WSJ.com, October 6, 2008
Now comes the hard part: raising the money to pay for the U.S. government's rescue plan.
Right now, there is good demand for low-risk U.S. Treasurys as investors around the world flee risky assets. The weakening economy adds to the allure of safe government debt.
But while those factors could help damp the rise in market rates that will come with the flood of fresh supply, long-term rates are still likely to rise, which could hurt the already struggling economy.
Even before the latest escalation in the credit crunch, the Treasury was considering ways to raise more money to fund the rising federal deficit. September's bailouts of Fannie Mae and Freddie Mac, the loan to insurance giant American International Group Inc. and the backstops for money-market funds all added to the government's cash needs.
Now comes the up to $700 billion Troubled Asset Relief Program to deal with toxic assets held by the banking system. As part of that package, lawmakers approved an increase in the federal debt ceiling to $11.3 trillion from $10.6 trillion.
As a result of all these actions, Merrill Lynch & Co. economists expect the budget deficit to reach $900 billion in the fiscal year that began Oct. 1. That is double the $407 billion deficit forecast early in September by the Congressional Budget Office for the just-ended 2008 fiscal year and the record $438 billion it expected for fiscal 2009.
Adding in debt that is maturing and must be rolled over, the Merrill economists see the Treasury's total funding need at close to $1.5 trillion next year, a tally that economists at Goldman Sachs Group Inc. also have reached.
Raising that amount of money will require some creativity, and the Treasury has several options. It could bring back three-year, seven-year or 20-year Treasurys, or even introduce a 50-year bond. It could sell two- and five-year notes on a weekly, instead of a monthly, basis. And it could sell Treasury bonds on a one-time basis, explicitly earmarking the money to fund the bailout.
"They are going to have very large and very concentrated financing needs, which means they could go beyond the normal pattern of regular, predictable auction cycles," said Louis Crandall, chief economist at Wrightson ICAP LLC.
Ed McKelvey, senior economist at Goldman Sachs, thinks the Treasury should consider reopening "off-the-run" issues as a way of reducing its borrowing costs. Those are securities issued before the most recently sold bond of a particular maturity. Typically, these issues trade at a higher yield, and lower price, than the benchmark issue, because they are less frequently traded. But because of the supply concerns, off-the-run issues are trading at a lower yield than benchmark issues.
The Treasury Department already has increased the supply of bills and short-term notes this year to fund the rebate checks to consumers and to raise cash for the Federal Reserve's liquidity efforts.
Despite the increase in issuance, demand for Treasurys has yet to falter. Foreign central-bank holdings of U.S. government debt stood at a record $1.5 trillion last Wednesday. And there is natural demand from long-term investors such as pension funds and insurance companies.
But the rise in supply will pressure yields, which will lead to higher rates on mortgages and other types of consumer and corporate borrowings. Already, the benchmark yield curve, or the gap between two- and 10-year yields, is at levels not seen since March. It stood Friday at 1.99 percentage points. David Ader, rate strategist at RBS Greenwich Capital, thinks the curve could steepen to 2.5 percentage points over the next months.
