Premium Treasury Bonds to Circumvent the Debt Ceiling [Updated x 2]
I’m a fan of Platinum-Coin Seigniorage (PCS) to circumvent the debt ceiling, but a new contender “Premium Treasury Bonds (PDBs)” has emerged, and it has a few advantages that make it more likely to be adopted by the White House:
- It doesn’t involve shiny round metal objects of enormous power, and giddy journalists won’t write columns with titles like “One Bond To Rule Them All.”
- It uses no quirks of the U.S. monetary system, like the central bank paying the treasury face value for coins and allegedly unintended consequences of 31USC5112(k), the platinum-coin act of 1996. Any nation in the world can sell premium bonds and many have. Hopefully, journalists won’t call this “banana-republic behavior,” as they do PCS.
- The Federal Reserve does not need to participate other than to accept the proceeds of the bond sales, as they normally do.
Terminology: A bond has seven numeric attributes:
- Principal (par amount, face value): the amount that this bond will fetch when it is cashed.
- Interest (coupon): the yearly interest that this bond pays.
- Term (time from issue date to maturity date).
- Issue price: price for which this bond was sold
- Issue date: date on which this bond was issued
- Maturity date: the date at which this bond stops paying interest and becomes redeemable for face value.
- Discount: which is the principal minus the issue price. Negative discounts are called “premiums,” and bonds with negative discounts are called “premium bonds.”
and two binary (check-box) attributes:
- Redeemability: the ability of the owner to redeem (cash in) this bind before it matures.
- Callability: the ability of the issuer to redeem (pay off) this bond before it matures.
The Debt-Limit Law (31USC3101):
(a) In this section, the current redemption value of an obligation issued on a discount basis and redeemable before maturity at the option of its holder is deemed to be the face amount of the obligation.
(b) The face amount of obligations issued under this chapter and the face amount of obligations whose principal and interest are guaranteed by the United States Government (except guaranteed obligations held by the Secretary of the Treasury) may not be more than $14,294,000,000,000, outstanding at one time, subject to changes periodically made in that amount as provided by law through the congressional budget process described in Rule XLIX  of the Rules of the House of Representatives or as provided by section 3101A or otherwise.
(c) For purposes of this section, the face amount, for any month, of any obligation issued on a discount basis that is not redeemable before maturity at the option of the holder of the obligation is an amount equal to the sum of—
- the original issue price of the obligation, plus
- the portion of the discount on the obligation attributable to periods before the beginning of such month (as determined under the principles of section 1272(a) of the Internal Revenue Code of 1986 without regard to any exceptions contained in paragraph (2) of such section).
Section (b) defines a bond’s contribution to the debt that is subject to the debt limit to be its “fact amount.” And, Sectons (a) and (c) define a bond’s “face amount” to be:
- its redemption value (normally its principal), if it’s redeemable,
- its “original issue price” plus that other stuff in part (2), if its irredeemable.
So, a redeemable bond with a small principal makes a small contribution to the debt subject to the limit regardless of its original issue price, i.e., the premium adds nothing to the debt subject to the limit; the Treasury simply gets to pocket it.
How to view the interest on PTBs: Letsgetitdone has expressed the following concern:
… The Federal Reserve controls interest rates in the United States by targeting its Federal Funds Rate, which is currently very near zero. This rate in turn influences Treasury offering which are only a bit higher for short-term debt instruments, and progressively higher for longer-term instruments. These rates, in turn, percolate throughout the economy and keep interest burdens where the Fed thinks they should be in the current fragile economy. However, if the Treasury begins to offer securities at much higher interest rates, than this will affect other investments throughout the economy that will have to offer rates higher than Treasury premium rates throughout the economy. In short, premium bonds will undermine Fed monetary policy even as they stave off default.
Note, however, that there are three ways of describing a bond’s interest rate:
- dollars per year, as given by the bond’s coupons.
- percent of principal per year
- percent of original issue price per year
The market dynamics of the bond auction should keep the third of these reasonably close to prevailing rates, and the Fed has the ability to fine tune the market for any given class of bonds. The proceeds from the Treasury’s bond sales include the premiums and the interest on that amount will remain reasonable. It just that the debt subject to the limit will stop growing, but the real debt, which includes those premiums, will continue to grow as usual.
Per the Wikipedia, consols are, in essence, irredeemable bonds with an infinite term and $0 principal. IMHO, they are subject to Section (c), which makes them unsuitable for ducking the debt limit. But they could be given a very small principal, made redeemable, and given a finite term that coincides with the remaining life of the Sun. That would make them an extreme case of Premium Treasury Bond.
Matt Levine. The key proponent of Premium Treasury Bonds is Matt Levine, per Bloomberg News:
Matt Levine is a Bloomberg View columnist who writes about Wall Street and the financial world. He was previously an editor of Dealbreaker.
Levine has worked as an investment banker at Goldman Sachs and a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz. He spent a year clerking for the U.S. Court of Appeals for the Third Circuit and taught high school Latin. Levine has an A.B. in Classics from Harvard University and a J.D. from Yale Law School. He lives in Brooklyn.
Here is a very readable 10/2/2013 treatment that Matt published at Bloomberg News. And here is a much more tedious legal analysis from 1/15/2013, that he posted at dealbreaker.com. For perspective, Matt concludes his Bloomberg article as follows:
I think this basically works and, as lunatic schemes go, it gives off less of a banana-republic-from-outer-space whiff than the platinum coin does. That’s partly because it looks like a banana-republic-from-earth sort of scheme. Because it is! This happens! Countries really do enter into contracts that require high future payments but that create less formal “debt,” in order to get around restrictions on their debt. Greece did exactly that, entering a swap with Goldman that required large future payments but that reduced its official debt-to-GDP ratio in order to formally comply with EU treaties.
That’s what this is: Incur large future payments to reduce our official debt numbers in order to formally comply with the debt limit. Unlike the platinum coin, this scheme is practically normal, if by “normal” you mean “scandalous even in Greece.” Which, I mean: really is pretty much normal for the U.S. government these days.
I do have one quibble with Matt’s Bloomberg article:
The U.S. government takes in $277 billion in tax revenues each month, and spends $452 billion each month, for a monthly deficit of around $175 billion.**
** Source is Bloomberg’s useful CLIF [go].
The most recent (mid-May) CBO deficit projection for 2013 that I’ve seen is $642 billion, which amounts to $53.5 billion per month, which is way smaller than $175 billion.
Of course then you’d have to pay the interest! This would be a fairly short-term solution; after a year of doing this you’d be incurring an extra $250+ billion in interest payments that you’d have to fund by issuing ever-higher-coupon Treasuries, leading I suppose to a death spiral.
As I noted above, the “debt subject to limit” would stop growing, but the amount of money borrowed (par+premium) continues to grow at the normal rate. And the interest on it would be at only slightly-higher-than-normal rates to make up for the smaller par value. I don’t see any new “death spiral” here.
UPDATE #2: The value of a premium bond shrinks gradually during its term from it original issue price down to its par value (principal). That fact will, of course, be reflected in its original issue price. But, interest that the Fed receives on bonds it owns counts as its profit and gets periodically remitted to the Treasury. So, the Fed would not be compensated for such depletion, which would then show in its books as a corresponding loss in capital and could eventually put the Fed into the red. I would therefore not expect the Fed to be interested in holding such bonds long term.