Another Crack in Republic’s Foundations: Not the Size of the Debt, But When it’s Due

There are so many fractures in America’s foundations it’s easy to lose track.  One is subtle, not likely to cause problems — but in a crisis it could become a major or even terminal factor:  the maturity structure of the Treasury’s debt.

To save money as the debt has more than doubled since 2000, the government has shortened the average maturity of the debt by almost 1/3 (shorter loans usually have lower interest rates).  As the net public debt nears $8 trillion, this becomes risky.  As in this quiet warning to the Secretary of the Treasury from the folks who sell the bonds:

In fact, with the coupon calendar currently in place, the average maturity of issuance now exceeds the average maturity of marketable debt outstanding. This suggests that the decline in the average maturity of debt outstanding that that we have witnessed over the past seven years – from a high of approximately 70 months in 2000 to a low of approximately 50 months earlier this year should be arrested and begin to slowly lengthen going forward.

— “Report to the Secretary of the Treasury“, Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association, 5 August 2009

Go here to see the growth in the Federal debt over time.

Esp noteworthy is the shift in maturity of debt under 4 years. While this remained at 66% of total marketable debt during the 2005-2008 period, the % maturing within one year went from about 33% to 45% from 2007-09 (from “Tomorrow’s burden“, The Economist, 22 October 2009):

(update)  We’re talking big money, even for the US government.  From “Observations On The US Government’s Escalating Near-Term Funding Mismatch“, posted at Zero Hedge, 1 November 2009.

Why this is a potential problem?

Considers two scenarios if the US has a currency crisis, a solvency crisis, or some other financial stroke. 

(1)  We’ve borrowed $14T, one year’s national income, but financed it all with 30 year bonds.  The interest bill would be large, at 6% equivalent to roughly 1/3 of the Federal government’s revenue.  But only 3% must be rolled over every year.  In a crisis we might lose the ability to borrow (painful), but the debt remains manageable.  Also increases in interest rates affect us slowly, as the 3% of the debt rolls over annually.

(2)  We’ve borrowed $14T financed with 1 year bonds.  The interest bill would be far less, but any crisis threatens the government’s solvency:   bankruptcy, hyperinflation, and revolution would be our choices.  Also, a rise in rates immediately increases the interest cost.  Even if we manage to roll the debt in a crisis, the rise in rates alone might prove catastrophic.

With an average maturity of only 49 months, and almost half due in the next year, we are far too close to the second scenario.  Fixing this will be difficult, expensive, and slow, esp when running large deficits.  Will the market accept extraordinary issuance of long bonds?  At what interest rates?

How did we get into this mess?

We the people, though our government, borrowed with no thought of repaying it.  Treating borrowed money as free money was stupid.  Slow and stupid are the two sins most frequently punished by God (why that is I leave for wiser heads to explain).

Solutions

Triage.  The day is late, and drastic steps have become necessary.

1. Renegotiate the debt as soon as possible, as our position will likely weaken over time.  Extent maturities.  There will be a price to be paid for this.
2. Use government funds as need to maintain the economy until it recovers, but spend only to mitigate the suffering and invest in projects that provide an economic return for the overall economy (capturing as much of that as possible for the government, through ownership or loans).
3. As the economy recovers, cut government spending as fast and deeply as possible.

For details see these posts:

1. A solution to our financial crisis, in 3 steps
2. Stabilize the financial system.
3. Stabilize the economy.
4. Arrange long-term financing for steps #1 and #2 with our foreign creditors.

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any opinions expressed by outside contributors. We encourage cross-linking but must insist that no forwarding, reprinting, republication or any other redistribution of RGE content is permissible without expressed consent of RGE.