Fed Official Warns U.S. Debt Default Would Be ‘Catastrophe’ As Bank Of America Gears Up For The Worst

Topline

Federal Reserve official Neel Kashkari on Tuesday reiterated the Treasury’s concern over the nation’s looming debt ceiling crisis, and though he’s unsure how likely a potential default could be, the central banker’s comments come one day after Bank of America’s chief said the institution is gearing up for the worst.

Key Facts

Speaking to CNN on Tuesday morning, Kashkari said he “absolutely” agrees with Treasury Secretary Janet Yellen that a U.S. debt default would be “a catastrophe” if Congress fails to raise or suspend the debt limit by June; the limit was breached on January 19, forcing the Treasury to undergo “extraordinary measures” to help pay its obligations for a few more months.

Though Kashkari stopped short of saying whether the debt debacle now seems riskier than the conundrum that sparked a market correction in 2011, he reiterated Yellen’s warning last month, when she cautioned a default would cause “irreparable harm” to the economy, endangering basic government functions (such as national defense) and weakening the dollar and stocks.

“I’m hopeful that the political leaders in Washington… will come up with a solution,” Kashkari said, adding Congress, currently split with a Republican-led House and Democratic Senate, “needs to come together and reach a solution.”

The comments come one day after Bank of America CEO Brian Moynihan said “hope is not a strategy” as he noted the bank has already started to prepare for the possibility of a default by shoring up liquidity and setting up payment waivers for clients who get paid by the government.

Moynihan acknowledged lawmakers on both sides of the aisle have stated they don’t intend to risk a default in negotiations over the debt limit, but he echoed concern from experts on the brinkmanship that could rattle markets, saying “Right now, we’ve got to get past the issues.”

Crucial Quote

“There is a temptation to brush off the developing debt limit drama, thinking it will end as the others have with lawmakers coming to terms and signing legislation just in time,” Moody’s Analytics chief economist Mark Zandi wrote in a note to clients last month. “That would be a mistake given the heightened dysfunction in Congress… Odds that lawmakers blunder either out of intent or ineptness are uncomfortably high.”

What To Watch For

House Speaker Kevin McCarthy (R-Calif.) has repeatedly pledged the U.S. will avoid a debt default, but it’s unclear what compromise Democrats and Republicans will reach to prevent one. In the deal to elect him as Speaker last month, McCarthy promised Congress would not agree to raise the debt ceiling without significant spending cuts. Some Republicans have floated raising the age for Medicare and Social Security eligibility in an effort to reduce the federal deficit—an idea Senate Democrats would likely reject.

Key Background

According to the Treasury, Congress has either raised, extended or revised the definition of the debt limit, which caps the amount of debt the Treasury can issue to fund government obligations, 78 times since 1960, and it hasn’t yet failed to act on the issue when necessary. Still, many economists have warned the debt limit debacle this year could be the worst since the 2011 crisis that tanked the S&P 500 by 15%. Government spending deadlines will “pose a greater risk this year than they have for a decade,” Goldman Sachs economists told clients last month, pointing to the divided Congress as a complicating factor for crucial legislation, with an “extremely thin” margin of Republican control in the House and a two-vote lead by Senate Democrats.

Further Reading

Federal Government Officially Reaches Debt Limit, Triggering ‘Extraordinary Measures’ To Prevent A Default (Forbes)

U.S. Could Run Out Of Cash By Early June If Debt Limit Isn’t Raised, Yellen Warns (Forbes)