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Bernanke: U.S. would pay bondholders after August 2

Jul 13, 2011, 12:14 p.m.

By Deborah Charles and Andy Sullivan

WASHINGTON (Reuters) - If the United States fails to raise the debt ceiling by August 2, it will pay creditors first and stop benefits like Social Security payments, Federal Reserve Chairman Ben Bernanke said on Wednesday.

The central banker's comments offered the first public indication of how the Obama administration will prioritize its financial obligations after August 2, when the U.S. Treasury says the government would run out of money to pay all of its bills.

"The assumption is that as long as possible, the Treasury would want to try to make payments on the principal and interest to the government debt, because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy," Bernanke said.

His comments will reassure many investors, but threatening Social Security is dangerous politics ahead of 2012 elections.

Even though the expectation is for Washington to prioritize its debts, the Obama administration has so far refused to talk about planning for a possible default because it wants to avoid giving Republicans a reason to see August 2 as a soft deadline.

President Barack Obama and congressional leaders are due to meet for a fourth straight day at 4 p.m. EDT (2000 GMT) in an effort to reach a deficit reduction deal that would clear the way for Congress to increase the $14.3 trillion debt ceiling.

While both sides agree on the need to increase the debt limit, they are still far apart on how to do it. Talks have become more acrimonious in the last few days as Republican and Democratic leaders have lashed out at each other and hardened their positions, making compromise difficult.

Bernanke's comments could further complicate talks because they could be used by conservatives to bolster their claim that default can be avoided by paying bondholders first, something Treasury Secretary Timothy Geithner says is unworkable.

Republicans have insisted on steep spending cuts in return for voting to increase the debt ceiling. But both sides are divided over tax increases, which Democrats insist must also be part of any long-term budget deal. Republicans say they won't back any tax hikes because they could hurt the economy.

House of Representatives Republican leader Eric Cantor, who has been at odds with House Speaker John Boehner, the top Republican in Congress, over how to reach agreement, said the two sides should focus on the roughly $3 trillion in spending cuts that had been floated as part of a "grand bargain" that Obama had proposed.

Democrats are not likely to back that idea because it would require deep cuts to benefits programs that they oppose and would not include the $1 trillion in tax increases they seek.

Investors so far are more concerned about a mounting debt crisis in Europe than a possible default in the United States, analysts said. Demand remained strong on Wednesday for 10-year U.S. Treasury notes, with yields near their lowest mark since December.

NOT TAKING SIDES

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