Thursday, August 14, 2008

Is the U.S. Financing Itself at a Teaser Rate?

Vikas Bajaj via Felix Salmon:

Money market funds, the short-term cash alternatives, grew to $2.9 trillion in June, up from $2.1 trillion a year ago, according to Crane Data. Those funds, in turn, have more than tripled their holdings of Treasuries and other government debt while reducing the share of their portfolios invested in somewhat riskier corporate notes.
All that demand has created an opportunity for the U.S. to fund the growing national debt on the cheap at the front-end of the curve (an analogy can be made to adjustable rate mortgages). Since June 2007, growth in issuance has been relatively level across most debt instruments, except for Treasury Bills, which now have outstanding issuance 25%+ higher than this time last year.

The problem with this form of financing is that these T-Bills have maturities less than six months out. Thus, while U.S. debt has rocketed, the government hasn't locked in much additional long-term financing.

What happens when the inevitable shift away from T-Bills occurs at some point in the future? The U.S. will no longer be able to fund this $1.2 Trillion (see light blue bar below) at the below 2% T-Bill "teaser rate".
Assuming just a 2% bump in financing costs on this roughly $1.2 Trillion (only gets us to 4% at the front-end which is historically VERY cheap), financing costs increase ~$20 Billion a year. Lets not even think about what happens if that rate shifts up 6%, which would put T-Bill rates at a level witnessed in 1991 when CPI last saw the upper 5's.

Source: Treasury