Treasury Wants More Credit

No, not a pat on the back. The kind that will allow it to sell more debt.
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-Written by Katie Benner

Imagine maxing out your credit card, and then asking your bank to raise your spending limit.

That's essentially what the Treasury Department will have to do now that the

U.S. has bumped up against its legislated national debt limit

. This week the country's maximum credit limit, $8.18 trillion, was reached. That breaks down to nearly $30,000 for every person in the nation.

"It is imperative that Congress raise the debt ceiling by the middle of March," says Treasury spokeswoman Brookly McLaughlin. Congress and the Bush administration have been negotiating a roughly $781 billion extension for the current limit. If it passes, it will be the fourth increase since 2002 and bring the total amount of additional government borrowing authority to more than $3 trillion since President Bush took office.

The Treasury has sought increases before, but this time it has given economists another matter to consider as they debate the real impact that deficit spending will have on the economy going forward.

For starters, one effect that can be measured right now is that of the high cost of interest payments the government has to make. The U.S. will spend $217 billion this year to pay interest on the publicly held portion of the debt, according to the Congressional Budget Office, and that is more than will be spent on homeland security, education and transportation combined.

Because of the debt accumulation, "over the next five years ... interest costs will increase by 57%, compared with 23% for noninterest outlays. Interest payments are projected to grow from $184 billion in 2005 to $289 billion in 2010," the CBO says in its budget report.

Increasing the nation's credit limit should affect its favorite form of IOU, government Treasuries.

"When you flood the market with Treasury supply, that asset class has to cheapen compared with other asset classes," says Bulent Baygun, head of U.S. fixed-income strategy at Barclays Capital. "When it cheapens, it means tighter spreads."

In laymen's terms, this means that a flood of supply will eventually make U.S. government bonds less valuable. Prices and yields move inversely. If government debt prices fall and yields rise, the quality of other bonds and investments, relative to Treasuries, will start to look comparatively attractive to investors, and the government could lose lenders.

Foreign investors have played a big part in keeping rates low with their continuing purchases of U.S. debt. That's because on a pure risk/reward basis there's nowhere else for foreign investors to get the yield of a Treasury with such limited downside.

"Our fiscal situation is less problematic than that in Japan or Western Europe, where deficits are much higher and the demographic problems are more acute," says Michael Darda, chief economist with MKM Partners.

"This is probably one of the best environments for borrowing in recent or distant memory ... but Congress still needs to get the purse strings under control," Darda says, if for no other reason than because Social Security and Medicare are becoming unavoidable issues as the nation's baby boomers retire en masse.

Darda also believes that the long-term fundamentals for the Treasury market are "terrible" because the global demand that has kept U.S. yields low will eventually ebb to normal levels over time.

Matthew J. Smith, vice president of Smith Affiliated Capital, an investment advisory firm specializing in fixed-income portfolios, says that while no other country has the breadth and depth of the U.S. Treasury market, "no country before in history has maintained its economic superpower status with twin deficits."

Even though the current environment allows the government to issue near limitless paper without losing buyers, the uncertainty of being an indebted nation still has an impact.

The Treasury has taken its first steps to keep the auctions rolling. On Wednesday, it suspended sales of

state and local government series nonmarketable securities. The next day, it suspended investments in the government pension plan, and that will free up almost $65.27 billion, McLaughlin says.

Other steps the Treasury

could

take as it waits for the new limit include diverting funds from Social Security, withholding interest payments to government funds or issuing debt through the Federal Financing Bank, which isn't subject to the debt limit.

And the costs of a nonfunded government could directly effect government jobs if the Treasury, as a last resort, needs to temporarily lay off workers to elude the limit.

This article was written by a staff member of TheStreet.