Thursday, May 3, 2012

Floating-rate debt update

As reported in the WSJ, the Treasury delayed it's decision on floating rate notes.

I was interested to note in the article that the Treasury seems to be struggling with the same issue that occupied my post on the subject yesterday -- just how will the "floating" rate be set?

The Treasury is searching for an index, and considering the overnight Federal Funds rate, Libor, the general collateral Repo rate, or an index based on treasury bill rates. All of these have various problems outlined in the article.

A second indication of the problem with any index shows up in the article: The unsettled debate whether to let floating rate debt auction at a price greater than face value. That means Treasury also envisions the security trading less than face value.

I'm interested that what's missing is the most obvious mechanism: The price is exactly $100 every single day, and an auction mechanism sets the rate daily at whatever it takes to maintain that price. Any other mechanism means the security is not protected from capital losses, which makes it much less useful as an asset.


  1. Hard to see the real advantage of long term floating rate notes. Setting the interest rate is likely to be tricky. You cannot just use the thirty day rate because the whole point for both the lender and the borrower is that these are long term commitments. The benefits to the government of guaranteed rollover are suspect. The government is still a net issuer of bonds and if there was a refusal to take new bonds there would be a full on crisis. Long term floating rate bonds might make sense to investors if government was rapidly paying down the debt and investors were concerned about availability of future supplies of bonds - but that is not a problem that the US will face for at least a generation (the Boomers all have to die before that could happen).

  2. In 2008, the auction market for municipally issued floating rate securities collapsed, causing financial and legal harm to everyone involved. Why would your idea work any better?

    Just speaking as a taxpayer, not that anybody really cares, what I want treasury to do is to lock as much of the really cheap long term debt up as possible. At this point they shouldn't be selling anything other than 10 years and TIPS.

    1. I agree, since we have so much damn debt to service, try to lock it up in the long term very low rates.

    2. Yes, see earlier posts. I also agree that the treasury should be lengthening the maturity structure as much as possible. The question is whether, given a maturity structure, floating rate debt is an attractive option to rolling over short term debt.

      Indeed, auction rate securities fell apart. And so did the overnight repo market, which represents the alternative of explicitly rolling over debt. If there is a run on US treasury debt, no small changes like these will make much difference. That's why overall we should have a much longer maturity structure.

  3. Expand on that idea of using an auction to peg the price at 100. How would that work?


Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.