Monday, September 20, 2010

The Maturity Structure of the Public Debt

Over the decades there has been a debate about the maturity structure of U.S. Treasury debt. At one time, not only was there a debt limit but also a limit on the amount of bonds Treasury could issue with an interest rate greater than 4 percent. Bonds are similar to notes but with longer maturities. Currently, the dividing line is 10 years; it has in the past been shorter. When Treasury was given room in the late 70s and 80s to issue more bonds without regard to the 4% ceiling, Treasury officials took great pride in growing the market for 30-year bonds and were distressed during the Reagan Administration when some political appointees wanted to halt this progress by shortening the maturity of the public debt.

This did not happen during the Reagan Administration, but in the latter part of the Clinton Administration the issuance of 30-year bonds was reduced, and then it was eliminated for a time during the George W. Bush Administration.

Now Treasury has reversed course. In a letter to the Wall Street Journal published on September 18, Assistant Secretary Mary J. Miller proudly states: "We have explicitly pursued a strategy of reducing reliance on short-term debt. Over this period, the average maturity of the debt has extended at the fastest pace in history—from 49 months to more than 58 months today."

There is no easy answer as to the proper maturity of the public debt, and, after hearing and sometimes participating in arguments about this over many years, I have come to the conclusion that it may not matter that much as long as one does not follow extreme policies. I think, thought, that it is good policy to issue 30-year bonds, since different maturity sectors attract different investors, and Treasury needs as many investors as it can get. Also, it is useful for the economy to have a long-term benchmark interest rate.

I should note that the arguments about the maturity structure often focused on the average maturity of the public debt, which masked how sensitive interest costs are to short-term interest rates. Miller, in her letter, states that 55 percent of the public debt matures with three years. It is not clear whether she is referring to the total public debt, that held outside of government accounts, or that held outside of government accounts and the Federal Reserve system. But no matter. A change in interest rates will impact the budget fairly quickly.

In the Bush Administration, two arguments were used to justify the elimination of the 30-year bond. The first argument, at the beginning, was that the budget was in surplus and we did not need to issue long-term debt. There was, unbelievable as it may sound now, a concern at the end of the Clinton Administration and the beginning of the Bush Administration that the surpluses would continue for such a long-time that the Fed would have to look to other securities with which to conduct open market operations. (I remember thinking at the time how misplaced this concern was; budget surpluses would not continue because they were politically unsustainable and a recession, which at some point would happen, would cause it to go away. The Congress would either spend it or enact tax cuts, probably both. This in fact did happen, along with expenditures for wars in Iraq and Afghanistan that I did not foresee.)

It soon became clear in the Bush Administration that the budget surplus rationale for eliminating the 30-year bond was not valid. The argument then shifted to the shape of the yield curve; since it is usually positively sloped (that is, long-term yields are higher than short-term yields), the Treasury could over time save money by issuing only short-term debt. Note that this argument pushed to the extreme would mean that Treasury should only issue bills, though no one advocated that.

In the event, it was Under Secretary Peter Fisher who made the decision to eliminate the 30-year bond and it was reversed after he left, though not immediately. As I recall, the Treasury made some convoluted and unconvincing arguments that this was not a change in policy, but of course it was.

A flaw in the argument that Treasury could save money over the long-term by issuing mainly short-term debt was revealed by this episode. Political appointees are at Treasury for the short-term, and cannot stop their decisions from being reversed. (Of course, some decisions are easier to reverse than others.)

The current repudiation of the shortening strategy begun in the Clinton Administration and pursued with a vengeance at the beginning of the Bush Administration is striking. Treasury is probably right to pursue the current policy.

I am of the school that says that Treasury debt management should normally be very boring except to traders. The Treasury is too big to try to beat the market consistently. As one Assistant Secretary in the George H.W. Bush Administration remarked, it 's tough for an elephant to dance.

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