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Mr. Clinton's ARM
The wisdom or folly of some Bill Clinton financial sleight of hand depends on exactly the same analysis required from a home buyer contemplating an adjustable rate mortgage.
One of Clinton's post-campaign promises was to reduce the cost of financing the national debt by $16 billion. The method: sell fewer relatively high interest rate bearing Treasury bonds, and more low interest rate Treasury Bills.
(Certain wiseguys would suggest a more direct route to reducing the cost of debt: don't borrow as much money. However, oversimplifications like that have no place in a serious, scholarly analysis such as this.)
Currently, to sell a new 30-year T-bond, the Treasury must pay about 6.90% per year. New six-month T-bills are floated easily at 2.90%. Therefore, the Treasury can save four full percent per year by selling more bills and fewer bonds.
Shazam! Easy, wasn't it? Four percent on just this year's new borrowing of $300 billion would save $12 billion each year, and we didn't even have to argue with anybody about raising their taxes.
If it's this easy, why don't we turn the whole dang four trillion bucks into T-Bills? Why, we would be practically rich with all the savings.
Now, somebody shopping for a new or refinance mortgage has a similar thought. Why pay that nasty 7.75% when I can get a 4.25% adjustable? On a $150,000 mortgage, that's three grand -- after taxes -- I can blow onÉ.whatever.
This lovely, free money strategy has one obvious problem involving future interest rates. Future higher interest rates.
A homeowner can get a decent advantage from an ARM, provided the owner figures not to own the home for long. If you're out of your house in less than three years, the low start up rate will compensate you for what can happen in year three.
However, if you are going to finance your house with an ARM holding period of four years and out, you have the same problem the Treasury has, and there is an aspect of the problem that is not obvious, and is very painful.
The Treasury can't ever get the house sold. That is, I'm here to testify that that four trillion bucks in national debt isn't ever going to be paid off, or down. It's as permanent as the Flatirons. The Treasury will be rolling over that debt for as long as the USofA shall last.
For a certainty there will be periods of time in the future with interest rates higher than they are now. In analyzing Mr. Clinton's ARM, the key question is: will there be more time in the future with interest rates higher than now, or lower than now?
The answer is as uncomfortable for Dollar Bill as for the typical mortgage shopper calling in these days. That answer goes like this: "Long term rates are on a twenty-year low. Richard Nixon was in the White House the last time you could borrow this cheap. Why on earth would anybody want to borrow at a variable rate?"
For those still tempted by that three grand in early-year ARM savings, the hidden danger is worse. Interest rates can move up in the future, but the real pain comes from the fact that rates of different maturities move in different speeds and directions at the same time.
The most painful situation is when short term rates are higher than long term ones at the same time.
Today, the Clinton ARM is tempting because short term rates are at a historical low versus long term ones (a "positive yield curve" very positive). T-Bill rates were last this low when Jack Kennedy was in the White House.
A disastrous interval for the Clinton ARM would have been just about any time from 1979 until 1990. (Bill would blame Reagan, Ron would blame Jimmy, Jimmy would blame national malaiseÉ.). At the worst of the interval, T-Bills paid 17% (that's seventeen) while 30-year bonds paid only 14%. In a "negative yield curve" environment (short term rates higher than long term ones), that cute interest-saving trick is expensive.
The '80's also brought protracted periods of "flat" curve. In 1989, 30-year bonds and T-bills both yielded within a tenth of a percent of each other.
To pile up the national debt in maturities of less than a year is unpardonable foolishness. You just don't gamble with four trillion dollars in the self-deception that interest rates will always go your way.
Oh, almost forgot. There is one little difference between Bill's gamble and yours. When the Treasury sells a T-Bill yielding 3.30%, it pays 3.30%.
For an ordinary homeowner borrowing on a one-year T-Bill ARM, you pay a spread of 2.75% above whatever the Treasury is paying. Pleasant dreams.
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