Originally created 08/05/98

U.S. Treasury unable to refinance debt



Interest rates are so low that only the clueless and lazy haven't refinanced by now.

Eleven-percent mortgages are so much nostalgia, stuck under the rafters with the Culture Club records and Tama Janowitz books.

Fourteen-percent junk bonds are gone. All the double-A, 10-percent corporates are retired, sipping rum tonics in Vero Beach, Fla.

One indebted grandee, though, continues to pay for money at 1984 prices: the United States.

The U.S. Treasury must be the only borrower in the country still liable for bonds bearing a 15.75 percent interest rate. Surely the only one that has a gilt-edged credit rating.

But at least the 15.75 paper matures in three years. On another bond issue, Treasury is stuck paying 12 percent until 2005. And somewhere out there, canny investors will be happily clipping 11.25 percent Treasury coupons for the next 17 years.

The average coupon on outstanding T-bonds these days is 8.8 percent, 3 points above current rates.

This costs money.

By my calculation, the government could save $6 billion a year if it reduced the average coupon on its long-dated liabilities by a single percentage point. Instead of giving the $6 billion that ends up on Wall Street and in the Bank of Japan, shouldn't we be supporting worthwhile programs?

But the United States can't refinance.

Except on a very few loans, the government is required to pay interest for the full term of the deal. This is comparable to telling a homeowner: Sorry, you can't borrow new money at 7 percent to pay off the mortgage you took out at 9 percent. We want the 9 percent -- for another couple of decades.

Actually, mortgages used to be like that. So did a lot of other debt. If loans weren't bulletproof against refinancing, many had high early payment penalties. But after interest rates started misbehaving in the 1970s, borrowers obtained greater and greater pre-payment, or "call," rights. They didn't want to get stuck with expensive loans if rates re-entered the atmosphere.

Almost all mortgages are callable now. So are many municipal bonds and most corporate bonds with maturities of 10 years or more, said Charles A. Knott Jr., chairman and chief investment officer of Logan Capital Management in Philadelphia.

But the federal government keeps borrowing money the old-fashioned way. Expensively.

There are good arguments to do so.

The country isn't like other borrowers. It's huge, for one thing. Treasury wiggles can push the bond market to conniption. Noncallable bonds ensure that Treasury issues mature at regular, predictable intervals, that the government won't have to refinance $5 trillion all at once.

It's not like the government can't enjoy some lower rates, anyway. About $640 billion of the national debt is in bills due in a year or less. They get retired with new bills sold at prevailing rates.

The subject of callable bonds pops up every year or so at Treasury.

"Every time we look at it, we come to the conclusion that what it would cost us to sell callable debt isn't worth what we'd get for it," said Roger Anderson, deputy assistant secretary. "A call right is basically an option, and we have to pay people for the right to call the bonds" -- in the form of a slightly higher interest rate.

But Los Angeles-based financial historian Bryan Taylor II suspects the government's aversion to calls "is more of a habit. ... It's more the bureaucratic mentality than the bottom-line mentality. It's `We're the government. We run things. This is the way we've always done it.' "

Other borrowers have embraced safety-valve debt. What does Treasury know that they don't? With deflation spreading, there's reason to believe that interest rates will fall even further and that new refinancing chances will surface.

The government has another debt experiment going: inflation-proof bonds. Maybe it should try at least a few callables, too, and join the 1990s.