How A 28-Year-Old Financial Trap Is Exploding Now
Our story began nearly 28 years ago, on January 11, 1995. That was the day that Robert Rubin was sworn in as the 70th United States Secretary of Treasury, the day the transformation of the Clinton Administration began. Bill Clinton was the quintessential big-spending, progressive President. Under his first Treasury Secretary, Lloyd Benson, those free-spending ways were reigned free. Had Benson completed the term with Clinton, that Administration would have been known as just another debt-laden eight years of government.
Rubin was able to change all that. He brought fiscal discipline to a government that badly needed it. Somehow this former Goldman Sachs Executive convinced Clinton that they should try to balance the budget. They could see lower overall interest rates and economic improvement if they did so.
Clinton bought Rubin’s concept hook, line, and sinker. And in many ways, it was a perfect combination of the free-spending social program Clinton. And the economically conservative, balanced budget Rubin. Clinton and Rubin, New York finance joined down south progressiveness. But there’s no doubt it worked.
And Clinton knew it. In a 2010 C-Span Interview, Clinton talked about how his Administration reduced the deficit and promoted the economy. Chief accomplishments in this regard were the Deficit Reduction Act of 1993 and the Balanced Budget Act of 1997.
Unfortunately, like everything in Washington, the good news is often combined with the bad.
According to my research, the Clinton Administration, under Robert Rubin, was the first, in a significant way, to “trade” the bond market. As you know, general bonds with shorter maturities have lower interest rates.
Incidentally, this discussion on bond yields does not apply today. Currently, bond yields are inverted. But we’ll leave the why’s and wherefore’s for another day.
So, let’s talk about how the bond market usually behaves and how it behaved back in the 1990s when Rubin was devising his bond strategy.
The thinking was straightforward, if bonds with shorter maturities have lower interest rates, then let’s switch to shorter maturities.
And that’s just what the Clinton Administration did. They reduced maturities so that the Weighted Average Maturity of US Treasuries was much lower, and therefore the interest paid was much less.
But there’s one other aspect of these short-term maturities; they react quickly to changes in interest rates. If rates are steady, or if they decline, this strategy works marvelously. But if rates go higher, look out! Because very rapidly, as you roll over the Notes and Bonds, your interest expense will escalate.
And that is what’s happening today. For the first time since Clinton and Rubin, we are seeing a Federal Reserve serious about raising interest rates. Some of the earlier Feds tried but, in the end, retreated. This Fed, under Jerome Powell, seems determined to keep the rate high.
And so, all those short-term bonds and notes will have to be rolled over and refinanced at these new high rates. And remember, it is not just a little higher. It differs from fractional interest yield, well under 1%, to nearly 5%. Multiply that 4% interest rate hike times the Nation’s $31 Trillion Debt, and you can see the magnitude of the current interest rate swing.
It is as if we suddenly double our Debt. And you and me, the taxpayers, will have to pay the trillions in extra interest payments on those US Treasuries.
That’s why no finance person out of B-School would ever recommend this kind of program. Yes, there are short-term benefits, but the long-term risk is horrific.
Now the $31 trillion I mentioned is just the direct obligation of the Federal Government. This number does not include Medicare or Medicaid. Nor does it have Fannie Mae or Freddie Mac on any government guarantee program, such as student loans. And interest obligations for all those loans are also increasing.
So, I needn’t tell you that this country has a debt problem. But a debt problem made much worse because of a little-noticed bond trading strategy of nearly 30 years ago, a plan that moved our long-term Debt to short-term. And in so doing, it made us vulnerable to every interest rate hike that came our way.
Unfortunately, two subsequent administrations have used this same risky strategy in managing the Nation’s Debt. First, the Obama Administration shortened maturities, and now the Biden Administration is following suit.
It’s a dangerous strategy that can explode any time interest rates are raised.
It’s a light day in economic reports today. However, there is one report that’s worth considering: Consumer Credit. Now in an ordinary world, an increase in Consumer Credit is a bullish sign that Americans are feeling expansive, ready to purchase the latest new retail item right off the shelf. In other words, in a strong economy, where consumers are confident about their future earnings, economists like to see Consumer Credit increase as this drives economic growth.
Unfortunately, we haven’t been in that kind of economy for three years—nothing here to make the consumer feel upbeat about the future. Instead, we’ve endured the terrible days of the Pandemic, a quarter where the economy fell the most on record, and biting inflation.
The increase in Consumer Credit has come from the average American having to reach deep to cover their everyday expenses. This is not an upbeat America, willing to purchase the latest high-tech do-dad or gadget; this is an American fighting for financial survival.
Today we expect that Consumer Credit will decline as people seek to pay down some of that credit they used to pay for food and gasoline earlier last year.