Wave of Debt Payments Facing U.S. Government

[Cees Binkhorst]

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http://www.nytimes.com/2009/11/23/business/23rates.html
November 23, 2009
Payback Time
Wave of Debt Payments Facing U.S. Government
By EDMUND L. ANDREWS
WASHINGTON — The United States government is financing its more than
trillion-dollar-a-year borrowing with i.o.u.’s on terms that seem too
good to be true.

But that happy situation, aided by ultralow interest rates, may not last
much longer.

Treasury officials now face a trifecta of headaches: a mountain of new
debt, a balloon of short-term borrowings that come due in the months
ahead, and interest rates that are sure to climb back to normal as soon
as the Federal Reserve decides that the emergency has passed.

Even as Treasury officials are racing to lock in today’s low rates by
exchanging short-term borrowings for long-term bonds, the government
faces a payment shock similar to those that sent legions of
overstretched homeowners into default on their mortgages.

With the national debt now topping $12 trillion, the White House
estimates that the government’s tab for servicing the debt will exceed
$700 billion a year in 2019, up from $202 billion this year, even if
annual budget deficits shrink drastically. Other forecasters say the
figure could be much higher.

In concrete terms, an additional $500 billion a year in interest expense
would total more than the combined federal budgets this year for
education, energy, homeland security and the wars in Iraq and
Afghanistan.

The potential for rapidly escalating interest payouts is just one of the
wrenching challenges facing the United States after decades of living
beyond its means.

The surge in borrowing over the last year or two is widely judged to
have been a necessary response to the financial crisis and the deep
recession, and there is still a raging debate over how aggressively to
bring down deficits over the next few years. But there is little doubt
that the United States’ long-term budget crisis is becoming too big to
postpone.

Americans now have to climb out of two deep holes: as debt-loaded
consumers, whose personal wealth sank along with housing and stock
prices; and as taxpayers, whose government debt has almost doubled in
the last two years alone, just as costs tied to benefits for retiring
baby boomers are set to explode.

The competing demands could deepen political battles over the size and
role of the government, the trade-offs between taxes and spending, the
choices between helping older generations versus younger ones, and the
bottom-line questions about who should ultimately shoulder the burden.

“The government is on teaser rates,” said Robert Bixby, executive
director of the Concord Coalition, a nonpartisan group that advocates
lower deficits. “We’re taking out a huge mortgage right now, but we
won’t feel the pain until later.”

So far, the demand for Treasury securities from investors and other
governments around the world has remained strong enough to hold down the
interest rates that the United States must offer to sell them. Indeed,
the government paid less interest on its debt this year than in 2008,
even though it added almost $2 trillion in debt.

The government’s average interest rate on new borrowing last year fell
below 1 percent. For short-term i.o.u.’s like one-month Treasury bills,
its average rate was only sixteen-hundredths of a percent.

“All of the auction results have been solid,” said Matthew Rutherford,
the Treasury’s deputy assistant secretary in charge of finance
operations. “Investor demand has been very broad, and it’s been
increasing in the last couple of years.”

The problem, many analysts say, is that record government deficits have
arrived just as the long-feared explosion begins in spending on benefits
under Medicare and Social Security. The nation’s oldest baby boomers are
approaching 65, setting off what experts have warned for years will be a
fiscal nightmare for the government.

“What a good country or a good squirrel should be doing is stashing away
nuts for the winter,” said William H. Gross, managing director of the
Pimco Group, the giant bond-management firm. “The United States is not
only not saving nuts, it’s eating the ones left over from the last
winter.”

The current low rates on the country’s debt were caused by temporary
factors that are already beginning to fade. One factor was the economic
crisis itself, which caused panicked investors around the world to plow
their money into the comparative safety of Treasury bills and notes.
Even though the United States was the epicenter of the global crisis,
investors viewed Treasury securities as the least dangerous place to
park their money.

On top of that, the Fed used almost every tool in its arsenal to push
interest rates down even further. It cut the overnight federal funds
rate, the rate at which banks lend reserves to one another, to almost
zero. And to reduce longer-term rates, it bought more than $1.5 trillion
worth of Treasury bonds and government-guaranteed securities linked to
mortgages.

Those conditions are already beginning to change. Global investors are
shifting money into riskier investments like stocks and corporate bonds,
and they have been pouring money into fast-growing countries like Brazil
and China.

The Fed, meanwhile, is already halting its efforts at tamping down
long-term interest rates. Fed officials ended their $300 billion program
to buy up Treasury bonds last month, and they have announced plans to
stop buying mortgage-backed securities by the end of next March.

Eventually, though probably not until at least mid-2010, the Fed will
also start raising its benchmark interest rate back to more historically
normal levels.

The United States will not be the only government competing to refinance
huge debt. Japan, Germany, Britain and other industrialized countries
have even higher government debt loads, measured as a share of their
gross domestic product, and they too borrowed heavily to combat the
financial crisis and economic downturn. As the global economy recovers
and businesses raise capital to finance their growth, all that new
government debt is likely to put more upward pressure on interest rates.

Even a small increase in interest rates has a big impact. An increase of
one percentage point in the Treasury’s average cost of borrowing would
cost American taxpayers an extra $80 billion this year — about equal to
the combined budgets of the Department of Energy and the Department of
Education.

But that could seem like a relatively modest pinch. Alan Levenson, chief
economist at T. Rowe Price, estimated that the Treasury’s tab for debt
service this year would have been $221 billion higher if it had faced
the same interest rates as it did last year.

The White House estimates that the government will have to borrow about
$3.5 trillion more over the next three years. On top of that, the
Treasury has to refinance, or roll over, a huge amount of short-term
debt that was issued during the financial crisis. Treasury officials
estimate that about 36 percent of the government’s marketable debt —
about $1.6 trillion — is coming due in the months ahead.

To lock in low interest rates in the years ahead, Treasury officials are
trying to replace one-month and three-month bills with 10-year and
30-year Treasury securities. That strategy will save taxpayers money in
the long run. But it pushes up costs drastically in the short run,
because interest rates are higher for long-term debt.

Adding to the pressure, the Fed is set to begin reversing some of the
policies it has been using to prop up the economy. Wall Street firms
advising the Treasury recently estimated that the Fed’s purchases of
Treasury bonds and mortgage-backed securities pushed down long-term
interest rates by about one-half of a percentage point. Removing that
support could in itself add $40 billion to the government’s annual tab
for debt service.

This month, the Treasury Department’s private-sector advisory committee
on debt management warned of the risks ahead.

“Inflation, higher interest rate and rollover risk should be the primary
concerns,” declared the Treasury Borrowing Advisory Committee, a group
of market experts that provide guidance to the government, on Nov. 4.

“Clever debt management strategy,” the group said, “can’t completely
substitute for prudent fiscal policy.”

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