Bloomberg News

Bernanke Warns of ‘Self-Inflicted Wound’ Should U.S. Default

July 14, 2011

July 14 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke warned lawmakers that they would cause a “self- inflicted wound” should they prompt a credit-rating downgrade by failing to raise the $14.3 trillion U.S. debt ceiling.

Congress should recognize it’s “tremendously important that we have the confidence of the world in terms of willingness to hold Treasuries, to trade in Treasuries, to maintain a liquid market in Treasuries,” he said today in testimony to the Senate Banking Committee. “It’s a very important asset and losing that credit rating is, again, I think a self-inflicted wound.”

The Fed chairman, responding to lawmakers’ questions, urged Congress to reach a solution on the debt ceiling and a broader fiscal deal before U.S. borrowing authority expires Aug. 2. He warned of higher unemployment and the risk of global financial market instability, while noting that a lower credit rating would increase borrowing costs, further widening the deficit.

“Loss of investor confidence could potentially raise interest rates quite significantly” and complicate efforts to reduce the deficit, Bernanke told Senator Jack Reed, a Democrat from Rhode Island. “If you raise interest rates, that means your interest costs go up substantially, and you’re actually making -- you’re regressing rather than progressing in this.”

Yields on 10-year Treasury notes rose 5 basis points, or 0.05 percentage point, to 2.93 percent at 2:26 p.m. in New York. The Standard and Poor’s 500 Index fell 0.3 percent to 1,313.29 after Bernanke said “We’re not prepared at this point” to take further action to stimulate the economy.

Calm Before Storm

“Maybe it is the calm before the storm,” said Richard Schlanger, a vice president at Pioneer Investments in Boston, which oversees $20 billion in fixed-income securities. “Bond- market participants believe there will some kind of resolution of the debt ceiling and the government will meet its obligations.”

Moody’s Investors Service raised the pressure on U.S. lawmakers to increase the debt limit by placing the nation’s credit rating under review for a downgrade yesterday.

The U.S., rated Aaa since 1917, was put on review for the first time since 1996 on concern the debt threshold won’t be raised in time to prevent a missed interest or principal payment on outstanding bonds and notes, Moody’s said in a statement. The risk of such an outcome is low, Moody’s said.

The rating may be reduced to the Aa range, and there is no assurance Moody’s would restore its top rating, even if a default is quickly “cured.”

President Barack Obama is considering summoning congressional leaders to Camp David this weekend to work on a plan to raise the debt ceiling after yesterday’s negotiations on a deficit-cutting plan of at least $2 trillion stalled, according to two people familiar with the matter.

--With assistance from John Detrixhe and Daniel Kruger in New York. Editors: James Tyson, Christopher Wellisz

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net;


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