More Debt Is Not the Answer

Abstract

By financing the bulk of its debt with short-term securities, the U.S. Treasury has fully exploited the recent low interest rate regime. However, in so doing it has vastly increased the risk associated with refinancing costs. That refinancing risk and continuing deficits have raised concerns about the credit rating for Treasuries—see the S&P downgrade of U.S. Treasuries from AAA to AA+ on August 2, 2011. Private firms issue equity when financing with more debt would impair their credit. This article explores one such option for the Treasury: that is, selling, in a securitized form, a percentage of the gross domestic product for a fixed term. In effect, the Treasury raises capital, buys a financial hedge, and sells a consumption hedge to investors by using a selfamortizing security. However, the U.S. Treasury is not an innovative institution because it has no way to deal with failures. We suggest a method for coping with losses and note that the potential damage to the taxpayer from the coming rise in interest rates should be sufficient motivation for the Treasury to take steps now to make itself more proactive by designing and offering products with more value added for both the buyer and seller.

TOPICS: Fixed income and structured finance, legal/regulatory/public policy