The New York Times
January 9, 1993, Saturday, Late Edition - Final
HEADLINE: What's Good for Homeowners . . .
BYLINE: By Barry Nalebuff; Barry Nalebuff is professor of economics at
the Yale School of Organization and Management.
The projection of increased deficits this week renewed concern about inflation,
prompting a quick rise in long-term interest rates. Bill Clinton can cut
the Federal deficit and reassure the financial community by encouraging
a significant shift toward short-term financing of the national debt. After
all, savvy homeowners have saved money by refinancing their mortgages at
a 15-year rather than 30-year maturity. Others have saved even more by exploiting
low rates with adjustable mortgages. What works for homeowners could work
on a grand scale for the Government. Refinancing the debt at a shorter maturity
could provide $10 billion in yearly savings.
How? Today's yield curve is remarkably steep. The three-month Treasury
bill yields 3.13 percent while the 30-year bond pays 7.46 percent. This
offers a potential savings of 4.33 percent. Since the privately held Federal
debt is $2.2 trillion, refinancing 15 percent would lead to $10 billion
in annual savings.
Even if the Government took just a one-year hiatus from issuing seven-year,
10-year and 30 year bonds and replaced them with one-year notes, at current
rates this would save $4 billion in the first year and $65 billion over
the life of the bonds not issued.
What's the catch? Is it fair to assume that today's rates would prevail
if we shortened the maturity of the debt? Would the savings be real or just
a tricky way of shifting payments into the future? Didn't Ross Perot warn
against short-term solutions to long-term problems? When Mr. Perot criticized
the debt's short-term financing, he was wrong on the facts. Whether the
debt is long or short term can be measured by taking a weighted average
of the outstanding maturities: the amount of 30-year bonds, 15-year bonds,
and so on, all the way down to one year and three-month bills. Over the
last 25 years, this weighted average maturity has averaged four years and
two months, and has fallen as low as two and one-half years. Today, it is
six years -- a 25-year record.
Critics would charge that the savings would be illusory, arguing as follows:
The yield curve is steep for a reason. Long-term rates are 4.33 percent
higher than short-term rates because investors expect interest rates to
rise. But if interest rates rise, short-term financing of the debt offers
no savings.
Interest rates need not go up if Bill Clinton and Congress are serious about
their commitment to maintain low inflation. Shortening the weighted average
maturity gives them a way to help commit themselves to low inflation. When
the debt's maturity is long term, as now, the Government can gain by inflation:
it repays holders of long-term debt in cheap dollars. This puts upward pressure
on long-term rates. But as the debt maturity shortens, inflation offers
less gain, for it leads to a rise in interest rates and thereby increases
the cost of refinancing the shorter-term debt. A move toward shorter-term
financing would lower long-term rates on two accounts: There would be a
reduced supply of long-term debt, and people would have lower expectations
of inflation. Of course, this would only work if Bill Clinton really intends
to control inflation. Shortening the maturity of the debt is what game theorists
call a "credible commitment." It saves money if the Government
truly intends to control inflation and is very costly otherwise. The financial
market is looking for just such a signal.