Friday, July 15, 2011

A Buyer For 14th Amendment Bonds

There has been speculation that, if the federal debt ceiling isn't raised by August 2, 2011, the President might order the Treasury Department to issue more U.S. Treasury securities anyway, relying on supposed authority from the 14th Amendment to the Constitution. The President has said he won't do this. But if push comes to shove, and the ship is about to hit the iceberg, who knows? Desperate times call for desperate measures.

Legal talking heads have yammered busily about the correct interpretation of the 14th Amendment. Market talking heads have speculated that buyers would be hard to find because the uncertain legality of 14th Amendment debt would make it a pig in a poke that investors would shun.

The legality of such debt is open to vigorous debate. But in terms of finding buyers, that's easy. No sweat. There's a buyer out there who will snarf up all 14th Amendment debt, if necessary, and not worry a bit about its legality. That buyer would be the Federal Reserve.

Fed Chairman Ben Bernanke hasn't said a word publicly about the Fed buying 14th Amendment debt. The thought may not have even occurred to him. But if push comes to shove, and the Sword of Damocles is about to drop on the federal government, the Fed will undoubtedly ride to the rescue with regimental colors flying and Garry Owen playing. A central bank buying its government's debt is said to monetize that debt, a serious no no in the view of many economists because it could trigger inflation. But the Fed hasn't, in recent years, seen any inflation it didn't like. And with the economy slowing again, Chairman Bernanke may well be pondering how to slip a little more quantitative easing into the financial system. Buying up 14th Amendment debt may be the least controversial way to do it, since the Fed could claim it's monetizing debt for the sake of Old Glory.

The Fed need not send a check directly over to the Treasury for the 14th Amendment debt. That might be a tad indiscreet. Instead, it could quietly signal to its primary dealers that they wouldn't take any losses on the stuff. The dealers would likely do the patriotic thing and choke down these latter day Liberty Bonds even if they taste an awful lot like broccoli. The Fed could then buy the stuff up from primary dealers or accept it as collateral for their borrowings from the Fed.

What if the 14th Amendment bonds turn out to be unlawful? The Fed would surely protect its primary dealers and take the losses itself. The uncollectable bonds would simply relieve the Fed of the necessity of withdrawing some liquidity from its quantitative easing program. Nothing would make the Fed happier. Of course, the Fed would have a paper loss. But the loss would consist of money it printed, not real money from member banks or taxpayers. Easy come, easy go.

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