At a Treasury auction in early December, investors accepted Treasury rates of zero percent on four-week T-bills. While this is a positive development with respect to the cost of government debt, it might foreshadow the bursting of another bubble.
The next time you hear Dire Straits' "Money for Nothing" on the radio during an '80s flashback weekend, think of the U.S. Treasury. The cabinet department currently has the enviable ability to borrow money for free.
The U.S. Treasury Department periodically holds auctions to sell Treasury bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS) to individual and institutional investors. This activity finances government debt and provides investors with a safe place to stash their cash. At these auctions, investors can specify their minimum yield in a competitive bid, or they can agree to accept the Treasury rate determined by the auction. The latter is called a noncompetitive bid, and all of these are accepted. Competitive bids are then accepted from lowest to highest, until the cumulative total reaches the offering amount. All investors receive the highest accepted yield.
Better safe than sorry
This year, the turbulence in the stock market and the uncertainty surrounding the banking system has investors spooked about the safety of their money. Risk-free, U.S. government debt has therefore been a popular investment of choice. Investors are so eager to lock their money into a safe place that they don't even care about the yield. This mindset was evident at the December 9 auction, when investors pushed Treasury rates down to zero.
The feds raised $30 billion of short-term government debt-four-week T-bills-at a yield of zero percent. T-bill holders don't receive interest payments; instead, these securities are issued at a discount from face value. In this case, investors paid the full maturity amount at the outset.
Free government debt; investors pay the price
Borrowing money for free is a good thing for the Treasury, because it reduces the cost of the government debt. But it may be a bad thing for investors. Some investment gurus are warning that Treasuries might be ready for a price correction. And if the secondary market value of Treasuries starts to freefall, investors will have to choose between two not-so-great options:
* Selling low after purchasing high
* Accepting a lower yield than what's currently available on the market
Secondary market anomaly
The same day that the Treasury auctioned off securities for a zero yield, secondary market investors drove yields on T-bills into negative territory. Bloomberg News reported that the annualized yield on three-month Treasury bills actually dipped to a negative 0.01 percent-meaning that investors paid more for the instruments than they will receive at maturity. This is another indication that the Treasury bill bubble might soon burst.
In any case, the Treasury Department's money-for-nothing privilege isn't going to last forever. As soon as investors detect signs of a recovery in the stock market, they'll be in dire straits to drop those zero-yield T-bills and move into better performing assets.
