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U.S. Could Be Pushed Into Debt Overload by the Treasury

DURHAM, N.C. (TheStreet) -- Testifying before Congress in 1993, when interest rates were 7.5%, I advocated shifting some of the federal debt to floating rate debt. If the Treasury had shifted half of the debt to floating rate at that time, the U.S. would have saved $2 trillion to date.

Today, however, interest rates are at, or near, historic lows. It is the wrong time to issue floating rate debt. This type of debt introduces unneeded funding risk.

Treasury Announcement

Traditional Treasury bonds have a fixed maturity, say 10 years, and a fixed coupon rate, say 2%. When you issue such a bond, you know exactly what the cash flow liabilities are: 1% every six months until maturity. Floating rate notes (FRNs) have a fixed maturity but variable coupon. An example is a bond that has 10 years to maturity but with a coupon that resets every six months to reflect the rate on a short-term Treasury bill. When FRNs are issued, the liability is uncertain because interest rates could rise or fall.

Many expected the Treasury to push forward with floating rate notes (FRNs) yesterday. They were originally proposed in February. See the original report. While the Treasury still sees benefits in the issuance of floating-rate notes, a decision appears to have been deferred because of "a significant amount of feedback". See the Policy Statement.

The initiative appears to be coming from an industry group called the Treasury Borrowing Advisory Committee (TBAC). It stated:

"The Committee reiterated that its main goals in unanimously supporting FRNs were continued diversification of the investor base and average maturity extension through issuing floaters in lieu of shorter dated issuance. Furthermore, FRNs should lead to a reduction of term premium expense over time. While initial issuance should have final maturities of one to two years, eventually the Committee anticipates FRNs of longer final maturities." Read the TBAC report.

This committee is populated with representives from JPMorgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and other banks.

The Case Against Floaters

When I made my testimony to the House Ways and Means Committee in 1993, floating rate issuance made a lot of sense. Interest rates were relatively high (7.5%). Indeed, if the Treasury had funded half of its needs with FRNs, $1.9 trillion would have been saved ($2.3 trillion taking the time value of money into account).

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