What’s happening in the Treasury bill market today should terrify you

October 8, 2013

This is likely the scariest graph you will see today. It shows the interest rate for the Treasury bill maturing on Oct. 31. It has spiked dramatically in the last 48 hours.

A lot of the market indicators of how much the financial world is worrying about a debt default have been quite calm over the last week. The Standard & Poor's 500 index, for example, is only about 1 percent below its close eight days ago, when the government shutdown began.

But in the less widely followed -- but in many ways more important -- market for Treasury bills, things are starting to get scary. These are short-term IOU's of the U.S. government, bills issued for 30, 60 or 90 days. They enable Uncle Sam to manage cash flow much the way a homeowner might use a credit card. They also form the backbone of trillions of dollars in transactions: Major corporations and banks use them as a place to park short-term cash; they are held by money market mutual funds; and they serve as collateral for millions of transactions in markets around the world.

Normally, the interest rate the government pays on bills is around the same as the short-term interest rates in other money markets (for example, the interest rates banks charge each other for overnight cash, or the interest rate that the Federal Reserve targets). Both of those are near zero right now, which is why on Sept. 30, eight days ago, the interest rate on Treasury bills maturing Oct. 17 was a mere 0.03 percent. Nothing, in other words.

But since then, the possibility that the Treasury might have trouble paying or might not be able to pay its bills over the next few weeks has grown -- and the interest rate has skyrocketed. It was at 0.16 percent at Monday's close. On Tuesday the rate so far has been almost double that, as high as 0.297 percent.

There are reports, including this one from Reuters, indicating that some of the biggest money managers in the world are starting to avoid U.S. government debt that matures in the near future out of fear they will not be repaid promptly. Bond investors seem to be confident that the U.S. government will make good on its obligations in the longer term --securities that mature a year or more from now are actually seeing their rates fall. But they are becoming less confident that these short-term securities will pay on time.

Ironically, this can create self-fulfilling problems for the Treasury. Treasury bills roll over every week, on Thursdays. Here's how it works: The government issues the bills for a "discount," then refunds the par value when they come due. So, for example, an investor might pay $995 for a bill that returns $1,000 in three months, for an equivalent of about a 2 percent annual interest rate.

But if buyers don't want to roll over their bills -- if they don't trust the government enough to pay the usual high price for that debt -- then the government's cash crunch becomes even more severe. If, for example, investors were only willing to pay $950 for a 90-day, $1,000 bill (about a 20 percent annualized interest rate), then the government would run into its legal debt limit even faster than it is now scheduled to. We're nowhere near that point now. The rate has risen to 0.3 percent, not to single-digit, let alone double-digit, percent levels. But the abruptness of the move, in a market that usually is rock-solid and stable, is startling nonetheless.

As researchers at the Bipartisan Policy Center put it in a new report: "As the X Date approaches without action on the debt limit, one risk is that buyers of government debt will be less likely to participate in Treasury auctions and, for those that continue to participate, more likely to demand higher interest rates, increasing the cost of servicing the existing debt. The amount of debt maturing during this period will increase as Treasury schedules additional short-term auctions in the days ahead."

In the 2008, post-Lehman Bros. crisis, major banks -- even those that seemed to be fundamentally solvent -- were facing a liquidity crisis, as short-term access to cash became a challenge. Buyers of Treasury bills have no evident concerns about the longer-term solvency of the United States. But the action on the bill market over the last several days, and especially Tuesday, looks like the early phase of a liquidity crisis.

Of course, it is one that can be averted very easily: All Congress has to do is raise the debt ceiling to ensure that the investors who buy Treasury bills get paid on time, every time, and that the Treasury can issue the debt it needs to pay the obligations that Congress has already enacted.

Update: The post previously indicated that the chart above showed the rate on Treasury bills maturing Oct. 17. It is actually a chart of the bill maturing Oct. 31. The two charts show a similar basic trend.

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Dylan Matthews · October 8, 2013