The U.S. Treasury Department recently announced that it would again issue 30-year bonds. These long-term bonds were discontinued in 2001 and will probably receive a warm welcome in the market.
Treasury plans an auction of about $10 billion to $15 billion worth of these bonds starting next February, with another of equal size later in the year. The delay between the announcement and the actual introduction of the bonds was scheduled to allow market participants, including the Treasury Department itself, to make the adjustments to the financing calendars necessary to accommodate this additional issue.
The Treasury is also undoubtedly acting cautiously. While 30-year bonds make sense to a lot of market analysts, and to economists, there is always some doubt about how a new issue, or even a revived one, will be received by investors. And, of course, the price of failure is high.
An unsuccessful, or even simply disappointing, Treasury auction of long-term bonds could roil the financial markets and kick interest rates upward, destroying the delicate balance that both Treasury and the Federal Reserve try to maintain.
The official reason for the resurrection of the 30-year bond was given by the Treasury Department assistant secretary for financial markets Timothy Bitsberger, who said it was “portfolio management.” What that means in this case involves lengthening the average maturity of the U.S. debt, which has shrunk in recent years and is now down to 54 months.
The $20 to $30 billion issue of long-term bonds isn’t enough by itself to have a dramatic effect on average maturity – the outstanding debt held by the public now stands at $4.58 trillion – but it is a step in the right direction.
It also involves a gentle push to shift ownership of U.S. debt from foreign to domestic holders. Long-term bonds such as the 30-year Treasury have never been all that popular with foreign investors, and most are purchased by U.S. insurance companies and pension plans attempting to “maturity match” – that is, making long-term investments that will pay off at the same time their long term obligations come due. A life insurance company, for example, might expect, based on mortality tables, that a certain number of its policy holders will die in 2036, and wants to make a nearly risk-free investment, like the 30-year Treasury, which will insure that it has the money to pay off the beneficiaries.
Maturity matching institutions and other buy-and-hold investors, though, are a diminishing presence in the market for U.S. government securities. There are a lot of other buyers and sellers of these securities, and it is their level of activity that has become worrisome recently.
U.S. Treasury debt is considered a risk-free investment. The theory is that if the U.S. fails to pay off on its financial obligations, you will probably not even notice it on account of the other distractions … such as the apocalypse and stuff like that.
Because of their risk-free status. Treasury securities are traded like currencies, and also used as collateral for loans of various types (including repurchase agreements) that allow market participants to shift and rebalance their investment portfolios. Since the collateral is held by a third party – like the bet in a pool hall game – the lenders and borrowers don’t need documentation for even their large transactions. Treasury securities, by extracting most of the risk from these buys and sells, greatly improve the efficiency of the market.
At the same time, though, the risk-free characteristics that make Treasuries a good investment and good collateral also make them very attractive to speculators of various persuasions. The trading volume in U.S. Treasury securities has been growing substantially over the past few decades, and has seen a particularly sharp increase in the past five years.
Some people blame hedge funds for the increase in trading volume, and hedge funds do use U.S. Treasury securities as their principal tool in establishing their “positions” in the market. If, for example, they think that our economy is going to hiccup for some reason – oil prices, or the dismal box office of “War of The Worlds” – they would buy government bonds with the idea that interest rates would fall.
More significantly, though, hedge funds and other domestic and foreign speculators collectively represent a market overhang of liquidity that is worrisome. While the outstanding U.S. debt seems like a big number to us ordinary mortals, it hasn’t been growing anywhere near as fast as the transaction volume in financial markets, making them, and our economy, increasingly vulnerable.
The return of the 30-year bond is most welcome, then. And the Treasury Department should be seeking out other opportunities to encourage and expand the “buy and hold” market. We certainly don’t want our economic prosperity held hostage by market speculators.
James McCusker is a Bothell economist, educator and consultant. He also writes “Business 101,” which appears monthly in The Snohomish County Business Journal.
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