Structuring the Treasury's Bet For a Long-Term Payoff

By Allan Sloan
Tuesday, April 14, 2009

Financial wheeling and dealing is out of fashion these days. So is the idea of suffering short-term pain in return for the prospect of long-term gain. But in honor of Tax Day, when we all ante up to Uncle Sam, here's a modest proposal: The U.S. Treasury should do some fancy financial dancing that would hurt taxpayers today but would save tons of money for taxpayers in the future.

How could the government do that? By borrowing as much money as it can by selling long-term Treasury securities before the financial world comes to its senses and rates rise, rather than continuing to sell shorter-term securities that save us interest today but are likely to cost us much more in the future.

Here's the deal. Borrowing money for 30 years at today's rates costs the Treasury about 3.6 percent in annual interest, while borrowing it for 30 days costs only 0.2 percent, and for six months, 0.4 percent. So if you're thinking about near-term federal budget deficits, you save $30 billion-plus a year for each $1 trillion you borrow at short rates rather than long rates. (Yes, we're talking trillions now -- it shows how much public finance has deteriorated in the decade since Alan Greenspan worried about the prospect of excessive federal surpluses.)

But the problem with short-term borrowings is that you have to keep rolling them over -- that's bizspeak for refinancing them. By contrast, when you borrow for 30 years, you are rollover-free for decades.

Short-term rates are so low primarily because the Federal Reserve -- which controls short rates -- has cut them to essentially nothing to try to revive the economy and give ailing financial institutions access to ultra-cheap funds. In addition, panicky investors have piled into Treasurys as a supposed safe haven.

Someday, though, that's all going to stop. And the rest of the world, which finances our budget and trade deficits, will catch on that owning low-yielding Treasury securities is a sucker's game.

Thus, it's not hard to foresee short rates in the 4 percent range in a few years, five-year Treasurys (currently 1.7 percent) in the 6 percent range, and 30-year Treasuries at 7 percent-plus.

So saving money today by selling short- or intermediate-term securities exposes us to the prospect of paying much more tomorrow when those borrowings need to be rolled over.

Then there's the apocalyptic question: What happens if we hold a Treasury auction to roll over debt but not enough buyers come? That may seem far-fetched, but the British Treasury recently had a failed auction. And until World War II the pound sterling was the world's preeminent currency, the way the dollar is now.

As for the idea that China, which has sopped up more than $1 trillion in U.S. government securities, has to keep buying U.S. paper to keep the value of its currency low to support its exports? Well, nothing lasts forever.

In fact, if I were advising the Chinese government, I'd suggest that it dump most of its Treasurys onto the Federal Reserve, which is buying them in the open market to drive down interest rates. Then I'd take the dollars from the sale and use them to buy natural resources like oil or coal reserves.

This isn't the first time I've suggested that the Treasury lock up long-term money. In October, I suggested we borrow $700 billion quickly to finance the Troubled Assets Relief Program. We didn't, of course. Although short rates have since fallen sharply, the 30-year rate hasn't. That's not a good sign.

I tried several times to get the Treasury to discuss its debt-financing strategy, but got no response. I suspect that I would have heard what I've heard over the years: to wit, that the best results for taxpayers come when the Treasury borrows as needed and doesn't try to outmaneuver the financial markets.

But given the dire state of our public finances, I wouldn't bet my financial future on that strategy. And I sure wouldn't bet my children's and grandchildren's future on it. But that's exactly what we're doing. It's a bet I fear we're going to lose. Big time. And on that note, Happy Tax Day.

Allan Sloan is Fortune magazine's senior editor at large. His e-mail address is

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