Exciting News About Treasuries!!!

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Now, on to what I’m thinking about today…




I think that the most important (long term) story that I’ve read in the past couple of days is that Moody’s has said that the United States’ AAA rating is stable.  This is great news!  I think it means that we’re as safe as the senior tranche of a subprime CDO was in 2007!  Yahoo!  That should make you feel good.




Moody’s said that the AAA rating of the US could be downgraded if we don’t manage our debt.  The ratings agency said that the ratings of US and the UK were stable, but “their distance-to-downgrade” has substantially diminished.  In other words, we’re closer to being downgraded than we were in the past.




Well, this can hardly be a surprise.  (And lets face it, none of us expect the credit ratings agencies to bring new information to the market.)  Think about the basic facts:

1. We’re running a deficit that is greater than 10% of GDP.
2. Our publicly held debt is going to easily double in the next ten years (and GDP won’t).  As rough numbers, our debt held by public investors is approximately $8 trillion and will easily head toward $18 trillion in the next ten years.  We are also borrowing money (~$4.5 trillion) from Social Security.
3. Interest rates are being kept low by a series of factors (such as a low Fed funds rate which allows banks to borrow for close to nothing and buy Treasuries; direct purchases of Treasuries by the Fed; a misguided belief that Treasuries are a safe long-term investment; a slow economy which has resulted in low inflation) which will eventually change.
4. We have an off-balance sheet unfunded liability that the US government has just estimated at ~$46 – $52 trillion for Social Security, Medicare / Medicaid, Veteran’s Affairs and the Black Lung fund.

The point is that our debt is going to become a much larger percentage of GDP.  Investors tend to worry about debt when it approaches 90 – 100% of GDP.  If you believe that our unfunded liabilities are truly debt, our debt is 400 – 500% of GDP.  (Apparently, this is AAA in the eyes of the credit ratings agencies.)




Of course, not only will our debt rise, but our interest payments are going to eventually increase (unless you believe that the Fed will maintain a 0% Fed funds rate forever and that we will have a slow economy forever).  When interest rates rise, our interest payments are going to become a much larger percentage of our tax revenues.  (They are currently 8%; the credit ratings agencies tend to worry when they are over 10%.)




We’re going to have tremendous political problems – problems which will dwarf the current fighting.  Here’s the important line of what Moody’s said.  Moody’s said that “preserving debt affordability (the ratio of interest payments to government revenue) at levels consistent with AAA ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion.  This means that we’re going to have to cut spending or increase taxes.  In addition, this means that we’re going to have to do something about our unfunded liabilities.




Changing our spending is easier said than done.  According to CNN, Moody’s said that cutting back on spending too soon will result in a possible double-dip recession.  But, leaving stimulus in place for too long could lead to a sharp rise in interest rates with more abrupt rating consequences a possibility.




Changing our social insurance program will be even more problematic. As I showed yesterday, people have not save enough to pay for their retirement or healthcare – they are relying on Social Security and Medicare / Medicaid.  In my opinion, it’s a total joke to believe that we can easily solve those problems.  You should question people who want you to believe that eliminating a $52 trillion liability will just require a few easy adjustments.  Few people can work past 65, we don’t have the jobs to allow them to work and people can’t afford private health care insurance during retirement.  Most importantly, even if there are some solutions, we don’t have the political will to implement them.




Eventually, there will be a downgrade.  Among the impacts will be:

1. higher interest rates for the US – which would perpetuate our deficit
2. tarnishing the US image
3. higher rates for all other loans

If you want to hear the other side of the argument, look to Tim Geithner.  Our fearless Treasury Secretary laughs in the face of danger.  Geithner said that there’s no chance that the US will be downgraded.  I would agree that there’s little chance of an immediate downgrade.  Things aren’t desperate yet and we all know that credit ratings agencies are slow to act.  But, I would love to know what Geithner would have said if we had asked him three years ago about the chance of Bear Stearns, Lehman, AIG, Merrill and Washington Mutual being gone.  My guess is that he would have also said that there was no chance of this.  I’d say that the US problems are much more obvious than the ones I just mentioned.




All of this news really impacts our debt market.  As a result, there have been some other important stories which tie into this issue:

1. From 2012 – 2014, we’re going to have approximately $700 billion of junk bonds and CMBS that need to be refinanced plus approximately $4.5 trillion of Treasuries issued (this is new US debt plus refinancings).  Investment grade companies will have to refinance $1.2 trillion during that three year period.
2. States also have a $1 – $3.35 trillion gap for their pension and health care plans.  It is estimated that 41 states have pension programs that are less than 10% funded.  (This makes my retirement account look good!)  Only 5% of the $587 billion liability for current and future retiree health care  benefits is funded.  Hedgeye (a research firm) estimates that the six states in the most trouble are California, Arizona, Michigan, Nevada, Florida and Illinios.

I think that the corporate issuers will refinance ahead of time (if they can), as rates are currently low.  As a result, that doesn’t worry me.  But, the amount of Treasury debt is huge and our balance sheet could look much worse by then.  These problems are all huge.  This is the issue that we should all be thinking about and this is the issue that should be driving our voting decision in the fall.
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