Why is US Debt So . . . Immature?
The United States is borrowing about $1 trillion a year, give or take, from global markets. We are told not to worry about this because interest rates are so low that people are practically paying us to take their money. This is true, but it is radically incomplete. That borrowing is relatively short term borrowing, with most of the debt falling due within five years. And unlike consumer debt, US federal debt is not self-amortizing; all of our government borrowing is in the government equivalent of an interest-only mortgage. When the note matures, we have a big balloon payment to make, at which point we can either start paying down the debt--i.e., running a surplus--or we can roll over the debt, borrowing more money to pay off the old bondholders.
Because we need to keep rolling over so much of our debt, we are extraordinarily vulnerable to interest rate changes. Yet as John Cochrane notes, we have chosen an almost inexplicably short maturity structure for our debt:
As I think about the choice between long and short term debt, I feel like screaming4 “Go Long. Now!” Bond markets are offering the US an incredible deal. The 30 year Treasury rate as I write is 2.77%. The government can lock in a nominal rate of 2.77% for the next 30 years, and even that can be paid back in inflated dollars! (Comments at the conference suggested that term structure models impute a negative risk premium to these low rates: They are below expected future short rates, so markets are paying us for the privilege of writing interest-rate insurance!)
Our Government has taken the opposite tack. When you include the Fed (The Fed has bought up most of the recent long-term Treasury issues, in a deliberate move to shorten the maturity structure) the US rolls over about half its debt every two years.
Here’s the nightmare scenario: Suppose that four years from now, interest rates rise 5 percent, i.e. back to normal, and the US has $20 trillion outstanding. Interest costs alone will rise $1 trillion (5% of $20 trillion6 ) – doubling already unsustainable deficits! This is what happened to Italy, Spain, and Portugal. Don’t think it can’t happen to us. It’s even more likely, because fear of inflation – which did not hit them, since they are on the Euro – can hit us.
Moreover, the habit of rolling over debt every two years leaves us vulnerable to a rollover crisis. Each year our Treasury does not have to just borrow $1 trillion to fund that year’s deficits. It has to borrow about $4 trillion more to pay off maturing debt. If bond markets say no, we have a crisis on our hands.
Going long buys us insurance against all these events. And bond markets are begging us to do it! Most large companies are issuing as much long-term debt as they can.
To put it another way, your Congress just decided to take out the mother of all mortgages--in an Option ARM.
Of course, there's the question of whether we could lengthen maturities as much as we'd like. Yes, markets are begging us to go long. But would they still be begging if we tried to transform much of our $11 trillion public debt into 30-year notes?
I don't know the answer to that. But I wish we'd at least try to find out.
Update: readers point out something I forgot to mention, which is that lengthening maturities would raise borrowing costs (by a smaller amount) right now. And Congress has never been much for delayed gratification.