In a Nov. 16 letter to Congress, Treasury Secretary Janet Yellen wrote that there is “a high degree of confidence that Treasury will be able to finance the U.S. government through Dec. 15,” but beyond that “there are scenarios in which Treasury would be left with insufficient remaining resources to continue to finance the operations of the U.S. government.”
This follows earlier statements in which Secretary Yellen noted that leaving the debt ceiling unaddressed “can cause serious harm to business and consumer confidence, raise borrowing costs for taxpayers, and negatively impact the credit rating of the United States for years to come,” and that after hitting the debt limit, the country “would likely face a financial crisis and economic recession.”
Left out of the debt-ceiling discussion, however, is that Treasury’s inability to borrow would leave the U.S. severely constrained in addressing the consequences of any potential financial crisis.
As part of Congress’s response to the 2007-08 financial crisis, Title II of the Dodd-Frank Act granted the Federal Deposit Insurance Corp. the ability to resolve failing financial institutions — such as bank holding companies and insurance companies — whose demise would affect the stability of the financial system. This orderly liquidation authority provides that the FDIC essentially takes ownership of these institutions, operating them while winding them down in a way that mitigates systemic risk. The FDIC is authorized to make loans to the failing institutions, purchase their debt, purchase their assets, assume and pay their obligations, or otherwise make payments that ensure financial stability. To fund these operations, Congress created the Orderly Liquidation Fund.
Unfortunately, Congress did not pre-fund the OLF, and Dodd-Frank contemplates Treasury selling securities to fund the FDIC’s orderly liquidation activities. Specifically, the law expects that Treasury will issue debt to fund the FDIC’s orderly liquidation activities. The act allows the FDIC to borrow from Treasury up to “10% of the total consolidated assets” of a company during the first 30 days after it has been named the company’s receiver, and up to 90 percent thereafter.
To understand exactly what could happen if the FDIC could not use its orderly liquidation authority to stabilize and prudently unwind one, two or more of the largest financial companies because it cannot receive a loan from Treasury, one needs to simply look at the consequences of the financial crisis in which Lehman Brothers was allowed to collapse.
The Government Accountability Office estimated that the crisis reduced domestic GDP by more than $13 trillion and resulted in paper losses for homeowners of $9.1 trillion. The unemployment rate did not reach pre-crisis levels until nearly a decade after the crisis began. The decreased employment rate, lower savings rate, and lower homeownership rate of millennials have all been attributed to the crisis. And this was a crisis in which $370 billion was committed to bailing out AIG, Fannie Mae and Freddie Mac, and $30 billion was spent incentivizing JPMorgan Chase to buy Bear Stearns.
Hitting the debt limit could not only spur a financial crisis, but it could also leave the FDIC unable to mitigate the consequences of a financial crisis it causes. Policymakers should recognize this as one more risk of leaving the debt limit unaddressed.
