Column by Todd Buchholz and James Carter appearing in Investor's Business Daily July 30, 2013.
Earlier this month, President Obama swore in the first director of the Consumer Financial Protection Bureau to make sure naive borrowers are not duped into bad deals by devious lenders. Perhaps the Bureau’s first client should be the U.S. Treasury, which does not appear to understand basic math or the dangers of short-term borrowing.
Since the President took office, the U.S. has racked up $6 trillion in new debt, according to White House numbers. Supporters think it was prudent and unavoidable; detractors think it was dumb and reckless. But no one disputes that it’s a lot to borrow.
Likewise, no one disputes that interest rates are still near historic lows, despite June’s vicious bond sell-off. These facts suggest that the Treasury could do a huge favor for future generations by locking in today’s low borrowing rates.With the Federal Reserve’s encouragement and the meltdown of the PIIGS in Europe (Portugal, Ireland, Italy, Greece and Spain), the world has been willing to lend the US money in the form of 10-year bonds at rates near 2.50%, and 5-year money at about 1.50%.But what happens when rates rise? The Congressional Budget Office calculates that normal, higher rates would increase the deficit by about $4 trillion over 10 years.This risk could be better managed by the Treasury locking-in today’s low rates by issuing 50-year or 100-year bonds.Corporations and cartoonists understand the idea. In 1993, Disney auctioned off $300 million in 100-year “Sleeping Beauty" bonds, and the market applauded. According to the Los Angeles Times, “Disney had said it planned to sell half that much - $150 million … but demand proved greater than the company had anticipated."
Norfolk Southern enjoyed a similar reception in 2010 when the railroad issued 100-year bonds. CBS News reported, “institutional investors bought them like crazy, leading Norfolk Southern to more than double the issue from the $100 million announced earlier.” Norfolk Southern issued another $400 million in 100-year bonds a year later.Dozens of other companies, including Coca-Cola, IBM, Federal Express, and Ford have also issued 100-year debt.It doesn't take a rocket scientist to understand the benefit of ultra-long bonds, but institutions of higher education—including the University of Pennsylvania, Ohio State, the University of Southern California and Yale have also issued 100-year bonds.Governments across the globe are also grasping the concept. In 2011 buyers grabbed Mexico's 100-year bonds despite that country's dubious history of currency devaluations. Just a few months ago, the Canadian government announced it was “assessing the potential benefit of issuing bonds with maturities of 40 years or longer.”
Japan, France, and the United Kingdom already issue bonds with durations of 40-years or more.The Obama administration claims it has taken advantage of low yields and extended the average duration of debt, but it's an empty boast. This duration averaged 64.3 months earlier this year, up from an average of 48.5 months in October 2008 but short of the record of 70.9 months in May 2001--and not even close to what is appropriate given current circumstances.According to the April minutes of the Treasury Borrowing Advisory Committee, the acting director of debt management stated that the Treasury wants to “remain flexible." Sometimes flexibility is good, if for example, you are a rubber band, a Slinky or an acrobat at Cirque du Soleil.
But if you’re a debt manager with the opportunity to lock in borrowing rates that will help avoid a financial catastrophe, it’s better to be firmly in place.
Political self-interest might argue for short-term debt because short-term debt yields are typically the lowest, which makes the deficit picture look temporarily better. But short-term borrowing also virtually guarantees that future generations of Americans will face higher debt burdens and higher taxes.
Would you advise a friend who’s buying a home to accept an adjustable teaser rate mortgage that could catapult higher in a few years? In today’s environment, teaser rates are for fly-by-night salesmen. We are not a fly-by-night country.