How Jerome Powell stopped a US default — in 2011

Posted at 6:00 AM, Jul 19, 2019
and last updated 2019-07-19 08:00:11-04

In May of 2011, then-Treasury Secretary Tim Geithner issued a stark warning letter to Congress: the US government had hit the debt limit and would no longer be able to pay its bills past August 2. That gave Congress exactly 11 weeks before America’s wallet would be empty.

Lawmakers, many of them newly elected Tea Party Republicans eager to do battle with President Barack Obama, needed someone to guide them through what a US default would mean for the economy, then still recovering from the 2008 financial crisis.

The person they then turned to? Jerome Powell, now chairman of the Federal Reserve.

Nearly two decades prior, Powell had been in charge of the country’s cash management system as undersecretary at Treasury for domestic finance during the President George H. W. Bush administration. He had crunched the numbers, understood auction markets and knew first-hand exactly when the government’s biggest bills were due — and the potentially catastrophic consequences for financial markets that rely on US Treasury notes for safe investments.

“People thought you could have a platinum coin, or you had a secret gold stash,” said Jason Furman, who was chair of Obama’s Council of Economic Advisers at the time. “They didn’t realize the absoluteness of it.”

Today, it’s Democrats who control the House trying to find a deal with President Donald Trump before early September, when the US again faces the possibility of default. And Powell finds himself once again, eight years later, urging Congress to raise the debt limit in a timely manner as House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin push to reach an agreement before Congress departs for its August recess.

“I wouldn’t be able to capture the range of possible negative outcomes from that,” Powell told House lawmakers last week. He was in France this week for meetings of G7 finance leaders and not available for comment.

But many of those trying to negotiate a deal today were students in Powell’s 2011 lectures — including former South Carolina Republican Rep. Mick Mulvaney, now Trump’s acting chief of staff.

Not since the 1990s had raising the debt ceiling been a contentious issue in Washington. Congress had routinely raised the debt limit each and every time it was needed. But the influx of Tea Party Republicans, who had seized the House during the 2010 midterm elections, triggered a battle with the Obama administration over the nation’s ballooning debt — and they were reluctant to trust estimates coming from Treasury about when the US would actually run out of money.

There was also no way for Congress to fact check whether Treasury’s math was correct or if they were shading the numbers to give themselves a little bit of wiggle room. The administration held its model behind closed doors, and there were only a handful of private firms doing their own calculations.

“There were certainly some in the Republican conference who were, ‘Eh, surely they have additional time. They couldn’t possibly have given us the real date the first time around,'” said Rohit Kumar, who served as McConnell’s deputy chief of staff and domestic policy director.

Enter Powell.

He left government to spend more than a decade in private equity, eventually as a partner at The Carlyle Group and then as a managing partner at the Global Environment Fund. But by 2011, he was making $1 a year as a visiting scholar at the Bipartisan Policy Center, a nonpartisan Washington think tank founded in 2007 by four former Senate majority leaders from both parties: Democrats Tom Daschle and George Mitchell, and Republicans Howard Baker and Bob Dole.

From his perch at the BPC, Powell could see the “unthinkable” potentially unfolding, the federal government going over a fiscal cliff for the first time in US history. He proposed to his colleagues going to Capitol Hill to help members of Congress understand the basics: What is the debt limit? Why is it important? What would be the consequences if no action were taken?

“Jay was able to see this issue was coming,” said Shai Akabas, now the director of economic policy at the BPC. “This all happened pretty fast. There wasn’t a lot of time to prepare. We were doing what we could.”

Akabas and others said it quickly became apparent to Powell at the time that simply briefing members wouldn’t be enough to convince those who distrusted Treasury’s calculations. So he built an independent, objective model with his team as a way to validate Treasury’s estimates, culling daily and monthly statements, mapping out anticipated government bills, and relying on prior year’s data to estimate revenue flowing into the government’s piggy bank.

“There was no one else to depend upon but the Treasury to tell you,” said Bill Hoagland, senior vice president for the BPC. “It was fine if the party in control of Congress and the White House were the same. When we started to get a little bit more polarized people started questioning whether the Treasury secretary had to do it by then.”

Then, with Akabas and two other colleagues, Powell prepared a presentation with more than 50 slides for lawmakers to explain the basics. In the slideshow, which he later shared with the American public on C-SPAN, Powell explained to lawmakers the urgency of the situation, showing that once Treasury had exhausted its emergency borrowing authority, it would be relying on cash on hand and whatever daily revenue flowed into the government’s coffers.

A US default, he explained, meant there would be days when the government would have to delay all payments — including Social Security benefits — as they waited for revenue to fill the till. The reality would be “chaotic” with “unfair results” and “unanswered questions as the government was forced to pick winners and losers.

“Talk about political suicide,” a former senior House leadership staffer said. “In effect, he was telling us, ‘You’re not going to make it through August.'”

Once the limit was reached, Powell warned that “Treasury had no secret bag of tricks to finance government operations” beyond that point in time. That shocked some Republicans who thought it would be possible to keep key checks going out as new tax revenue came in.

“Over the course of that presentation he convinced almost all of the believers of the folly of the prioritizing payments concept,” said the former staffer.

In the end, two days prior to the Treasury Department’s August 2 deadline of exhausting its borrowing authority, Republicans agreed to finally lift the debt ceiling in exchange for a deal that included significant future spending cuts.

The BPC has continued modeling US government finances, remaining a key player in debt negotiations. It most recently updated its forecast last week, reporting that the US government would run out of its borrowing authority by the first week in September — a projection that Mnuchin affirmed in a subsequent letter a few days later.

“We like to claim that the Federal Reserve chairman is pretty responsible for the model that we use here,” said Hoagland.