The recent government decision to issue “floating rate notes” (FRN) could have a dramatic and dangerous effect on our economy and our industry. The government’s plan is to issue FRN with an adjustable rate reestablished every 6 months. Instead of fixed interest rate notes, this new approach would have a variable interest rate.
The Gorilla in the room is of course inflation. As long as inflation is within its current range (yellow and the white line) the danger is minimal. But, if inflation begins to increase, the FRN approach to debt management could be a disaster for the US, our industry and the economy in general.
US Treasuries now are issued (mostly) as 30 year notes, their attraction is simple, and they are safe. As an offset for safety, the investor sacrifices yield, no risk equates to low interest.
The tie in to the annuity industry is simple, US Treasuries are safe, and annuities are safe. The tradeoff is always yield (Treasuries) and for us, added benefits such as income riders etc.
Now layer in the FRN and what happens? The government has put its competitive advantage at great risk because already in force notes (FRN) will need to adjust up to satisfy the contractual agreement. By putting their competitive advantage at risk we are also swept into the fray, our advantage of safety over other investment options could be diminished by the loss of our competitive position.
This affects the annuity industry in a very nasty way, our current enforce annuities will be at a disadvantage because current interest rates offered by Treasury backed investments will be on the increase and our clients will be trapped in lower yielding products.
What are the chances of this happening? Simply history. Throughout history inflation has never been able to rest; it always raises its head. The only option the government currently has to keep inflation at bay is what?
Issue more and more and more debt. (currently at $85 billion a month in new debt). The cycle is dangerous and one thing we have learned over the years, the biggest guys will win.
FRN is a potential disaster and one that is not necessary and not currently needed. As inflation rears its head, the government will be forced to increase interest on debt it has already spent the money on (the deficit).
How would you answer this question? How much is the annual interest bill on $16 trillion at 2% 4% more? How about 10%? (Remember Treasuries at 15% in the early 1980’s?) Who will pay and HOW will we the tax payers be able to pay? Better yet, who is the real beneficiary of FRN’s? It couldn’t be tax payers, could it be Wall Street? Will they chop these up in tiny pieces and resell them like they did with our mortgages?
Doesn’t the government already issue this type of debt? I thought their name was TIPS. How can floating rate notes be any different unless the answer is simple, maybe the government doesn’t care about how much these instruments cost the taxpayers? Does that seem too farfetched? It doesn’t to me and the reasoning is simple, the more you spend, the more the future will be controlled by it. Look at the increase in our national military spending, look at the swing of the baby boomers from earners to retirees. Am I a doomsayer? No, I am merely an amateur historian, look at the debt this country has incurred since 2000.
Who is actually the largest buyer of national debt? The biggest buyer of Treasuries is the Fed, which is doing it with printed money to keep demand up and bond yields down. This is the administrations (last 2) attempt to move the economy, an economy build on low debt interest. So why issue FRN? If the Treasury had to go to the free market with 100% of its debt needs, it would certainly face a much higher rate.
Of course the key question is basic. Who has allowed the Federal Reserve to buy this debt? Our congress!
Now with debt over $16 trillion (but with an actual decreasing interest rate) would anyone think FRN would be a good idea? Bankers? Wall Street? Tax payers? Who? If you owned FRN and wanted to sell, what would they be worth? How will they be traded? What happens to FRN if deflation occurs?
There are just too many unanswered questions and unfortunately, those who are answering them have no one to really answer to, The Secretary of the Treasury and the Federal Reserve.