U.S. Treasury Reaches Its Debt Ceiling

In a January 13, 2023 letter to Kevin McCarthy, Speaker of the U.S. House of Representatives, Secretary of the Treasury Janet Yellen warned that the nation’s debt limit was projected to reach its limit on January 19, 2023. The current statutory limit of approximately $31.381 trillion was established by Public Law 117-73 on December 16, 2021.

Yellen said that the U.S. Treasury will be forced to take extraordinary measures to prevent the United States from defaulting on its obligations. She said this month Treasury will (1) redeem existing, and suspend new, investments of the Civil Service Retirement and Disability Fund (CSRDF) and the Postal Service Retiree Health Benefits Fund (Postal Fund), and (2) suspend reinvestment of the Government Securities Investment Fund (G Fund) of the Federal Employees Retirement System Thrift Savings Plan.

Yellen stated: “Congress has expressly provided Treasury with authority to take these actions, and prior Treasury Secretaries have used these measures, which will reduce the amount of outstanding debt subject to the limit and temporarily provide additional capacity for Treasury to continue financing the operations of the federal government. After the debt limit impasse has ended, the CSRDF, Postal Fund, and G Fund will be made whole.”

Debt Limit and Deficit

In my “U.S. Treasury Faces Imminent Financing Crisis” article published by Seeking Alpha less than a month ago I addressed the issue of the U.S. Treasury having to issue more debt to fund the fiscal 2023 deficit, which I suggested would approximate $2.4B. That article noted the Fed’s current QT policy was to reduce its holdings by $60B/month and foreigners were also liquidating U.S. Treasury securities. Neither the Fed nor foreigners are likely to cry if Treasury stopped adding to their outstanding debt.

In fact, the Fed might welcome the Treasury not issuing more debt as a way the help quell the unacceptably high rate inflation. In the past, delays in raising the debt limit have created downward pressure on stock prices and reduced somewhat the level of economic activity. In turn, that would help dampen inflationary pressure.

Recent History of Statutory Debt Limit

The debt limit has been raised or suspended by Congressional action 61 times since 1978 and the occasions have become increasingly problematic. Perhaps, the most contentious occasion occurred in 2011 and resulted in Standard & Poor’s downgrading the United States sovereign credit rating from AAA status. The delay in raising the debt ceiling also caused an increase in stock and bond volatility, a stock market decline, widening credit spreads, and an economic slowdown.

Anecdotal evidence suggests raising the debt ceiling this time will once again be contentious. Furthermore, recent experience suggests no quick congressional agreement.

Face/Par Value in Debt Limit Calculation

The debt limit statute applies to the face amount of U.S. Treasury obligations. For example, if Treasury auctions $10 billion in face/par value securities to raise new money, then $10 billion would be added to U.S. Treasury debt regardless of whether the securities were auctioned at a discount or a premium.

For example, on 12/29/2022 Treasury auctioned $38,500,490,100 face/par value 52-week bills due 12/28/2023. The average price paid (dollar price) was $95.434833. Treasury received $36,742,878,000, but $38,500,490,100 was added to U.S. Debt outstanding, because that was the par value of the bills actually issued. By the way, U.S. Treasury bills are always sold at a discount, except in rare instances where the yield in 0% or negative.

An example of a recent bond sale illustrates the debt ceiling impact of a U.S. Treasury bond that sells at a premium or above its face/par value. On 1/17/2023 Treasury issued $18 billion in 4% coupon bonds that mature on 11/15/2052 at an average dollar price of $107.556697. The U.S. Treasury received $19,360,205,000 for these bonds. Buyers paid a premium of $1,360,205,000, but only $18 billion was added to the U.S. Treasury debt outstanding subject to the debt limit.

At the present time there are 49 U.S. Treasury notes and bonds selling at a premium. The 6.25% coupon Treasury due 5/15/2030 is selling at a dollar price of $117, which equates to a yield-to-maturity “YTM” of 3.586%.

Another Treasury with the same maturity date has a meager 0.625% coupon and is selling at a dollar price of 81.204, which equates to a YTM of 3.486%. The latter security has a lower YTM because its duration is greater and the yield curve is negatively sloped. If the yield curve was flat, the higher coupon security would probably be selling at a lower YTM than the lower coupon security, because its current yield is greater.

A Novel Solution To Debt Crisis

In a recent newsletter/blog Matt Yglesias mentioned a novel solution to the debt ceiling problem. His solution was then mentioned by Matt Levine.

Both writers suggested the Treasury could just ignore Congress and issue notes and bonds with coupons well above current yields. By doing so, the U.S. Treasury would receive funds well above the face/par value of securities it issued and the premium paid by buyers would not be counted toward the debt limit.

For example, as previously mentioned, Treasury issued 4% coupon bonds due 11/15/2052 and collected a premium of ~$1.4 billion that did not count toward its debt ceiling. If it issued a 7.625% coupon bond, which equals the highest coupon of any security it has outstanding, with the same maturity and received comparable bids at auction, the dollar price of those securities would be ~ $175 and the Treasury would receive a premium of $13.5 billion in cash that would not count against its debt ceiling.

On November 1, 1979, a month after Fed Chairman Volcker’s declared war on inflation, the U.S. Treasury issued 10.375% coupon bonds due 11/15/2009. They were auctioned at a dollar price of $99.407 or a YTM of 10.44%. They became painfully known among bond traders as the DC-10s because they immediately plummeted like some McDonnell Douglas planes did around that time.

In today’s market, if the U.S. Treasury once again issued a 10.375% coupon bonds, they would auction the bonds at a dollar price of ~$220 or a YTM of 3.7%. At that price the U.S. Treasury would receive $21.6 billion in premium money that would not count toward its debt ceiling.

Conclusion

The debt ceiling crisis has once again arrived on the doorstep of Congress. It is bound to stir heated debate and cause a loss of confidence among the electorate.

The information provided in this article should comfort you in the knowledge that this is the 62nd time since 1978 that Congress has had to cope with the debt ceiling issue; and, the issue has been successfully resolved every time. If Congress chooses to ruin its 62-0 record, then Treasury Secretary and all bond sales organizations need to develop sales pitches to sell high coupon bonds with significant premiums. I suggest these sales pitches focus on the high current yield offered by such bonds.

For the immediate future, Investors need to be prepared for increased volatility in financial markets and a further erosion in consumer confidence as the debt ceiling debate intensifies. Recent strength in gold and silver along with a weakening U.S. dollar may in fact be signaling a loss of investor faith in the ability of Congress to resolve the nation’s debt issue.

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