The Treasury Crisis

The President of the richest nation on earth last week publicly confessed what everyone on Wall Street has known for months. The U.S. Treasury cannot sell its long-term bonds. This week Congress got the President's proposal to tide the Treasury over its crisis. In a special message Ike 1) recommended an end to the statutory ceiling on interest rates both for savings bonds (now pegged at 3.26%) and long-term Treasury securities (pegged at 4.25%) so that they can compete in the open market, and 2) asked for a 1/2% boost in the interest rate on all E and H series savings bonds if they are held to maturity. As an added help to the Treasury, he also requested a $5 billion increase to $288 billion in the permanent debt limit, plus a temporary one-year increase to $295 billion.

How did the U.S. get into such a predicament? It has been in the making for years.

P: An unbalanced budget of $13 billion in fiscal 1959, piled on top of other deficit spending, forced the Treasury to borrow so heavily that the national debt has climbed to $285.7 billion, straining the resources of the money market.

P: Inflationary fears by banks, corporations, insurance companies and private investors encouraged them to take their funds out of conservative bonds, put them instead in stocks, land, home mortgages and other investments where prices and interest rates keep pace with inflation.

P: A collapse in the U.S. bond market. Speculators, buying on margin, had tried to make a killing during the 1957-58 recession as bond prices rose and other securities went down. When the economy reversed itself, and bonds went down as stocks rose, the speculators were caught, and many had to dump their bonds.

Discounts & Redemptions. The bond market last week was so weak that the highest-rated corporate issues, such as Consolidated Edison, offering 5 1/8% interest, barely maintained par, and the Treasury's lower-interest bonds went begging. In the first quarter of this year the U.S. Government was forced to borrow $8.5 billion for current cash needs alone, and so far this year has refinanced $20 million worth of maturing securities. Only $1.5 billion went into long-term bonds; all the rest had to come from short-term securities, since investors were not willing to tie up their cash for more than a year. By January the Treasury must roll over another $31 billion in securities or raise new cash. It has little hope of bettering its past record. Outstanding Treasury issues now on the market are selling at discounts of 5% to 10% below par, so low that even though some bear a formal interest rate of 2 1/4% to 2 1/2%, the effective yield is 4% or better (see chart). And they are headed lower. At first news of the proposed changes last week, Treasury bonds took a bad spill; yields pushed past the 4.5% mark for the first time in nearly 30 years.

The situation is little better in savings bonds, whose sales have slumped and redemptions have increased ever since 1955. Savings bonds outstanding at the end of April totaled $50.8 billion, down $1.4 billion since last year, and $7.8 billion since 1955.

The Fed & Inflation. Whether or not Congress grants a rate increase, the request is bound to touch off a noisy squabble. Many a Congressman already feels that the general rise in interest rates throughout the economy has put too much of a burden on home buyers and other small borrowers, benefits only the moneyed. They are aware that any Treasury increase will only nudge interest rates higher all along the line. Last week there was talk of corporate bond rates rising to 7% or higher, even that home mortgage rates might climb to 7% from the current 5 1/2% to 6% level. The grave fear is that such high interest rates reaching into every corner of the economy might choke off the boom in a hurry.

Congress may well refuse to go along and instead pressure the Federal Reserve System to resume its role as sugar daddy to the Treasury by pegging the price of bonds. The Fed has done it before, notably during World War II and the Korean war. But in those years large sectors of the U.S. economy were under anti-inflation controls that restricted consumer and corporate spending. Today, without such restraints, the Fed would lose much of its control over the money supply, would add to inflation by pumping money into the economy through its purchases of Treasury securities.

To both the Fed and the Administration, a boost to make Treasury interest rates competitive is the lesser of the evils. The Treasury's current dependence on short-term financing is too inflationary to risk any longer. Long-term bonds are bought for investment, may not add to the overall money supply. But short-term securities are bought largely by commercial banks and corporations, are the closest thing to cash, and are readily used to increase credit and further complicate the Fed's problems. At that, even short-term notes are so unpopular that last month, when the Treasury tried to refund $1.8 billion worth of securities with one-year certificates offering 4.05% interest, the attrition was 30%. To make up the difference, the Treasury has to issue new securities.

Under the circumstances, a hike in long-term rates is the best way out of the mess. The prospect is for a balanced budget in the fiscal year starting July 1. Even so, spending will run above income for at least another six months because of this year's deficit and the lag in tax receipts. Therefore, the Treasury will have to find an estimated $6 billion in new money, over and above what it will have to make up in savings bond redemptions and the attrition in refunding old issues. By raising interest rates, the Treasury hopes that it can get a breather until income matches outgo some time next year and then fix rates high enough to sell long-term bonds again and put its fiscal house in order.

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