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How the Bond Markets React 05.05.05
Then and Now - The Thirty Year Note
I was at odds considering what to name this article. Should it be
called "Cost Effective vs. Cost Effective" or perhaps something more
poetic, "Another Carrot, Dangling". Nonetheless, the possible
reintroduction of the 30-year Treasury Note surprised traders on
Wednesday as yields rose dramatically pushing prices down. For many,
the most obvious question was: "Why did they do away with it in the
first place?"
At the end of October 2001 the country was reeling. The terrorists
had done something unprecedented and the Bush administration understood
what the cost of engaging the enemy would do to the surplus. At the
time of the attacks, this country still had a significant amount of
capital inherited from the previous administration which was openly
targeted by the GOP for their tax cutting plans. The war, however would
need more than the surplus could offer. The 30-year note was seen as
too expensive to be used to raise money through borrowing and was
discontinued citing its lack of cost effectiveness. The 30-year note is
offered at a generally higher yield than shorter term offerings, money
the government did not want to pledge for the long term.
No one expected that surplus to turn into lingering deficits as
quickly as it did. While many factors have added to the national debt,
none was worse than the rampant spending that took place with the full
knowledge that repayment was not possible in the near term. Now the
Bush administration through the Treasury is seeing the cost of managing
that debt as too expensive. What they want is a way to spread the cost
of those deficits further out into the future. The 30-year Treasury is
just what the administration needs to make current year books appear in
better shape.
View it as admission of guilt. The deficit is not likely to go away
and by offering this note they are admitting to having failed to
estimate the cost of runaway spending and stimulative tax cuts.
This sudden change of heart, also billed as cost effective, would
force the Treasury to offer much higher rates to attract investors, both
foreign and domestic. Neither group of investors should purchase one of
these notes with their eyes closed. This new issue is meant to enable
the President to fund his ideological push for privatized accounts.
This is another way to dig deeper into the world's savings accounts to
finance what has become a bad experiment in economic growth.
Beside the President, there are basically two other groups that would
benefit from the re-issuance of the note. Wall Street would love the
idea. Historically more volatile, the note would provide bond traders
the opportunity to make money. Although the Treasury doesn't plan on
finalizing their decision until August, there is little chance it won't
be issued.
Pensions would benefit as well. The need for locking in a secure
maturity will solve many of the underfunding problems facing defined
benefit plans. The S&P 500 has 350 companies with such plans with less
than 20% of them able to meet the promises they have made to their
employees. What the Treasury should do is offer a inflation protected
note much the way Britain is doing with their 50 year offering. So far
they have made no indication that they will add inflation protection.
If you are a fixed income investor, you can look for the new note to
be issued in February of next year. If you are a pension manager, there
will no longer need to speculate on the movement of short term bonds.
If you are a Wall Street firm, you will be looking forward to the return
of the days when money could be made with these types of offerings.
If you are Mr. Bush however, you can begin to make plans to offer a
way to finance your changes in Social Security. The ability to shift
the debt to the very generations that you are trying to convince need to
be saved is a Godsend. It will give the costly attempt at overhauling
the program seem smaller even as the economy slows, the twin deficits
expands and inflation begins to rear its ugly head.
If you are a foreign bank however, you should be be wary of the move
to bring the note back. It is, you will understand, an excellent way
for Americans to avoid facing a real economic dilemma: continue to spend
to keep the economy propped up or begin to save for the rainy days ahead.
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