Who would benefit from floating-rate Treasury notes?

August 1, 2012

The U.S. Treasury Department announced on Wednesday it would begin issuing floating rate notes (FRNs), even if such a new program is at least a year away from implementation. The rationale behind these short-term securities is to give investors protection against the possibility of a sudden spike in interest rates. The Federal Reserve has held overnight rates near zero since late 2008, helping to anchor borrowing costs of all maturities.

But is issuing variable rate securities really a good idea from the taxpayers’ standpoint? Stephen Stanley, chief economist at Pierpoint Securities, thinks not. He believes Treasury officials are getting played by sell- and buy-side investors and their respective vested interests. The Treasury has made the decision in part due to the recommendations of the Treasury Advisory Borrowing Committee (TBAC), made up exclusively of members of the financial industry.

Argues Stanley:

Sell-side participants love it because FRNs represent a new product to trade and one that will be much less liquid and thus may exhibit juicy bid-ask spreads. Buy-side participants love FRNs because they are starving for yield at the short end and FRNs will undoubtedly yield noticeably more than comparable conventional securities.

Of course, those two reasons, among others, are exactly the reasons that Treasury should never have had any interest in this program. I am pretty confident that the FRN program will be a mistake from Treasury’s perspective, though of course it will be difficult to measure.

Continuing in the mode of offering self-serving advice that would be bad for Treasury, the TBAC recommended that Treasury use the new GCF index as the reference rate for FRNs.  This would put Treasury in a position of taking on private credit risk, since, if we had a 2008-style meltdown and general collateral (rates) widened out due to counterparty risk, Treasury’s FRN borrowing costs would soar.

Good luck to any Treasury Secretary who would have to explain that to the House Oversight Committee.  That sounds like a one-way ticket to a forced resignation.


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