This Day On The Street
Continue to site
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here

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

Let's take a hypothetical example for perspective. Suppose the Treasury decided to fund half the federal debt with floaters. Currently, the average interest rate on the federal debt is 2.8%. This would lead to some immediate savings. However, what happens if rates jump -- which is not unreasonable given the Federal Reserve's balance sheet of $2.8 trillion, or 19% of GDP. The savings would be wiped out if rates rose to 2.8% (which by the way, is roughly today's inflation rate). If rates go to 4%, then the government has to come up with an extra $1 trillion to pay the extra interest they precommitted to. Do you think 4% rates are out of the question? I certainly don't.

The uncertainty about future interest service is what I call funding risk. The amount of cash needed is unpredictable. If interest rates rise, then extra interest service must come from: 1) higher taxes; 2) spending reductions; 3) more borrowing; or 4) printing money. Note that (4) usually causes rates to increase even more, leading to even higher service costs. (3) can have a similar effect.

Extending Maturity

Yes, FRNs extend maturity -- if they are replacing securities that have a shorter maturity. Suppose they replace Treasury bills. In this case, the interest rate risk is identical (both pay the Treasury bill rate). Suppose they replace fixed rate coupons. In this case, the interest rate risk changes. As rates go up, the FRNs become more expensive to service.

The Treasury's February 2012 document is a good read. They make the case that there could be some cost savings in minimizing the rollover risk. That is, instead of going to market every three months for Treasury bills, you commit for a longer period, say, two or five years. They also argue there is a modest term premium that could be captured.

If the FRNs are just two years to maturity, then not much additional risk is created. This is especially true today when the Federal Reserve is on record saying that rates will remain low through 2014. However, what makes me nervous is the phrase: "... eventually the Committee anticipates FRNs of longer final maturities."
3 of 4

Check Out Our Best Services for Investors

Action Alerts PLUS

Portfolio Manager Jim Cramer and Director of Research Jack Mohr reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

David Peltier uncovers low dollar stocks with serious upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
14-Days Free
Only $9.95
14-Days Free
Dividend Stock Advisor

David Peltier identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Real Money

More than 30 investing pros with skin in the game give you actionable insight and investment ideas.

Product Features:
  • Access to Jim Cramer's daily blog
  • Intraday commentary and news
  • Real-time trading forums
Only $49.95
14-Days Free
14-Days Free
AAPL $94.19 -1.04%
FB $118.06 0.54%
GOOG $695.70 0.48%
TSLA $222.56 -4.20%
YHOO $36.00 -0.03%


Chart of I:DJI
DOW 17,651.26 -99.65 -0.56%
S&P 500 2,051.12 -12.25 -0.59%
NASDAQ 4,725.6390 -37.5850 -0.79%

Free Reports

Top Rated Stocks Top Rated Funds Top Rated ETFs