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

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

Bernanke said he was reluctant to take sides in the deficit reduction debate but made clear that prioritizing the debt would hurt ordinary Americans.

"As a matter of arithmetic, fairly soon after that date there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money," Bernanke said, focusing on areas affecting the elderly and the military that could affect key voting blocs ahead of 2012.

Missing the August 2 deadline would force an immediate 40 percent cut in government spending, he said.

The chairman of the central bank is not a member of the administration, but the Federal Reserve has been involved in the Treasury Department's discussions on how to prepare for a possible default.

Obama issued a similar warning on Tuesday, saying he could not guarantee that Social Security pension checks would go out on time in August if no deal was reached.

Asked in a new Reuters/Ipsos poll what bills the government should stop paying if the debt limit is not raised, 36 percent of Americans listed international creditors like banks.

Bernanke also echoed the oft-repeated warning of a global financial crisis if the United States defaulted on its debt.

"It's the foundation for much of our financial system and the notion that it would become suddenly unreliable and illiquid would throw shockwaves through the entire global financial system," he said.

Not everyone on Wall Street saw his statements on prioritizing U.S. debt in a positive light.

"If they're literally scrambling over a weekend to avoid a technical default by making selective payments I'm not sure that's really a solution," said Christian Cooper, head of dollar derivatives trading, Jefferies & Co, New York.

"The markets would broadly perceive that as a failure of leadership and a fiscal failure, because the markets would perceive that we have a complete failure of leadership."

Several conservative House Republicans, however, questioned whether financial markets would be affected by a default as long as the government continued to make its bond payments.

They proposed a bill that would require the Treasury Department to prioritize military salaries, along with bond payments, over other forms of government spending in the event the debt ceiling is not raised.

(Additional reporting by Donna Smith, Thomas Ferraro, Doug Palmer, Caren Bohan and Tim Reid in Washington and Emily Flitter in New York; Editing by Ross Colvin and Vicki Allen)

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