It’s no secret the the federal government’s need to borrow has sky-rocketed. Thanks to the various bailouts and stimulus measures, expenditures by the feds have increased by one third and are likely to grow even higher. Meanwhile, the economic slowdown has decreased the amount the government collects in taxes. The only way to bridge the gap is more borrowing.
While many are confident that the global appetite for the soveriegn debt of the United States will remain robust, some of the government’s own programs may start to diminish that appetite. The government’s guarantees of various kinds of debt issued by financial institutions essentially makes some bonds issued by banks as “risk free” as Treasuries. But these bonds pay higher yields than government debt, which should make them more attractive for risk-adverse investors looking to maximise their returns on investment.
A financial sector panel took up this risk yesterday in Washington DC’s Hays Adams hotel. The occassion was a meeting of the Treasury Borrowing Advisory Committee of the Securities Industry and Finacial Markets Association, the leading securities industry trade association.
The member presented a slide indicating that debt issuance by sovereign issuers continues to rise. This was followed by a series of sides depicting flows into various asset classes. The member pointed out that Treasury issuance has benefited from a flight to quality and general risk aversion. Aggregate foreign inflows into US assets have shifted dramatically in favour of Treasuries.
So far the Treasury has benfitted from what is called a “flight to quality,” with investors seeking the safety of government securities in rocky markets where corporate debt and municipal debt is at risk of defaulting, the committee members were told in a presenation by one of its members. Because of this, the government has been able to borrow cheaply and the Treasury’s share of the overall debt market has been growing.
But the government’s guarantees may be creating competition for safe debt, which could mean the government’s borrowing costs would increase. Although the guaranteed bank debt is viewed as less liquid and less standardized than Treasuries, the ever-increasing size of the guaranteed debt offerings may at some point bite into the Treasuy’s market share.
The committee noted that issuance of quasi-governmental debt is projected to increase dramatically.
“One member stated that many of these assets were directly competing with Treasuries and cited an expected $50 billion of issuance of Build America bonds as an example. Another member noted that FDIC-backed debt offered a significant pick-up in yield over comparable Treasury debt and that substitution by traditional Treasury investors was occurring,” the offical minutes of the meeting explain.
The bottom line is thatpolicy makers should not assume that there is no cost to offering guarantees of private debt. Even if banks don’t default and so those guarantees never have to be paid out, at some point the growth of the quasi-government debt market will make it more difficult and more expensive for the government to borrow.