The press is busy reporting about zero and even negative yields on T-Bills. Well, it didn’t happen. I have evidence in the form of a research paper published, presciently, in 1989. Here’s the abstract from SSRN:
During the 1930s and early 1940s U.S. Treasury bonds and notes had negative nominal yields as they approached maturity. But since an investor can always hold cash, this is impossible. Any bond must have a positive nominal yield. This paper poses a resolution to this puzzle: in addition to making coupon payments, Treasury securities were options that gave the owner the right to buy a new security on a future date. The paper proposes a method for valuing this `exchange privilege` and computing the yield to the coupon bearing component of these composite bond/options. The case of the negative nominal interest rates demonstrates that the construction of accurate data requires close examination of the institutional environment, even when studying financial markets. The corrected bond and note yields are used to calculate new estimates of the term structure of interest rates from 1929 to 1949. These new data allow one to follow changes in the both the level and the shape of the yield curve during the Great Depression (1).
So the construction of accurate data requires making it match your theoretical ideas? The distinguished author worked for BIS, CEPR and NBER in 1989--I’m guessing he got a job with one of the ratings agencies soon after. Not to pound on Mr. Cecchetti--the paper actually has many virtues and contains a worthwhile analysis of how to deal with negative rates analytically--but the important thing to realize is that people can’t always hold cash. For economic agents with any significant amount of capital, putting it under the mattress isn’t an option and putting it into a depository institution is not a riskless transaction.
Therefore, instead of ‘correcting’ or removing the negative rates, the model should recognize that there’s another variable that needs to be factored in (an ‘unavoidable risk factor’, kind of like dark matter--but we’ll save that discussion for another day).
Anyway, what does the US government’s ability to borrow at zero or negative rates mean? Well, I’m guessing that if there is anyone in power who happens to have spent his life studying the Great Depression (let’s call him Ben), and if Ben just happens to have a job that will continue into the new administration, then I would hope Ben is spending a lot of time trying to convince people that the proper reaction to being able to borrow at negative rates is quite simple--JUST DO IT!
Here’s a proposal: One of Ben Bernanke’s academic findings regarding the Great Depression is that government institutions were consistently too timid in their response. One obvious response right now, if you want to be aggressive is to double the size of the TARP borrow immediately and purchase every illiquid security you can find at the cheapest levels you can negotiate. It is important that the purchases represent fire sale prices (see my previous blog post “If I had a trillion dollars...”), so I would say start with the worst, purchasing no more than half of any position held by a bank, thrift, dealer (are there any dealers left with positions?) or insurance company, if they can find a buyer for the other half. The Fed or Treasury could even offer to fund the other half taking a hefty spread, as long as somebody else takes the exposure (anybody want to buy mortgages at 40 cents on the dollar if Uncle Sam will fund up to 80% of your purchase for you at 1%?).
This would encourage companies to take their marks to realistic levels and clear the decks somewhat, getting capital engaged. Obviously some (some of the largest “too big to fail institutions”) would balk and still enter the new year loaded with worthless assets that are marked too high. ‘No soup for them!’--don’t fund their positions!
What would this proposal achieve? One, some of the capital that is on the sidelines would be pulled into the market, creating at least a smidgen of liquidity for the assets that are clogging the system. Two, Uncle Sam would be putting dollars into the system, massively. Three, maybe, if the assets are purchased correctly, Uncle Sam would make money--lots of it--any such windfall should be earmarked for paying down the national debt.
But let’s get back to that massive injection of dollars--Helicopter Ben probably could never find a better time to get those choppers full of money into the air. If it’s done through buying illiquid securities, through paying off everyone’s mortgage who is in foreclosure, giving everyone a job building highways that wants one, or just a check in the mail to every man, woman and child doesn’t really matter--the government must use its ability to borrow at negative rates aggressively if it wants to end this crisis.
And that means...inflation. Time to keep an eye on TIPS, or TIP, the iShare Barclays TIPS ETF. At 96.94 as of yesterday’s close, it is well off its low close of 90.73 of November 24th (it traded down to 84 and change on October 10th, before closing at 95.38). I think there will be pullbacks as more bad news starts coming out on corporate earnings (or lack thereof), and more firms are found to be insolvent. Those would be buying opportunities.
(1) Cecchetti, Stephen G.,The Case of the Negative Nominal Interest Rates: New Estimates of the Term Structure of Interest Rates During the Great Depression(February 1989). NBER Working Paper Series, Vol. w2472, pp. -, 1989. Available at SSRN: http://ssrn.com/abstract=978408