Killing the long bond was shortsighted

October 23, 2002|By JAY HANCOCK

LOVE YOUR NEW, 5.8 percent mortgage?

You might want to send a fruit basket and a nice note to Undersecretary Peter R. Fisher at the U.S. Department of the Treasury, 1500 Pennsylvania Ave. NW, Washington, D.C. 20220. You're supposed to call him "the honorable."

A year ago, Fisher was accused of trying to rig the markets and drive down mortgage rates by summarily killing new issues of the Treasury's 30-year bond, which had been part of the landscape since 1977. Canning the "long bond," the thinking went, would force money into other loans and would lower rates, help the economy and bolster the administration.

Fisher denied intentional manipulation, but rates have indeed plunged, homeowners have flocked to refinance, and the economy is better for it.

In truth, the bum stock market is more responsible for bedrock rates than anything else.

But there is a larger issue. By canceling the 30-year Treasury bond, the administration has denied U.S. taxpayers the opportunity to mimic the smart homeowners and lock in borrowing costs at incredible, historic, closeout lows. Predictions are hazardous, but I feel comfortable saying this will cost taxpayers tens of billions of extra dollars over time.

Treasury securities are how the government finances budget deficits. When it needs cash, Washington sells paper, collects the money and spends it on unneeded bridges in West Virginia.

Like a mortgage borrower, the government can choose the duration of its loans. It can borrow through short-term bills and notes, which results in floating interest charges not unlike those of an adjustable mortgage. Or it can sell longer-term obligations, in the current setup, of up to 10 years.

In practice, Washington does both, which is necessary. Dealers like to trade a broad menu of Treasury issues, and the government doesn't want big chunks of debt coming due all at once, like a balloon mortgage.

Even so, the Treasury has discretion to skew its borrowing toward one end of the term spectrum or the other. And these days the agency has defied common sense by stocking up on volatile short-term debt and blowing the chance to borrow at 4.9 percent, fixed, until 2032 -- a deal that could have been had through most of September. Since President Bush took office, the average term on the Treasury's privately held debt has declined at its fastest rate since the mid-1970s.

Sure, the short-term loans are cheaper, like the introductory, teaser rate on an adjustable mortgage. On Sept. 30, the average rate on outstanding Treasury bills, which mature in less than one year, was 1.7 percent.

But this won't last. A year ago, the average T-bill rate was 3.5 percent. As soon as the economy revives, short-term rates will rise, the 1.7 percent bills will expire and, just as adjustable-mortgage borrowers usually see their payments rise after a year, the Treasury will have to refinance at higher rates.

Except for briefly in 1998 and late last year, rates on 30-year T-bonds, which still trade but are no longer issued, have never been in this range. To see what a chance is being missed, consider that the average interest paid on the national debt, including low, short-term rates, was 5.3 percent last month (at a yearly rate), 6.1 percent a year ago and 11.5 percent in 1981.

I'm not suggesting that rates will pop back up to 11 percent or that the government can refinance the entire $6.2 trillion U.S. debt -- or even $200 billion -- in 30-year paper in the next few years. But what's obvious to Joe Cul-de-sac ought to be obvious to the administration: Long-term rates are low, are more likely to move up than down and are ripe for plucking.

So why not reintroduce the 30-year bond? For one thing, the administration would have to admit that budget deficits are back for the foreseeable future. White House impresario Karl Rove could never allow that.

Also, the financial media worry more about whether Treasury issues are good for retired stockbrokers than whether they're fair for taxpayers.

The White House is enjoying the extra cash flow -- more than $300 million annually, by my reckoning -- that comes by shortening the average maturity of privately held U.S. debt from 70 months in 2000 to less than 64 months on June 30. And nobody in the administration will be around when the chickens might come home to roost.

Rates got so low last month that Wall Street thought Treasury would be shamed into reviving the long bond. Fisher said the rumors "aren't worth spit."

Treasury officials say they aren't "market timers," implying that locking in long-term rates for taxpayers is the same as day-trading Enron stock. But they should have learned that the risk to bond buyers is greatest when terms are long and rates are low. This is when the risk for borrowers -- read, taxpayers -- is least.

Last summer, an unidentified Treasury official told Agence France-Presse that "it would have to be a quite extreme situation" for the Treasury to bring back the long bond. Like, say, when the administration starts acting fiscally responsible?

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