The Bush administration’s fiscal improbity is a seemingly inexhaustible topic (see Krugman, Paul: The Collected Works). Naturally, it’s the more glaring examples of folly and deceit—such as the $1.4 trillion in tax cuts spread over 10 years and targeted mainly at the affluent—that draw most of the attention. But there are smaller examples, too. Consider, for instance, the sidelining of the 30-year Treasury bond.
In October 2001, the Treasury Department stopped issuing the 30-year bond, the longest-term security the government sells. Why the long bond, as it’s known, was discontinued was never entirely clear. In announcing the decision, Treasury officials cited projected budget surpluses—with no deficit, there was obviously less need for the government to take on debt. They also touted the savings to taxpayers that would result from shifting more federal financing to short- and medium-term paper, such as two- and five-year notes. Under normal circumstances, the shorter the life of a note or bond, the less interest it pays. A 30-year bond carries more inherent risk than a five-year note and must therefore offer investors a higher rate of return. Thus it costs taxpayers more money.
The cynical view—and when it comes to the Bush administration and economic policy, the cynical view gets you far—was that the real aim was manipulating the market. Retiring the long bond could possibly achieve by fiat what successive rate cuts by the Federal Reserve had failed to accomplish—lower long-term rates. The Kennedy administration tried something similar in 1961. The idea was that because yields move in inverse relation to price, choking off the supply of 30-year bonds would force prices higher and rates lower. It would also push down yields on 10-year notes, as investors were forced into that sector of the bond market. In turn, mortgage rates would fall, sparking a refinancing boom that would put more cash in the pockets of consumers and help kick-start the economy.
Long-term rates have come down, though how much of a factor Treasury’s decision to suspend the 30-year played in their decline is an open question. At any rate, the resulting rush by homeowners to secure better terms has given the economy a much-needed boost. However, the refinancing frenzy has just about run its course now, and in the meantime, those big projected surpluses have become spiraling deficits.
In a report issued earlier this month, the nonpartisan Congressional Budget Office estimated that the deficits could reach $900 billion a year in the next decade if current spending trends persist and the Bush tax cuts are made permanent. Conservatives immediately pooh-poohed the projection, noting that as recently as last year, the CBO was forecasting surpluses as far as the eye could see. However, they didn’t challenge the larger point—namely, that the government’s balance sheet has taken a serious turn for the worse. The deficit hit $160 billion in fiscal 2002, 2 percent of the GDP, and is expected to reach $195 billion in 2003. More than $200 billion in new tax cuts may be on the way, and don’t forget the big rise in defense spending, huge outlays for homeland security, and the potential cost of war against Iraq (put at between $100 and $200 billion).
It’s thus reasonable to assume that deficits are going to be around for awhile. And it’s also reasonable to assume that interest rates, now at 40-year lows, have probably reached their nadir. The Fed doesn’t have much more room to cut rates further, and as the government floods the market with new debt, there is likely to be significant upward pressure on yields.
At a time of growing deficits and interest rates at historic lows, it would make sense for Washington to do exactly what the rest of the country has been doing: locking in those rates for as long as possible. Taking the 30-year bond out of mothballs would have just that result. Rates on 30-years—a number of them remain in circulation—are now at 5 percent. That’s the annual interest the Treasury would be obliged to pay for the lifetime of a bond were it to issue one tomorrow. By comparison, rates on 10-year notes are at around 4 percent. If tomorrow the government were to issue $10 billion in 10-year notes as opposed to $10 billion in 30-years, it would save taxpayers $1 billion in interest payments over 10 years.
Which sounds like a no-brainer, except when you take into account what’s called rollover risk. In 1995, 10-year notes were at 7 percent; in 2012, yields could easily be back at 7 percent, and that would be the rate at which those $10 billion in 10-years would have to be reissued. At that point, the decision not to have sold $10 billion in bonds at 5 percent will end up costing taxpayers an extra $2 billion between 2012 and 2022. In the late 1980s, as the Reagan deficits reached their peak, 10-year rates hit 9 percent. If that were the case in 2012, the added interest cost to the government would be $4 billion.
Clearly, it’s a long way from here to there, and all this is speculative in the extreme. A decade from now, we could again be basking in budget surpluses and rock-bottom interest rates, or we might be saddled with onerous deficits and punitive borrowing costs. You just never know—and that’s the point. In managing the debt, Treasury is supposed to protect taxpayers against all eventualities. Given the deteriorating fiscal outlook in Washington and the new strains that have been placed on government coffers in the past year, reviving the long bond would be a form of insurance. It would guarantee that at least a portion of the debt—Treasury would only be able to sell perhaps $30-$40 billion in long bonds annually; by contrast, it is currently issuing $27 billion in two-year notes per month—would be financed at very favorable rates for years to come.
There is a growing conviction among traders and analysts that the 30-year ought to be resuscitated. Doing so would strike a small but important blow for fiscal responsibility and might help the administration win back some of the credibility it has squandered with the markets. So why isn’t it happening? Probably because reissuing the bond would be an admission that the government is likely to run significant budget deficits for the foreseeable future, something the White House refuses to concede. The administration took office insisting that its massive tax cuts would not imperil the surplus. When the surplus promptly disappeared, it declared that this was just a blip and that the government would be back in the black shortly. As fiscal policy goes, the Bushies have a problem with inconvenient facts; apparently, they also have a problem with inconvenient possibilities.