The Return of the Long Bond
Yesterday, in what amounts to the biggest refinancing in world history, the Federal Government finally began issuing new thirty-year bonds. The return of the long bond comes none too soon, but it may be a day late and a few trillion dollars short.
For the past four years, the treasury has been artificially suppressing its interest expenses by borrowing massively at the short end of the yield curve. Like millions of Americans who have made the same mistake (with adjustable rate mortgages), this act of fiscal expedience exacts steep long-term costs. When individuals borrow on the short end, at least they do so with their own money, or at least their lender's money. But when the Federal government commits this financial sin, the entire nation bears the burden.
By concentrating on the short end of the curve the government has been able to spend more money than would have been possible had it paid the higher interest rates associated with long-term financing. Consumers have been able to follow the same spending policy by financing mortgage debt using ARMs. By keeping interest rates so low for so long, Greenspan enabled both public and private sector borrowers to live beyond their means. However, for those who have been dancing to the maestro's tune, it's finally time to pay the piper.
For the Government, refinancing trillions of dollars of t-bills into thirty-year bonds without dramatically increasing interest rates would be a feat of financial wizardly even the Great Harry Houdini couldn't pull off. As long-term rates ultimately soar, American tax payers will be stuck making excessive interest payments for generations to come, all because some irresponsible politicians wanted to win reelection and an irresponsible Fed chairman wanted to be reappointed.
For financially strapped homeowners living paycheck to paycheck with little or no home equity, the payment shocks associated with ARM resets will be the financial equivalent of a knock-out punch. Even if most savings-short households can somehow manage to swing the higher payments, it will require the complete abandonment of just about any other discretionary spending.
Since better than 70% of America's bubble economy is comprised of consumer spending, such austerity will result in wide-spread unemployment. If homeowners have trouble making increased mortgage payments while still collecting paychecks, imagine how much harder it will become when they lose their jobs. Further, since the unemployed go from being tax payers to tax consumers, imagine how much larger the already enormous budget deficit will swell. With cheap short-term financing no longer available and long-term rates spiraling out of control, the additional interest payments required that will also have to be borrowed will be staggering. If you listen very closely, you might just hear the sounds of helicopter blades spinning in the distance.
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