Treasury Debt Management and Floating Rate Notes

The U.S. Treasury Department is considering issuing floating rate notes (“FRNs”).  Judging by the 27 pages of “discussion charts” devoted to floating rate notes released on February 1, I would assume that Treasury is strongly leaning to issuing FRNs. (The slides on FRNs come after the Treasury slides.)  It is not clear who prepared these slides, but apparently it was one of the current members of the Treasury Borrowing Advisory Committee (“TBAC”), with no doubt assistance from staff of his or her firm.

Why Treasury is considering issuing FRNs at this time is puzzling.  While financing needs are at record levels, interest rates are at historic lows.  In fact, given market conditions, TBAC recommended in its report to the Secretary that Treasury accept negative yield bids in Treasury bill auctions.  (A negative yield means that the purchaser of a bill is effectively paying the Treasury interest for the privilege of lending money to the Treasury.)  The same report, though, indicates that the TBAC unanimously recommends that Treasury issue FRNs linked to a short-term rate, which would likely be either the three-month bill rate or the Fed Funds rate.  TBAC estimates that the FRN yield would be around 8 basis points higher than the three-month bill rate.  The report states that “FRNs give Treasury an attractive alternative to increase the average maturity of its debt.”

From Treasury’s point of view, this maturity argument makes no sense.  One of the reasons that is typically cited for extending the maturity structure of the public debt is “rollover risk.”  But Treasury never has a problem rolling over T-bills, and from an interest cost perspective, FRNs are a substitute for bills.  Given that Treasury sells bills every week, the marginal operational costs of issuing bills is approximately zero.  In fact, one could argue that the yield on FRNs should be lower than the bill rate, since FRNs eliminate the need for investors to roll over their holdings of short-term instruments.

Another reason cited for extending the maturity structure of the debt is to make interests costs a less volatile outlay of the federal government.  But FRNs, by definition, do not accomplish this goal, and thus they should not be viewed as substitutes for longer-term debt from Treasury’s perspective.

Back in the late 1990s, Treasury considered issuing FRNs, as well as inflation-indexed bonds.  There were disagreements among staff and political appointees on both instruments, but Larry Summers rejected issuing FRNs.  He was intent on issuing inflation-indexed bonds (now known as “TIPS”), as many economists were recommending at the time, and he saw no reason to issue FRNs, either as a substitute for or in addition to TIPS, especially since he was advised that the yield on FRNs would float above the bill rate.

Gary Gensler, the WSJ Editorial Page, and Political Competence

The Wall Street Journal editorial page has found a new regulatory villain:  Gary Gensler, chairman of the Commodity Futures Trading Commission (“CFTC”).  In passages that, except for writing style, could have appeared in Rolling Stone, recent editorials imply that Gensler’s supposed friendship with Jon Corzine, a fellow Goldman Sachs alum., led to the CFTC going easy on MF Global and the subsequent bankruptcy and missing customer funds.  (See “Mr. Corzine and His Regulator: MF Global and the new era of crony capitalism regulation” and “The Talented Mr. Gensler: Jon Corzine’s regulator wants you to know he’s been very busy.” )

Rolling Stone, of course, would have concluded that the cure to regulatory laxity is more regulation and purging the government of former Goldman Sachs employees.  The WSJ editorial page naturally draws the opposite conclusion with respect to regulation, while the editors’ opinion about former Goldman Sachs employees taking government jobs is left unexpressed.  According to the WSJ editorial page, because regulators failed, they should not be entrusted with more power.  In today’s editorial about the “talented Mr. Gensler,” the editors write:  “In classic Washington fashion, Mr. Gensler is nonetheless using his agency's regulatory failure in MF Global to impose still more rules and argue for still more power.  A better response would be to acknowledge that the political system has already entrusted too much power to regulators, who can never be all-knowing and all-seeing but are often vulnerable to political influence from executives or firms they know and like.  Investor beware:  Regulators cannot protect you.”

The New York Times Dealbook section effectively rebuts some of the factual basis for the WSJ editorials in an article dated November 8, i.e., some weeks before the Journal’s editorials.  The article states:

“A few days before MF Global’s collapse, regulators stationed at the firm were assured its books were in order.

“Their boss, Gary Gensler, was not convinced.  A former Goldman Sachs partner who once passed the test for certified public accountants, he bore into the numbers himself and grew uneasy with the firm’s finances.

“‘Keep pressing them,’ he told his regulators, according to people with direct knowledge of the conversation.”

The article also notes that, while Gensler and Corzine have known each other for years, they “have seen each other just a handful of times since Mr. Gensler left Goldman Sachs in 1997.  Mr. Gensler did not attend Mr. Corzine’s 2010 wedding.  And Mr. Corzine did not attend the funeral of Mr. Gensler’s wife, a noted artist who died of breast cancer in 2006.”  Moreover, personal relationships have at least sometime not inhibited Gary Gensler; after he left the Treasury at the end of the Clinton Administration, he wrote a book, The Great Mutual Fund Trap, with another former Treasury political appointee, Greg Baer.  The book is critical of actively managed mutual funds.  Gary Gensler’s identical twin brother, Robert Gensler, is a mutual fund manager at T. Rowe Price.

As for the investment practices and apparently shoddy books and records and inadequate segregation of customer funds in commodity accounts at MF Global, it would seem that something is amiss at the Chicago Mercantile Exchange and the Financial Industry Regulatory Authority, which are the self-regulatory organizations (“SROs”) which had the front-line responsibility to examine MF Global for regulatory compliance.  While one might also look at the adequacy of the oversight of the CFTC and the SEC of the SROs, it is unreasonable to expect that the Chairman of the CFTC would be involved with regulatory compliance at a particular firm until there was a clear problem that staff deemed needed his attention.

This leads one to wonder what is behind the Journal’s vendetta against Mr. Gensler, with little mention of the SEC, which also had regulatory oversight of MF Global.  The reason is likely not that Mr. Gensler has been too lax a regulator but that his regulatory initiatives and aggressive negotiation style have made him some enemies.  It is hard to imagine that his former colleagues at Goldman Sachs like what he has been trying to do.

The liberals in Congress who had put holds or otherwise spoke against his nomination because of his Goldman Sachs ties and his activities on behalf of the Commodity Futures Modernization Act when he was an Under Secretary of the Treasury in the Clinton Administration have been pleased by the positions he has taken since he was confirmed as CFTC chairman.  But Mr. Gensler has run into problems which may undermine his effectiveness.

I argued in one of my more controversial posts that former CFTC Chair Brooksley Born’s lack of political ability hurt the CFTC in its quest to regulate OTC derivatives.  Gensler is not making the same mistakes as Born.  He was, after all, successful in obtaining for the CFTC a great deal of regulatory authority over the OTC derivatives market in the Dodd-Frank legislation.  However, he has not been able so far to obtain from Congress the funding the CFTC believes it needs to carry out these responsibilities.

Gensler also runs the danger of getting into substantive and turf battles with the bank regulators.   He is vulnerable, because he is prone at times to exaggerate his case.  For example, as I pointed out in another post, his argument in a WSJ op-ed (!) that the dangerous interconnectedness of financial firms because of OTC derivatives could be addressed by clearinghouses did not make sense.  Also, Gensler has used volatility in oil prices, by which he usually means sudden increases, not decreases, in prices, for arguing for more regulation, such as speculative position limits, without much factual support that the volatility stemmed from the futures markets.  In fact, the CFTC’s economic staff led an interagency study that said, if anything, speculative positions in the futures markets may have had a stabilizing influence on prices.

While the Journal’s editorial page attacks on Gensler make little sense, they indicate that he has a political problem.  He cannot even mollify Congress by recusing himself from MF Global matters.  He has been attacked for that by Republicans, even though it was a Republican Senator, Charles Grassley, who suggested that Gensler recuse himself.  If he had not recused himself, he would have been attacked for his conflict of interest because of his long association with Corzine.

As a small agency charged with legislative authority that can be interpreted quite broadly, the CFTC has since its creation been the subject of controversy when it comes to financial instruments.  Whether Gensler can manage the relationships he must maintain with various constituency groups in order to remain effective, now that the CFTC’s authority has been unambiguously broadened, is now in question. The Times’ Dealbook article frames his political challenge with the Wall Street community accurately when it states:

“Mr. Gensler has been Washington’s most aggressive ambassador to Wall Street, introducing sweeping new rules to crack down on excessive risk taking.

“Even industry groups acknowledge his influence, though they are not fond of his aggressive tactics.  He can be difficult, colleagues said.  And his unshakeable faith in regulation has left some fearful the agency will jeopardize Wall Street’s anemic recovery and broader economic growth.

“‘It may be useful for Chairman Gensler in the short run to be viewed as an opponent of the financial industry, but to be successful in the long run, the C.F.T.C. will have to produce workable regulations that do not damage the economy too much,’ said Steven Lofchie, a partner at Cadwalader, Wickersham & Taft.  ‘The jury is still out on whether the C.F.T.C. can do that.’”

So far, while it is to be expected that Gensler’s substantive positions are opposed by Wall Street interests, his political style may undercut his effectiveness.  The Journal’s editorials are evidence that this may be the case.   


Disclosure:  I worked for Gary Gensler when he was a senior political appointee at the Treasury Department during the Clinton Administration.  With respect to Jon Corzine, I remember attending a couple of meetings, one in New York at Goldman Sachs and one in Washington, DC, at which he was a participant, but other than that I don't know him personally.

Republican Tax Proposals – Some Quick Observations

The Republicans contending to be the candidate of their party for President have put tax reform on the national agenda. The plans proffered by Herman Cain and Rick Perry have garnered the most attention.

Both these plans are bold in conception and bereft of detail. For most people, they are not really worth serious study, since they are unlikely ever to become law. Here, though, are some quick observations.

Neither plan addresses transition issues. In other words, can you get there from here? For example, many people have considered, with much encouragement, tax issues when saving for retirement. However, if the government decides not to tax dividends or capital gains, then Roth IRAs no longer make much sense and traditional IRAs would be much less attractive. I do not think Perry or Cain has been clear what the tax treatment would be for distributions from traditional IRAs and 401(k)s under their plans.

Also, the plans seem to hit moderate income people fairly hard, while giving a tax cut for the wealthy. For example, as some commenters have noted, the Cain's 9-9-9 plan consists of a 9 percent tax on wages and salaries, a 9 percent national sales tax, and the equivalent of a 9 percent value added tax. Those who devote a greater percentage of their economic income for consumption get hit harder than those who have room to save and those whose income include a significant amount of capital gains and dividends. Perry's optional 20 percent flat tax confers no benefit on those whose average tax rate is less, even though their marginal rate may be higher. Those in the highest income brackets might find it to their advantage, even after forsaking some deductions.

Neither plan is simple. There is deliberately created confusion here. A flat tax is not necessarily simple. Having different marginal rates is not what makes the current tax code complicated. Determining such things as the character, timing, source, and amount of income, as well as the eligibility for and valuation of deductions and credits are what make taxes complicated.

The Democrats would have an easy time picking apart the Cain and Perry plans, if either were the nominee.   Republicans would yell "class warfare," but I think Democrats would successfully counter that those who propose lowering taxes on the rich and raising them on moderate income workers are the ones engaging in class warfare.

Mitt Romney is apparently being more circumspect. He is making proposals that, while not likely to be enacted in their entirety and about which there can be strong disagreement, are nevertheless less ambitious and probably harder to ridicule.

Another thing that deserves mentioning is that many of those who lean Republican, including those who write the Wall Street Journal editorials, like to praise President Reagan and the Tax Reform Act of 1986. I agree that the Tax Reform Act of 1986 was a major accomplishment. But those on the right who praise this major piece of legislation forget that it eliminated the preference for long-term capital gains and taxed these gains at a maximum rate of 28 percent. I remember Charles McLure, who was the politically appointed Treasury Deputy Assistant Secretary for Tax Analysis from 1983 to 1985 and headed up much of the work that culminated in the Tax Reform Act, saying in speeches that income should be taxed the same whatever its character. Among other things, this would eliminate tax strategies aimed at recharacterizing income and losses because of tax treatment. In other words, the Treasury's position was that, borrowing from Gertrude Stein, income is income is income. Of course, the lack of preferential tax treatment for long-term capital gains was a provision which did not endure.

The case for broadening the base and lowering the rates has merit. I am all for sensible tax reform. We currently use the tax code for too many policy objectives in addition to raising revenue, though I believe that the tax code should be progressive and not have a flat rate. But why make this a priority now, when the unemployment rate is at 9.1 percent? After all, as the history since the enactment of the Tax Reform Act of 1986 demonstrates, the Congress will always be making changes to the Code and undoing even good ideas.

As for the Cain and Perry plans, they are not thought through. Again, borrowing from Gertrude Stein, "there is no there there." 

The Misery Index and GDP Growth – Then and Now

There is plenty of reason to be despondent about the economy.  Unemployment remains stubbornly high at 9.1 percent, the real estate market continues to be distressed, and a Eurozone crisis threatens to spill over into the U.S.

But it is not as if the U.S. has not suffered through bad economic times before.  Yes, there was the Depression in the 30s, but the latter half of the 1970s and early 1980s were also pretty bad.  For some reason, this seems to have been erased from our collective memory.

Some charts might help jog the memories of those who were old enough then to be cognizant of the situation and remind others of what their parents experienced during the earlier period.

The first chart starting in 1965 is the monthly unemployment rate.  As can be seen, we did reach current levels and higher in the early 80s.

The second chart is the inflation rate (monthly CPIs compared to a year ago).

Inflation was a real problem in the late 1970s and early 1980s.  It is currently creeping up, but it is nowhere near the level it was back then.

This brings us to the “misery index,” which is the sum of the unemployment rate and the inflation rate.  This is an index attributed to Arthur Okun as a quick way of summarizing how bad economic conditions are, though limiting it to these two statistics and giving them equal weight seems more due to convenience than the result of any thorough analysis.

Because of the stagflation in the late 70s and early 80s, the misery index was then much higher than it is now.

Finally, here is one more graph – the annualized growth rate of quarterly real GDP.

GDP growth went further into negative territory in 2008 than it did in 1980.  Note that there was a “double dip” in the 1980s, as the Fed squeezed the inflation out of the economy.

All this is not to minimize the severity of the current situation, but the earlier rough times should not be forgotten.  We should also recall the significant economic policy changes that took place in the 1970s.  For example, among other developments, the last meaningful link of the dollar to gold was broken when President Nixon closed the gold window to foreign countries, the Bretton Woods system of fixed exchange rates ended, and there was a failed experiment with wage and price controls.  Finally, we went through a recession essentially engineered by the Fed, which finally ended the high inflation and paved the way for better economic times. 

Realpolitik and Economic Policy

In thinking about the debate about the correct government policy to follow in an economic environment characterized by high unemployment, large budget deficits, slow growth, and economic and financial problems in the Eurozone which, if not adequately addressed by European officials, could aggravate problems in the U.S., the school of international relations known as “Realpolitik” came to mind. As a way of conducting international relations based on a country’s national interests, Realpolitik can be viewed as cynical, but an important point is that, in order to conduct a foreign policy based on its tenets, one must correctly understand what the national interest is.

I wonder if those who are currently advocating shrinking government and, even in some cases, reducing taxes, correctly understand where their interest lie. After all, a reduction in joblessness and a return of economic growth as quickly as possible will benefit everyone, including the rich and businesses.

There are some who believe that any attempt to increase economic growth through budget stimulus is doomed to failure, because of the hangover the economy will suffer when the stimulus comes to an end. According to this view, there seems nothing the government can do but to shrink and let the private market solve the problem. The trouble with this view is that it may be a very long wait before the economy resumes adequate growth to reduce unemployment, and the wait may prove to be politically intolerable.

Also, those who hold this view need to address why the deficit spending accompanying World War II., which resulted in a public debt in excess of GDP, put an end to the Depression once and for all, and the debt as a percentage of GDP fell markedly in the years after the war. In other words, sustained stimulus can work.

Perhaps those who oppose further stimulus know this but either believe that a sustained federal effort is not politically possible or fear that a multi-year spending program not the result of a war would be difficult to end. If that is what they believe, then there could be a healthy debate about the issue and what the government should do. The prerequisite is that thoughtful conservatives admit that this is what they think.

For liberals, the stimulus enacted under the Obama Administration demonstrates that to get out of the current slump there needs to be larger effort of longer duration with less reliance on tax cuts. The conservative view, which may be correct, is that this is not politically possible, though the political difficulty may in fact be due to conservatives. They may also be right that federal spending may be difficult to stop, though infrastructure projects do have obvious termination points.

Conservatives, though, may need to reassess their contingency plans if the economy worsens or the current slump shows no sign of ending. It may not be in their interest, correctly understood, nor in the national interest for the government to be seen standing idly by while the economy struggles.

The Success of Occupy Wall Street

It is not surprising that those on the right first tried to dismiss the Occupy Wall Street (“OWS”) movement with ridicule, which some cable news outlets, including CNN (here or here) joining in. To an extent, ridicule was inevitable since this is a protest movement with grievances but no proffered solutions.

The OWS lasting power and engendering of similar demonstrations in cities across the U.S. and in Europe has effectively silenced the ridicule. Now the attempt by some GOP politicians is to characterize the OWS as a “dangerous mob.” That’s not flying too well either.

While the lasting power of OWS throughout the winter may be in doubt, it has already been successful in one respect. For all its incoherence, OWS has focused national attention on unemployment and the increasing wealth and income disparities in the U.S. It was not that long ago that most of the attention was on the debt and budget deficits of the federal government. This is an important, and welcome, change. And for those whose chief concerns are the debt and deficit, they should realize that economic growth and a reduction in joblessness would help pave the way to address those issues. In fact, many, if not most, economists think that further stimulus measures (even if you do not want to call it that) are the necessary accompaniment to longer term efforts to reduce the deficit.

The G-20 Communiqué

International communiqués usually make for extremely boring reading. In this regard, they compete with Financial Accounting Standard Board statements, though the latter actually make sense if you take the time to study them, and they can be quite important. International communiqués, though, often make less sense the more one pores over them, and, while sometimes they are signaling something important, at other times, they seem to be produced even if there is nothing new to say, because that is what is expected.

The acronym laden “Communiqué of Finance Ministers and Central Bank Governors of the G-20:  Paris, France, 14-15 October 2011” is a case in point.  On the first page of this document there is the following sentence: “Advanced economies, taking into account different national circumstances, will adopt policies to build confidence and support growth, and implement clear, credible and specific measures to achieve fiscal consolidation.”  The more one thinks about this sentence, the more it becomes clear that the finance ministers and central bank governors did not agree to anything here, except that each country would do what it thinks best. The communiqué goes on to say:  “Those with large current account surpluses will also implement policies to shift to growth based more on domestic demand. Those with large current account deficits will implement policies to increase national savings…”  I suppose it is left as an exercise to the reader to divine what these policies are.

With respect to emerging market countries, the communiqué starts off with this informative declaration: “Emerging market economies will adjust macroeconomic policies, where needed, to maintain growth momentum in the face of downside risks, contain inflationary pressures and endeavor to enhance resilience in the face of volatile capital flows…”  Perhaps someone thinks this means that a significant agreement has been reached.

To be fair, in some badly written prose, there are some more specific statements later on in the document mostly reaffirming what the G-20 has said in the past.  As for the U.S., the agreement by the Fed and the Treasury on regulatory matters may not mean much unless the various bank regulators, the CFTC, and the SEC agree.

What is dismaying is that this mushy, poorly drafted document must have consumed many hours of staff time in all the countries of the G-20 as staffers participated in numerous meetings and conference calls to negotiate this document, which hardly anyone reads but whose absence would have been noted. Its vagueness about economic policy, though, does serve to signal that there is no real agreement in the G-20 about what the appropriate policies should be.  That is probably not what the drafters intended.