Bernanke Says Using Debt Limit as ‘Bargaining Chip’ Could Threaten Economy

Federal Reserve Chairman Ben S. Bernanke cautioned lawmakers against using the federal debt limit as a “bargaining chip” during budget talks, saying such moves could provoke market instability and harm the economy.

“I think using the debt limit as a bargaining chip is quite risky,” the Fed chief said today in testimony to the Senate Banking Committee in Washington. Failure to raise the debt limit would “at minimum” lead to “an increase in interest rates, which would actually worsen our deficit and would hurt all borrowers in the economy.”

The comments echo warnings by Bernanke this year over the potential costs if investor concern mounts that the U.S. will fail to repay its debt. Treasury Secretary Timothy F. Geithner has said lawmakers must raise the $14.3 trillion debt ceiling before Aug. 2 or risk a default. House Speaker John Boehner, a Republican from Ohio, says any increase must come with “significant spending cuts and reforms to reduce our debt.”

“It’s a risky approach” not to raise the debt limit “at a reasonable time,” Bernanke said.

The Republican Study Committee, a group of self-described fiscal conservatives, is circulating a letter asking Boehner to back a plan that would cut the federal deficit in half in one year in exchange for a vote to approve in increase in the statutory debt limit. The measure would reduce spending by about $380 billion in fiscal 2012.

Market Confidence

“Even if the debt is paid, there’s the issue of market confidence and how the market would respond to the risk of default or even the default of non-debt obligations,” he said. “The worst outcome would be one in which the financial system would again destabilize,” he said, adding that such an occurrence “would have extremely dire consequences for the U.S. economy.”

Separately during the hearing, Bernanke, 57, said lawmakers should have “reason to be concerned” that an exemption for smaller lenders from U.S. caps on debit-card “swipe” fees won’t work and may cause banks to fail.

“I can’t say with certainty, but I think there is good reason to be concerned about it,” Bernanke said in response to a question at the hearing. If the exemption doesn’t work, “it’s going to affect the revenues of the small issuers, and it could result in some smaller banks being less profitable or even failing,” he said.

The Dodd-Frank Act requires the Fed to cap debit-card swipe fees charged to merchants, while exempting card issuers with assets of less than $10 billion. The central bank has proposed capping the fees at 12 cents a transaction, replacing a formula that averages 1.14 percent of the purchase price.

Won’t Work

Community banks and credit unions have said the exemption won’t work and may make their cards less competitive. They oppose the Fed’s plan along with the biggest lenders, including Bank of America Corp. (BAC) and JPMorgan Chase & Co., which could lose more than $12 billion in annual revenue if the cap takes effect.

Lawmakers in the House and Senate have introduced legislation to delay the rule. Senator Jon Tester, a Montana Democrat, has proposed postponing the rule for two years and requiring a study.

On another issue, Bernanke said finding a solution to reduce U.S. home foreclosures has proven “very difficult” and that government efforts have had “modest success.”

The Fed is trying to address the problem through monetary policy aimed at lowering unemployment, Bernanke said during the hearing.

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net;

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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