Now is the time for Treasury to issue ultra-long bonds

The U.S. should issue 50- to 100-year bonds and use the proceeds to pay off as much of its short-term Treasury notes as practicable; otherwise, we’ll have to refinance that short-term debt at higher interest rates when rates rise. There is likely to be no better time — because interest rates are at record lows.

Other countries have done it. But Treasury Secretary Steven Mnuchin is resisting, and for the wrong reasons. 

Most of the $25 trillion in U.S. debt matures in one to five years and will have to be repaid by borrowing at higher rates if interest rates rise.

That risk is more acute than proponents of modern monetary theory (MMT) recognize. They argue that a government that issues bonds denominated in its own currency won’t ever default because it can always print enough money to pay its debt. 

But interest rates the government has to pay will rise if investors lose confidence that the U.S. economy is strong enough to justify continued low rates. The damage that the COVID-19 virus could wreak on our economy is incalculable and could shake that confidence, sending Treasury rates higher.

Proponents of MMP would tolerate printing excessive amounts of money, but that can lead to inflation and higher rates. Although inflation seems remote now, it could return in a recovery if the economy begins to approach its full potential. 

No matter what causes rates to rise, it’s critical to reduce our refinancing risk now.

But Mnuchin has bowed to political resistance against doing this. Short-term notes have political value: They make government officials look more fiscally responsible because their low rates keep deficits lower than the higher rates on long-term bonds.

The top ten primary dealers that distribute notes auctioned by the Treasury are arguably the most influential private-sector institutions in the financial markets. They don’t favor issuing 50- to 100-year (“ultra-long”) bonds.

Although low interest rates have thinned primary dealer margins, the frequency of Treasury issues adds to their revenues because they mark up the notes they buy at auction when they distribute them to clients. They also prefer five, 10, and 30-year maturities because those are more useful benchmarks for pricing corporate debt and mortgages.

Perhaps most important, the prestige of primary dealer status allows superior access to the broader credit markets, which adds to their clout. The top ten primary dealers account for almost 73 percent of foreign exchange trading. As counterparties to the Fed, they meet regularly with them and the Treasury to discuss monetary and economic policy and can sway decisions to their advantage.

Not surprisingly, the primary dealers expressed doubt that there’s enough investor-interest in ultra-long bonds to justify their issuance. Consequently, consultants have advised Treasury that there’s little evidence of strong enough demand.

Mnuchin has accommodated the primary dealers by shelving plans to issue 50- to 100-year bonds, claiming there’s little interest among investors. “We went out to a large group of investors and solicited feedback from our Treasury borrowing committee,” he said. “There’s some interest in this but perhaps not enough that it would make sense to issue those bonds at this time.”

Mnuchin’s delay is ill advised. The average maturity of Treasury debt is 69.6 months. Around $7 trillion of that matures in 1-5 years, costing from 0.15 percent for the 1-year to 0.31 percent for the 5-year. If the U.S. refinanced as much of this debt as it could with 50- to 100-year bonds now — while interest rates are at historic lows —  it would avoid a surge in interest costs on short-term debt issued later. The interest rates the U.S. will have to pay on ultra-long bonds issued now will be higher than on outstanding short-term Treasury notes — but in a rising interest rate environment, the rates on new notes could rise above the rates on those ultra-long bonds.

The concern that there are not enough investors to buy 50- to100-year bonds is unfounded. Pension funds and insurance companies buy ultra-long maturities to match their long-term liabilities.

In 2017, Austria issued a 100-year bond with a 2.1 percent coupon, raising €3.5 billion — and followed it in August of 2019 with a €1.25 billion re-offer at a 1.17 percent yield. In 2016, Ireland and Belgium issued 100-year bonds at yields of 2.3 percent. In 2017 the University of Oxford sold £750 million triple A-rated 100-year bonds at .85 percent over UK debt of similar maturity that drew orders of over £2.8bn. Last year, the University of Virginia sold a 100-year bond at 3.23 percent, and Rutgers University sold $330 million General Obligation Bonds maturing over 100 years at 3.195 percent.

Canada issued C$1.5 billion 50-year bonds in 2014 at a 2.96 percent yield. Last year Mexico issued its third 100-year bond — a €1.5 billion A-rated Eurobond at a 4.2 percent yield. Argentina’s $2.75 billion 100-year bond was oversubscribed by more than 3.5 times. Albeit at a 7.9 percent yield, the over-subscription attests to investors’ appetite for ultra-long maturities. Additionally, countless private-sector companies have issued similar bonds.

The high volume and low cost of those bonds are compelling evidence that the U.S. Treasury should follow suit and issue its own.

And 50- and 100-year U.S. Treasury bonds would cost less than others, given that U.S. debt is the world’s favorite safe harbor. For instance, a 50-year bond might be issued at 2 percent and would substantially mitigate the refinancing risk of the short-term debt it refinances. If down the road the yield on the 30-year rose to, say, 3 percent, the 50-year 2 percent Treasury would be selling in the secondary market at yield of perhaps 5 percent and a deep discount to its par value. If the U.S. ever got close enough to a balanced budget, it could buy them back for maybe half their par value, and with inflated dollars to boot. The benefits of a 100-year bond would be even greater.

Clearly, the market for 50- to 100-year Treasury bonds would be smaller than the market for shorter-term Treasury debt. Treasury therefore would have to balance the size of an issue needed to provide liquidity with the smaller size needed to accommodate a smaller market.

Given the interest rate tsunami we’d face when interest rates rise and bring the attendant increases to our already-ballooning deficit and debt, it is irresponsible to delay the issuance of ultra-long bonds.

Perhaps an appeal to President Trump’s aversion to being outdone by other countries would do the trick. Although his motive would be unrelated to solving the problem, it would serve the best interests of the country.

Neil Baron advised the SEC and congressional staff on rating agency reform. He represented Standard & Poor’s from 1968 to 1989, was vice chairman and general counsel of Fitch Ratings from 1989 to 1998. He also served on the board of Assured Guaranty for a decade.