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A Way To Cut The Deficit? - Think Ouside the Box
The following discussion is an effort to describe a massive transaction
that would have some significant impacts to the US financial picture.
While it is theoretically possible to do this deal, it won’t happen.
Mr. Geithner’s Treasury Department is too busy putting out political
fires to do any deep thinking. Others, including those who believe that
touching the Social Security Trust Fund is “Off Limits” will just rain
criticism on this approach. I can’t wait. This idea has merit even if
there are detractors. To even consider it we would have to think
outside the box. That is not likely to happen.
I propose that we refinance $2.5 Trillion of the US debt. There will be
a reduction in the cost of the debt to the taxpayers throughout the
life of the transaction. The total savings, in the example provided, is
$430 B. The transaction changes the ratio of Public to
Intergovernmental debt outstanding. In my opinion the ratio is
favorably impacted as a result.
In round numbers the US has $12 trillion of debt outstanding. Of that
amount the public holds approximately $8T, the balance of $4T is held
by government entities. The Intergovernmental total is equal to 1/3 of
all our debt. This is a critical ratio. It is infinitely more desirable
to have an increase in the Intergovernmental component of the debt than
an increase in the Public side. The less we have to sell to the public
the better.
In the 1960’s Congress passed a law that established the rules for the
Social Security Trust Fund’s investments in US debt. The law
established the method for setting the interest rates (short and long
term) that the Fund’s investments receive. I do not have the details of
these rules but it is easy to look at the results and conclude that the
formula is based on averaging historical rates over a period of years.
The result is a smoothing out of yearly ups and downs of interest
rates. The following graph looks at ten-year Treasury yields from 1990
on. The red line is the yield that the SSTF has achieved on its
investments. It is clear from looking at this graph that the TF has
benefited substantially as a result of these rules. They are enjoying a
much higher return today than they would have if they were obligated to
invest at market rates.
Two recent examples of how the rules create distortions:
-In December of 2009 the SSTF invested its short-term surplus for 6
months at 2.875%. Actual market rates for Treasury bill yields would
have resulted in a yield of no more than a ¼%. The Trust Fund got a
great deal. They invested a total of $90.7B. The rate was 12 times
higher than they should have received if market rates were applied. As
a result the Fund will earn $900mm more than if the rate had been set
at market levels.
-In June of 2009 the SSTF invested $153B in a fifteen-year maturity at
3.25%. That rate was 1% lower than market. As a result the TF will
suffer from annual income that is $1.5B lower each year for the next
fifteen years.
The existence of the rules that sets interest rates coupled with the
fact that the US has been in a decade long secular decline in interest
rates has created an interesting and exploitable opportunity. I did not
create that. It just exists and I want to take advantage of it.
As of December 31st the SSTF was sitting on a massive accumulated
surplus of $2.5 trillion. This surplus is fully invested in Treasury
IOUs that have maturities that go out as far as 15 years. The average
life of the portfolio is currently approximately 8 years and has an
average yield of 4.7%.
I want to ReFi the entire SS portfolio. I want to do it at a rate of 2
1/8%. This rate happens to be the arithmetic average of the current
8-year and one year Tbills. It really doesn’t matter what rate is used.
The 2.125% just happens to produce some meaningful results and it
reflects current markets.
The Trust Fund Perspective
There is zero economic impact to the SSTF over the life of the
transaction. Before they have a $2.5T portfolio yielding 4.7% after the
transaction they have a $3T portfolio with a yield of 2-1/8th %. The
Internal Rate of Return of the portfolio is identical. The Net Present
Value is also the same when the discount rate is 4.7%. There is no
consequence to the Fund as a result. There can be no opposition from
either the Fund or those that believe the Fund should not be meddled
with. After the one time ReFi of the Trust Fund portfolio the old
1960’s rules would be used to govern the pricing of future purchases
and sales by the Fund. There would be no lasting consequence to this
proposal.
The Impact to the US Budget Deficit
The transaction would result in significant annual cash flow saving to
Treasury during the life of the transaction. Using again an 8-year
average life you would get these results:
The Impact to the US Bond Market
Based on the average life calculation, the transaction would result in
$50b of savings per year of for a total of $430B. This amount would not
be sold as debt to the public market ever. It would stay on the
Intergovernmental side of the ledger. Does $430 less debt in the public
hands matter? I think so. It is more than half of what the Chinese
currently own.
The Impact on the Unified Deficit:
Total debt will rise as a result of the transaction. However, the
increase is in the Intergovernmental A/C. I am not sure that is
relevant. The question is, “What is the debt service to GDP ratio. This
proposal improves that ratio.
Total debt for the US is going to rise substantially this year and for
at least the next five. We can’t stop that. The only question is, "Where are we going to find investors for this at a cost we can afford?"
Borrowing from ourselves is far more desirable than borrowing from the
Chinese. This transaction does not address the long-term imbalances. It
buys us time to put our fiscal house in order. If we fail to take
advantage of the window that this transaction creates we will deserve
the consequences that will surely follow. Hopefully we will be able to
capitalize on that opportunity.
Note:
The biggest source of opposition to thinking like this will come from
those who think that SS is sacrosanct. It can’t be touched. They will
say,"You are doing something different! You can't change the rules!" I say to that, “Hogwash”.
This transaction is being done in small amounts every month. That has
been the case for the past five years. There is nothing new to what I
propose. I just propose doing it in a much grander scale.
The following is a slide showing the SSTF purchases and sales for the
month of December 2009. The transaction I highlight is a sale by the
Fund of a small amount of high coupon bonds for cash. This transaction
resulted in a capital gain to the Fund of $12mm. Meaningless in the
scheme of things. But if one takes the time to look at the Purchase/Sale report
provided by the Fund you will see that they have repeated the pattern
of this transaction (sell high coupon, replace with low coupon) to
achieve a capital gain that adds to the principal balance of the Fund
nearly every single month for the last five years.
To those that hate the idea of financial engineering I say, “I’m sorry you feel that way”.
Look at this as if you were a homeowner with a 7% mortgage. You can now
Refi at lower rates and achieve a real benefit for your household. This
transaction would be the same, except that it has a lot more of zeros
involved. An additional benefit is that we would owe this debt to our
rich Uncle, (SSTF) versus a foreign Central Bank.
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Great Idea! Let's mark the trust fund to market, while there's a gain in it and continue to mark the banks to fantasy values! Now THAT's financial engineering at its finest! Shouldn't be too hard to convince FALOSB either (Financial Accounting Lack-Of-Standards Board).
National accounting is insane.
US Inc doesn't have any equity on its balance sheet: and it shows the mortgage but not the house.
The US might do what the UK did in the 1750s and consolidate debt into a new class of undated debt. These UK anachronisms - which have never been redeemed because it's cheap funding - are known as "Consols".
To all intents and purposes these are Redeemable Preference shares in UK Plc.
If the US were to refinance $2.5 trillion with US Consolidated Prefs paying an Index-linked 1% that might cut the burden a bit, and create a US National Equity while you are at it.
Who are we kidding here? Government debt is MEANT never to be repaid. All government bonds are just "guaranteed certificates of confiscation".
you only need to look at the Christmas holiday retail sales numbers to know that America has learned diddly about money, cutting spending or living within one's means. 17% unemployed/under employed and people were still spending like crazy people. America has learned nothing, that's the truly tragic part.
common theme:
great idea, but we don't trust 'em at all. sort a vote for "just leave us alone with our problems and we'll do just fine."
i'm with the guy who wants to stop the gov spending. now *that* makes more sense than anything. nice dream, eh?
They'll get the funds from seized 401s, where else?
"The Net Present Value [pre- and post-transaction] is . . . the same when the discount rate is 4.7%. There is no consequence to the Fund as a result. There can be no opposition from either the Fund or those that believe the Fund should not be meddled with."
I leave it to others to correct me if I am mistaken, but it strikes me that it is too simplistic to conclude that "there is no consequence to the Fund" merely because NPV (calculated as of the commencement of the proposed transaction) is equal pre- and post-transaction.
If the post-transaction NPV were to be recalculated after 12 months using a then-appropriate market-based discount rate, the post-transaction NPV at that time could be substantially higher or lower, depending upon changes in the nominal level of interest rates and/or the steepness of the yield curve.
Inasmuch as the proposed transaction would increase the terminal payment from $2.5 trillion to $3.0 trillion, in the event of substantially higher interest rates and a substantially steeper yield curve in 12 months, presumably the post-transaction NPV would be reduced substantially.
The only problem I have with your scenario is that you honestly think that the government has any intention of paying out the Social Security Trust Fund, long term... but then again, if that's the case, why aren't the doing this already? I mean, they can just roll the IOUs along at a lower rate indefintely until they actually have to print -er, pay out the dough.
I'm not like you guys.
I have every confidence in MY President that he'll just tell the Fed to get like $15 Trillion from somewhere and just pay off the national debt and still leave a little something for everyone to have free medical insurance and perpetual tax cuts while saving the planet from alien invaders and CO2 emissions etc.
HOPE and CHANGE,
4 MORE YEARS !!!!!!!!!!
Bruce -- I don't know whether the SS trust fund uses the same securities as the Fed's 401k, but their G Fund has access to *overnight* Treasuries with yields appropriate to 4+ year bonds. See http://www.tsp.gov/rates/fundsheet-gfund.pdf
That's a bold throw, Bruce.
I gotta think about this one a bit.
If We don't start thinking outside of the Box there isn't going to be anything left inside the Box real soon.
I'm throwing this up on Market Ticker for Karl & the Bears to chew on if it isn't there already.
Ok, let's be serious for a minute. Does anyone really think that some sort of value added tax is not coming to the US? It's not a matter of if but when. And even if it doesn't cure the deficit, it will replenish government revenues.
We have plenty of tax income for modest government and national defense. Raising taxes for big Gov. and a socialist agenda is political suicide and won't happen. Folks like you Leo have never experienced true freedom and liberty the government teat was in your mouth at birth. You're comfortable with it, it's acceptable to have you're hand out. For the vast majority of Americans it's not acceptable and won't be allowed to happen. Obamacare is dead, so's Cap and Trade. It's Obama and his libel agenda that got Brown elected. It's just the beginning Leo. I don't just think a VAT is not coming. The freedom and liberty that I was born with (instead of a Government teat) is the same freedom and liberty that lives in each and every one of those voters that elected Scott Brown. So I really don't expect you to understand when I say a Vat tax is not going to happen. And that's too bad. You, "not understanding"
None of this makes any difference because there is no discipline in Washington. Thus any possible benefit will soon have been spent.
What we need is leadership and discipline first. Of course a good plan wouldn't hurt.
no amount of leadership or discipline will matter. The entire federal system is the problem, there is far too much power concentrated in Washington.
I used to be a Constitutionalist, but now I'm actually starting to think that the Constitution is the problem, that it was a hopeless endeavor. Maybe we need to go back to the Articles of Confederation.
Hey, why not just raise income taxes AND impose a GST!!!
Awesome!!
Just kidding. I think it would be a much better idea for millions of us to swarm the congress and demand that they quit wasting our f#@%ing tax money.
If you've never gotten together with large numbers of pissed-off, like-minded folks, you ought to try it... It's a blast!
Hey, why not just raise income taxes AND impose a GST!!!
Awesome!!
Just kidding. I think it would be a much better idea for millions of us to swarm the congress and demand that they quit wasting our f#@%ing tax money.
If you've never gotten together with large numbers of pissed-off, like-minded folks, you ought to try it... It's a blast!
Why not just impose a goods & services tax (GST) like we have in Canada? One senior economist I know says the US can wipe out its entire deficit if it imposed GST tax similar to ours. It's non regressive and captures a lot of the black market gains because it's a consumption tax.
Is that why Canada's debt & deficit is large & growing?
http://www.vancouversun.com/business/Federal+government+runs+billion+def...
i know the kiss principle is popular among the masses, but overly simplistic thinking to the point of trivializatioon isn't what I expect to see on Zero Hedge.
I agree.
All in favor of the US government imposing a GST on the Canadians?
TF has benefited substantially as a result of these rules. They are enjoying a much higher return today than they would have if they were obligated to invest at market rates.
In what, Monopoly Money or Zimbabwe dollars?
AndyC