WASHINGTON, DC – As demands to preserve wasteful tax loopholes continue to hold America’s creditworthiness hostage and prevent the U.S. from paying its bills and taking needed steps to reduce the deficit, U.S. Senator Jack Reed (D-RI) today questioned Federal Reserve Chairman Ben Bernanke about the potential job loss and economic fallout if Congress fails to prevent a government default.

Reed supports a balanced approach to reducing the nation’s long-term debt that includes cutting spending and reforming the tax code.  He has warned that failing to raise the $14.3 trillion U.S. debt ceiling by August 2nd would hurt the economy, wipe out Americans’ savings, prevent companies from hiring, and increase the national deficit.

In response to Reed’s questioning during a Senate Banking Committee hearing today, Bernanke warned lawmakers that failing to raise the debt ceiling in a timely fashion would cause a “self-inflicted wound” that could include higher interests rates and a slowdown in job creation.

“Loss of investor confidence could potentially raise interest rates quite significantly” complicating efforts to reduce the deficit, Bernanke told Reed.  “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 [the budget deficit].”

Bernanke also stated: “So I can only conclude that this would be very bad for -- for jobs.”

After the hearing, Reed stated: “People need to understand the debt ceiling needs to be raised to pay the bills that are due.  This money has already been spent on things like unpaid for wars, unpaid for tax cuts skewed to the wealthiest, and a host of other ‘buy now, pay later’ policies from the last decade.  America simply cannot afford to default on our past debts and cause a double-dip recession.  We need a balanced approach that won’t undermine our nation’s economic recovery and that will bring our budget under control.”

During the hearing Reed also asked Bernanke if the Tea Party-backed proposal to ignore the debt ceiling and simply prioritize federal spending in the event that Congressional leaders and the President do not agree on a way to prevent default by August 2nd.  Bernanke testified that this would essentially amount to paying China before paying U.S. workers and citizens.

Reed asked: “So, effectively, if we were to be paying our debt and not paying our Social Security payments, we would be principally paying the Chinese central bank in lieu of paying Americans?”

Bernanke responded: “That's right. But if we didn't did do that, of course, we would suffer financial consequences.”

A full transcript of Senator Reed’s questioning follows and you can watch the exchange here:

REED: Thank you very much, Mr. Chairman.

Mr. Chairman, following up on Senator Johnson's question, which was about a default on our outstanding obligations of the federal government, some have suggested that if our Treasury -- if we cannot resolve the debt ceiling limit, we simply prioritize payments.

We would presumably pay on some treasuries as long as we can, pay principals and interest. That, of course, requires us to not pay on things like military pay and Social Security.

But just in the context of the financial sector, would that fix the problem, simply, you know, not having the debt limit extended and trying to pay as long as we can on our securities?

BERNANKE: Well, Senator Reed, first -- first of all, of course, it's the Treasury's area to determine how they're going to manage this. They have been pretty clear that they don't think it's either appropriate or feasible to prioritize.

And as the fiscal agent, we, the Federal Reserve, simply does what they tell us to do. And I think there are in fact some operational issues that arise if you were to try to do it.

But, again, the Treasury is the determinant of this. And they are pretty clear that they don't think that's a workable solution.

That being said, whether -- whether default is on securities or whether it's on payments we owe to Medicare recipients, it's going to constitute a default of some type on obligations incurred by the U.S. government.

And it will certainly have an impact on both the economy but also on confidence. You know, what -- what inference should investors take from the fact that the U.S. is not paying its bills and that it can't resolve this issue.

So I think that, you know, no matter, there's not really any solution other than to find a way to solve these problems, to address the fiscal issues and to...

REED: Pass the debt limit.

BERNANKE: ... raise the debt limit at the appropriate time.

REED: Let me just explore a little bit. Moody's today and Standard & Poor's have suggested that they are putting us on a watch, downgrading. And what clearly is behind them is that if we do not pass the debt limit ceiling, raise them, they will downgrade us, not only U.S. treasuries, but they have -- Moody's has indicated Fannie Mae paper, Freddie Mac paper, Federal Credit Bureau paper, and we have also placed for possible downgrade securities either guaranteed by, backed by, collateral securities issued by or otherwise directly linked to the United States government.

Essentially, they're gonna downgrade things we don't even know -- yet. Maybe you know.

What does this do in terms of interest rates across the board, likely raise them even in a, quote, "technical default"?

BERNANKE: Well, the combination of downgrades, which we were already seeing it, by the way -- we're still some weeks away from the deadline...

REED: Right.

BERNANKE: ... and loss of investor confidence could potentially raise interest rates quite significantly. And the ironic aspect of that, of course, is all -- what we're all interested in doing is reducing the deficit. 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.

REED: So a failure to raise the debt ceiling would be probably the most significant immediate increase in the deficit that we're likely to see, the one act that would dramatically increase the deficit?

BERNANKE: It would be a self-inflicted wound, I would say.

REED: And let me ask about something else, too. And that is, because you've talked about a fiscal crisis but also a jobs crisis.

What's your presumption under this scenario about jobs? Are we likely to see people eagerly going out and hiring under this situation of technical or real default?

BERNANKE: Well, I mean, we have a recent example -- in 2008, when the financial system froze up and we saw an immediate, very sharp retraction in the global economy. Even if we didn't -- things didn't get that bad, and I -- I -- one of the key issues here is it's very hard to predict exactly what's going to happen. But if interest rates rise, that's clearly going to reduce investment, uncertainty will rise, that will reduce the abilityness (ph) of firms to hire and invest.

So I can only -- and, of course, if the government's reducing its payments by 40 percent, that's going to have an impact as well.

REED: Right.

BERNANKE: So I can only conclude that this would be very bad for -- for jobs.

REED: Let me ask you another area, which was -- we discovered much to our chagrin was a huge and explosive problem. That is the situation of derivatives.

I would presume that there are a lot of credit default swaps written on many of these securities, et cetera, and that if they are downgraded, that could be a condition of default, that could require additional collateral.

Do you have any idea on the institutions that you regulate, the potential exposure they would have as credit ratings fall, or as there is a default on the market? Is it in the trillions?

BERNANKE: Well, there are many knock-on effects from a default ranging throughout the entire system. But CDS directly on treasuries as opposed to on other securities are actually not that big, so -- and it would take an action of the ISDA to invoke, you know, the credit event.

So that could be a problem for some institutions, but it wouldn't be the biggest problem among all the things that we've been discussing.

REED: But your point, which I want to reiterate, is that this could be a self-inflicted wound, doing more damage to the deficit than anything done to date.

BERNANKE: It's really not an option that we want -- we should be considering.

REED: Thank you.

Later in the hearing, Reed engaged Bernanke in a second round of questioning:

REED: Thank you, Senator Schumer. I just -- I just have one question. Who's the largest holder of our Treasury debt and our (inaudible) debt? Is it the Chinese government or Chinese institutions, or do you...

BERNANKE: Well, the Fed has a lot...

REED: You have a lot of it?

BERNANKE: The Chinese, I think, probably right.

REED: Right after the Fed would be the Chinese?

BERNANKE: As an individual institution, the reserve -- reserve holding -- the central bank that holds the reserves...

REED: Of China?

BERNANKE: Of, China, yeah.

REED: So, effectively, if we were to be paying our debt and not paying our Social Security payments, we would be principally paying the Chinese central bank in lieu of paying Americans?

BERNANKE: That's right. But if we didn't did do that, of course, we would suffer financial consequences.

REED: I -- I -- I completely concur. And I think the solution is to appropriately raise the debt ceiling, deal with the fiscal and -- issues of the deficit that we face, and we're trying to do that. But just, ironically, you know, this -- when you give this sort of prioritization, the irony is the priority is to the Chinese central bank, and lower on the pecking order would practically be seniors and Social Security recipients and maybe even American military personnel.

I think that's the reality, isn't it?

BERNANKE: Well, again, if prioritization were even feasible...

(CROSSTALK)

REED: Right, even feasible. And your point is you don't believe it's even feasible.  Well, Mr. Chairman, thank you again, not only for your testimony today but your service to the nation in very, very difficult and challenging times.

And the hearing record will remain open for seven days for additional statements and questions. With that, the hearing is adjourned.

 Thank you, Mr. Chairman.

BERNANKE: Thank you, Senator.

-end-