it dead­line nears.

On the face of it, it’s con­fus­ing that in­vestors would seek refuge with the U.S. gov­ern­ment at the same time the gov­ern­ment is in danger of de­fault­ing on its debts. But in­vestors fig­ure Wash­ing­ton will even­tu­ally meet those ob­lig­a­tions, and that in the tur­moil ac­com­pa­ny­ing a brush with de­fault — or if the coun­try’s cred­it rat­ing is lowered — oth­er in­vest­ments would fare worse.

“Treas­ur­ies are worth a little less [after a down­grade],” Hoff­man says. “And guess what? Every­body else is also worth a little less.”

The Fed may already be re­spond­ing to the un­cer­tainty of today’s gov­ern­ment shut­down and po­ten­tial de­fault. Bernanke was ex­pec­ted to an­nounce the be­gin­ning of a di­al­ing-back in Fed stim­u­lus in Septem­ber, but his policy-mak­ing com­mit­tee shocked in­vestors by an­noun­cing the Fed would keep go­ing full speed ahead and ob­liquely ref­er­en­cing Wash­ing­ton’s fisc­al tur­moil as one of the causes for the de­cision.

It’s un­clear how much lever­age they have left. The Fed has already bought more than a tril­lion dol­lars worth of bonds and has kept the fed­er­al funds rate, the cent­ral bank’s bench­mark in­terest rate, close to zero for more than four years — and none of that has man­aged to move the un­em­ploy­ment rate down to 6.5 per­cent, the point at which the Fed said it would be­gin to slow down its stim­u­lus ef­forts. Bernanke has said the stim­u­lus pro­grams could of­fer “di­min­ish­ing re­turns” over time.

There are also risks in the Fed’s re­spond­ing to fisc­al chaos by buy­ing more bonds and keep­ing in­terest rates low. Fed­er­al Re­serve Board Gov­ernor Gov­ernor Jeremy Stein has warned that a pro­longed low-rate en­vir­on­ment could cause in­vestors to “reach for yield,” Fed­speak for in­vestors who seek profit so des­per­ately that they pile in­to the ris­ki­est in­vest­ments and im­per­il the en­tire fin­an­cial sys­tem. And Kan­sas City Fed Pres­id­ent Es­th­er George has voted against the Fed’s stim­u­lus ef­forts this year, cit­ing con­cerns about cre­at­ing “fin­an­cial im­bal­ances.”

But for now, with un­em­ploy­ment still high, and with a gen­er­a­tion of work­ers watch­ing as the pro­longed eco­nom­ic slump dam­ages their long-term eco­nom­ic pro­spects, Bernanke’s big­ger worry is that all his ef­forts have failed to pro­duce the good-times-are-here-again growth that Amer­ic­ans are wait­ing for.

Throughout his ten­ure, Bernanke has spoken op­tim­ist­ic­ally about the Fed’s power to heal a dam­aged eco­nomy, but bar­ring a dra­mat­ic course cor­rec­tion, the chair­man will spend his fi­nal few months watch­ing Con­gress break it all over again. Maybe Janet Yel­len, whom the White House nom­in­ated Wed­nes­day to suc­ceed him, will have bet­ter luck with Cap­it­ol Hill.

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