Oct 12 2013

Economic Populist: Premium Bonds Would Disarm Default Threat

(6 PM – promoted by TheMomCat)

Just as the GOP Shutdown was getting underway, 2 October, Matt Levine at Bloomberg was calling on the administration to Mint the Premium Bonds!.

The creepy trick that has swept the nation* is the platinum coin option, in which Treasury mints a $1 trillion platinum coin, deposits it at the Fed, and suddenly has an extra $1 trillion of money to spend without incurring any debt (and, thus, without breaching the debt ceiling). This is a good trick as tricks go, and it’s been extensively advocated by Josh Barro, Paul Krugman, Matt Yglesias, Joe Weisenthal, basically every economics blogger really. I am unaware of any good arguments that the platinum coin wouldn’t work, but it does have the problem that it is really really really really obviously a trick. I mean, it’s a trillion dollar coin, come on. So it’s sort of sub-optimal symbolically, and would make people really mad. It’s a crisis-enhancer, although with the benefit of avoiding immediate default.

So there is an alternative that Matt Levine is putting forth:

Instead of just rolling those Treasuries — paying them off at 100 cents on the dollar by issuing new Treasuries at 100 cents on the dollar — it should pay them off at 100 cents on the dollar by issuing new Treasuries at 275 cents on the dollar and using the extra money to pay its bills. The 10-year yield today is around 2.6 percent, so you could sell a 10-year with a 23 percent coupon for 275 cents on the dollar.**** The 30-year is about 3.9 percent, so a 14 percent coupon should get you there. Etc. Math here.

Now, given my previous writing on Fixed Interest Payment Consol Bonds … would this work too?

Yes, in a functional sense, of course it would. Its a similar, though not identical, answer, but it goes through the same loophole. Premium bonds are, by law, counted on their face value. So any bond with a face value substantially below its issue price that is used to roll over maturing long term bonds would “roll back” the debt ceiling count.

Funny that Matt Levine should mention symbolism …

Its funny that Matt Levine should mention the symbolism of the platinum coin, and then propose an alternative that people unfamiliar with capital and money market are likely to find even more baffling. After all, for the platinum coin, for anyone who gets punches through money illusion and understand that IS dollars are just tickets to ride the rides that make up the US economy, its obviously how it fixes the problem: deposit the coin at the Fed, the Fed credits reserves, the Government doesn’t have to borrow, so no default.

But this … huh, what? How does a President explain this to the ordinary voter. Hell, how does a President explain this to the ordinary member of the Washington Press Corps? “Mr. President, is there going to be a math quiz after the speech?”

I’d simplify it to a 100% coupon. Worrying about trying to set the “right” outsized coupon rate to exactly avoid default is walking on the ledge of default, when it makes more sense to set up a simple, easy to explain system that goes further than we need. After all, if we pull the debt ceiling count down by more than we need, that frees us up to sell conventional Treasury bonds, so there is no big win from getting the coupon rate “exactly right”.

And a 100% coupon rate is easier to explain to regular people.

“These premium bonds will pay the face value to their holders every year, for ten years, and then pay back the face value on maturity. The government will not set the value of these bonds: they will be sold at auction, and the market will set their value. By law, the debt ceiling counts bonds of this type at their face value. They will replace ordinary Treasury bonds that have a much higher face value, so replacing ordinary Treasury bonds with these bonds will reduce the official debt ceiling count.”

“Some will say this is taking advantage of a loophole in the law. And they will be right.”

“It is not surprising that this loophole exists. The debt ceiling law was originally written to make it easier for the government to meet its obligations. It was not written with the intent of forcing the government to default. So it should not surprise those who want to abuse the debt ceiling law, those willing to play political games with putting the full faith and credit of the US Government into jeopardy, that its not a perfect tool for pushing the government into default.”

“And this is not without cost. The cost of servicing the debt with these financial tools are higher than using regular Treasury bonds. That is, after all, why we use regular Treasury bonds. This gives us a legitimate tool to use to disarm the threat of default, and paying this extra financial cost is a far better option than defaulting on our debt. Still, those in Congress who have been threatening to push us into default should do their job, increase the debt ceiling, and let us meet our obligations at a lower debt service cost using regular Treasury bonds.”

Basically, the exact same explanation has to be used for the form of Premium Bond advanced by Matt Levine … which is bad enough … but also has to explain what a coupon rate of 28% and 14% is, and how we arrived at those rates.

And, yes, given that these would push the debt ceiling count down faster than Matt Levine’s premium bonds … if we gain sufficient breathing room under the debt ceiling, we can reduce the cost of debt service by mixing in sales of conventional 10yr Treasury bonds.

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