Surplus may let U.S. cut its debt

Treasury proposal would buy back trillions in bonds

August 05, 1999|By William Patalon III | William Patalon III,SUN STAFF

Like a repentant consumer who got a raise after surviving for years on credit cards, the federal government said yesterday that budget surpluses created by a strong economy could ease an addiction to credit and help it pay down a debt load that's reached $5.5 trillion.

The Treasury Department said last year's surplus, combined with others projected for the next 16 years, would let the government slow its issuance of new debt and buy existing debt securities back from investors for the first time since 1972.

A debt buyback by the government would be "analogous to a homeowner refinancing a mortgage or a company refinancing its debt," said Treasury Secretary Lawrence Summers.

Treasury officials said this is only a proposal and the government will seek input on how it should go about conducting debt buybacks and would likely publish rules by early next year.

Optimistic market-watchers said the long-term impact would be to reduce overall U.S. interest rates enough to make it cheaper for the nation's consumers to borrow money for things such as new cars and houses.

"This plan looks like sound fiscal management. It makes sense to pay down the debt and it makes sense to pay down higher-interest debt that was issued years ago first," said Mark Zandi, senior economist at Regional Financial Associates in West Chester, Pa.

Skeptics say it's too early to bet that the government will cut up its credit cards. Any debt repurchases, they point out, will depend on the economy remaining strong enough to generate budget surpluses. What's more, they contend the amount of debt bought back will likely be too small to have much effect.

"My feeling is the market is not going to be fooled in the long run," said Sung Won Sohn, chief economist for the Minneapolis-based Wells Fargo Co.

Traders had generally expected the Treasury Department to announce a debt-repurchase plan. However, the agency also said it would cut the number of times it sells bonds from three times a year to two. That dovetails with a yearlong push to cut the amount of investor-held debt by squeezing the size of some Treasury auctions, the process through which the government incurs credit.

The yield on the benchmark, 30-year Treasury bond fell 6 "basis points" -- six-hundredths of a percentage point -- to close at 6.10 percent. The 30-year yield governs a lot of other borrowing costs in the marketplace, while the yield on the 10-year Treasury guides mortgage rates.

Of the $5.5 trillion national debt, $3.6 trillion is "public debt" -- government IOUs held by investors in the United States and abroad. The government sells Treasury bills that mature in less than a year, Treasury notes that mature in one to 10 years and Treasury bonds that mature in 10 to 30 years.

The remaining $1.9 trillion of debt is held by government trusts, the largest of which is the under-funded Social Security trust.

Bond yields move opposite their prices, meaning that if prices rise, yields fall. So if there's a smaller supply of Treasuries -- desired by fixed-income investors because of their low default risk -- demand should theoretically increase, said Richard O'Brien, vice president in charge of fixed-income investments for the Hunt Valley office of Folger Nolan Fleming Douglas Inc. Higher demand would translate into higher bond prices, pushing yields down and therefore helping overall market interest rates to fall.

But lots of variables exist. First, the surplus of $69.2 billion in the last fiscal year and the projected surplus of $120 billion for this fiscal year would have to be followed by more -- which the Congressional Budget Office forecasts will happen for the next 15 years.

If CBO projections prove accurate, the federal government would pay off the public debt by 2015.

That's going to happen only if the economy stays healthy enough to allow corporate profits, incomes and stock prices to remain reasonably strong. Recently released economic figures seem to show that U.S. growth is slowing, and concerns remain that the Federal Reserve will boost interest rates this year -- perhaps as early as Aug. 24 -- which could induce growth to slow still more.

A severe slowdown would drastically cut revenue from corporate, personal and capital-gains taxes.

Then there's the struggle between Washington lawmakers, with Republicans crafting plans for a 10-year tax cut while Democrats want to devise new spending programs. Either would erode the amount of money available to buy back debt. President Clinton has said he would veto a tax cut, even though many economists say that would be preferable to spending programs, because it would be hard to cut new programs if the economy soured.

But success in paring back debt would have far-reaching implications. First, if the government swaps high-rate debt for lower-rate liabilities, interest costs will fall, freeing up money to repurchase other bonds, or for other spending programs.

If the national debt is reduced, there will be less competition for money in the marketplace, so corporations will be able to borrow at lower costs -- theoretically making them more profitable. Consumers, too, will be able to borrow money more cheaply, giving them more disposable income -- no small factor since consumer spending accounts for 70 percent of the nation's gross domestic product.

Federal Reserve Chairman Alan Greenspan has said the government's priority should be to cut debt. Barring that, he would rather see a tax cut than new spending programs.

But like the overextended consumer, the government will have to be disciplined to reduce debt.

"It's going to have to be a very big number to even make a dent" in the national debt, said Wells Fargo's Sohn.

Wire services contributed to this article.

Pub Date: 8/05/99

Baltimore Sun Articles
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.