Tuesday, May 12, 2015

Hensarling Letter

June 20, 2014

The Honorable Jacob Lew

U.S. Department of the Treasury
1500 Avenue, NW
Washington, DC. 20500

Dear Secretary Lew:

In testimony before the Senate Committee on Finance on October 10, 2013, when asked
whether the Treasury Department (?Department?) could prioritize payments on Treasury
bonds in the event the debt ceiling was not lifted thereby ensuring that a default on
Treasury bonds could be averted and market panic could be forestalled you testi?ed:

We [the Department] write roughly 80 million checks a month. The systems
are automated to pay because for 224 years, the policy of Congress and every
president has been we pay our bills. You cannot go into those systems and
easily make them pay some things and not other things. They weren?t
designed that way because it was never the policy of this government to be in
the position that we would have to be in if we couldn?t pay all our bills.

In a May 7, 2014 letter to the Committee on Financial Services (?Committee?), you painted
a somewhat different picture of the technological feasibility of prioritization:

If the debt limit were not raised, and assuming Treasury had suf?cient cash
on hand, the New York Fed's systems would be technologically capable of
continuing to make principal and interest payments while Treasury was not
making other kinds of payments, although this approach would be entirely
experimental and create unacceptable risk to both domestic and global
Financial markets.

Departmental and Federal Reserve System documents reviewed by the Committee staff
demonstrate that, as early as March 2013, Department and Federal Reserve Bank of New
York staff had documented in writing and in painstaking detail the steps the Department
would take to successfully carry out any directive to prioritize payments on Treasury bonds
if the debt ceiling were not raised. These plans raise the question whether you knew or
should have known that it was possible to prioritize such payments when you testi?ed
before the Senate Finance Committee in October 2013. The plans additionally raise the
question whether there was an adequate factual basis for your assertion that ?Mon cannot
go into those [payment] systems and easily make them pay some things and not others.?
Documents and e?mails reviewed by the Committee staff relating to planning in the event
the Department chose not to fully prioritize debt payments despite its apparent ability toThe Honorable Jacob LBW

June 20, 2014
Page 2

fully make such payments also call into question the basis for your testimony; such
planning suggests that the government could. pay certain bonds while rolling forward the
dates on other bonds.

I. Documents indicating that the Department and/or the Federal Reserve System
could fully prioritize Treasury bond payments and thereby prevent default on
Treasury bonds

The following documents reviewed by the Committee staff suggest that the Department
could instruct the Federal Reserve Bank of New York to process principal and interest
payments on Treasury obligations if the debt ceiling were not raised, and that the Bank?s
payment systems could carry out those instructions:

I Treasury Debt Ceiling Internal Securities Procedures (March 2013) [See
Document from Bates Stamp 224-#244]
?Fedwire Securities Delayed Payment Support"(September 2013); and
?Fedwire Securities Delayed Payments Wholesale Internal (October
2013) [See Document beginning at Bates Stamp 308]?

The documents, which were prepared by the Federal Reserve Bank of New York prior to
your Senate Finance Committee testimony, exhaustively detail how the Department and
the Bank would implement any plan to prioritize payments on Treasury bonds. For
example, they describe how, during any ?suspension period," the Department could
determine whether suf?cient funds existed to make payments scheduled for settlement the
next day and that, if the Department ?determine to make principal and interest
payments (or only the interest payments), the payment wires [would] need to be released no
later than 4 pm. Eastern." The documents include sample e-mails for use by the
Department and/or the Federal Reserve to communicate the Department?s actions to third
parties and to communicate the Department?s instructions to the NY Fed; they further
describe how status messages could be posted to an Internet-based portal accessible to such
third parties. The documents also include a dial-in number and passcode for Treasury and
Federal Reserve staff to communicate with each other about debt ceiling prioritization

Simply put, the documents do not appear to support your October 2013 testimony that
?[y]ou cannot go into those [payment] systems and easily make them pay some things and
not other things.? In fact, the Committee?s preliminary review suggests that the
Department failed to share with the American public, and with holders of US. Treasury
debt, material information that could have prevented needless market volatility in the
Treasury bond market in the period leading up to the congressional debate over the debt
ceiling. A similar misleading representation by an issuer of publicly traded corporate bonds
could result in exposure to liability for securities fraud.

1 The documents the Department made available for the Committee?s review do not provide an
adequate basis to fully assess the Department?s unsubstantiated claim that it might not be able to
raise suf?cient funds in auctions to continue making principal payments if the debt ceiling were not
raised. Documents in the Department?s possession that have not yet been produced may contain
information probative of this question.

The Honorable Jacob Dew
June 20, 2014
Page 3

11. Documents and e-mails re?ecting additional planning by the Federal Reserve
Bank of New York to minimize market disruptions if the Department decided to
partially delay Treasury bond payments

Nothing in the documents indicates that the Department would be unable to prioritize
payments on Treasury obligations. Yet the documents also indicate that out of an
abundance of caution the Federal Reserve further engaged in extensive planning to prepare
for the contingency that the Department would choose not to prioritize Treasury bond
payments, and choose to default on those obligations, in order that the Department might
cause a brief market panic and thereby induce a quick resolution of the debt ceiling vote.

Those documents, as well as various emails to which James Narron (the of?cial then in
charge of the Federal Reserve Bank of New York?s Fedwire' Securities System) is a party,
demonstrate that the Federal Reserve had extensive operational plans in place to roll
forward maturity dates on outstanding securities (including choosing to roll forward only
some batches of securities on a particular maturity date); to track any maturity dates rolled
forward and make future payments on deferred payments; and to continue ?business as
usual? with respect to discount window acceptance of Treasury obligations as collateral and
to continue to value that collateral.2 The Federal Reserve Bank of New York also
determined during previous planning efforts in 2011 that even if the debt ceiling were not
lifted ?[dluring the summer of 2011, most large clearing banks indicated they would likely
still be able to clear trades and perform other services for their clients including custody
services, tri-party repurchase agreements, and securities lending, albeit with substantial
manual intervention.?8

In the event that the Department chose to default on principal and interest payments,
despite its clear ability to prevent that from occurring, the Federal Reserve was also
prepared to conduct open market operation repo transactions directly with dealers to
further forestall market disruption caused by an unfortunate decision by the Department to

In a scenario in which the Department chose to default, the Federal Reserve further
determined that legislation may be required to compensate ?holders of securities affected by
delayed payment on Treasury debt for the delay in these payments? but that ?market prices
of Treasury securities would take into account the possibility of such compensatory
Accordingly, the Federal Reserve proposed policies and procedures to
accommodate such compensatory payments in planning documentation which would have
been of considerable material value to potentially affected debt holders in 2013.6

It is clear that these documents and emails would provide ?nancial markets with
substantial comfort the next time that the Congress and the President contemplate a vote

3 See Bates Stamp #578, 747, 759, 899.
3 See Bates Stamp #882.

4 See Bates Stamp 1064?1065.

5 See Bates Stamp 884.

6 Id.

The Honorable Jacob Lew
June 20, 2014
Page 4

to increase the debt ceiling. It is clear that the substantial bene?t of this information to the
American public outweighs any political calculation that has led you to keep these
materials secret.


We note that the Department has thus far failed to cooperate fully and completely with the
Committee?s legitimate oversight and that the Department?s failure may have inhibited the
Committee?s assessment of the Administration?s debt ceiling contingency planning. First,
the Department has permitted the Committee to review the above-described documents,
together with certain other documents, on an in camera basis only, notwithstanding that
the documents marked merely as ?sensitive but not classi?ed? are not subject to a
legal privilege that might qualify the Committee?s right to obtain custody and control of
them. Second, despite the Committee?s previous requests, the Department has failed to
provide assurances that it produced all known responsive documents for the Committee?s in
camera review. As a result, the Committee cannot rule out that the Department has
withheld responsive documents in its possession.

It may have been in the Department?s strategic political interest to keep its extensive debt
ceiling contingency plans secret during 2013. This Committee nevertheless has an
obligation to insist that those secret debt ceiling plans be shared with the American people
without further delay. We trust that the American people and holders of U.S. Treasury
debt will then be in a position to reach their own informed conclusion about the veracity of
your statements concerning the debt ceiling. Accordingly, by July 1, 2014, please produce
all documents and other records that are responsive to the Committee?s previous requests
on this matter. In addition to producing the documents previously reviewed by the
Committee on an in camera basis, please produce any other known responsive documents
and records.

Please contact .W. Verret or Joseph Clark of Committee staff at (202) 225?7502 with any
questions regarding this matter.


Chairman Chairman

Subcommittee on Oversight
and Investigations

cc: The Honorable Maxine Waters
The Honorable Al Green
The Honorable William. Dudley