The Treasury Should Begin Testing The Market For Consols

Includes: AFC, AGO, ARCC
by: Philip Mause

Our 30th anniversary is coming up next June and this has led me to do a little bit of long term thinking. Only a fixed income nerd would focus on the fact that his marriage was about to have the same duration as the longest term Treasury bond. I should instead focus on an anniversary gift - it must be made of pearl; maybe a pearl handled revolver so my wife can shoot me next time I begin to prattle on about interest rates. But it is interesting that when we got married - June 26, 1982 - we were just about at the crest of the yield cycle on 30 year Treasuries (that Friday, the yield was 14.24%).

It would have been nice if someone had given me a fistful of those instead of silverware and china, but it would have been even better to get shares in an index fund with the S&P 500 at 109 (no, I did not leave out a zero). If we get divorced sometime soon, we may appear in Ripley's Believe It or Not for having the largest negative yield spread between the date of our wedding and the date of our divorce - I think I will raise this the next time we are in "couples' therapy."

The big lesson here is that there is nothing magic about 30 years. There are all sorts of longer term bonds. I own some AFC - oringinally bonds of Allied Capital and now bonds of Ares Capital (NASDAQ:ARCC), which mature in 2046. And I made out very well on bonds of Financial Security Assurance (which - unfortunately - ran into problems which made its name a bit ironic), now bonds of Assured Guaranty (NYSE:AGO) which mature early in the next century - about 95 years from now.

The British government still has outstanding consols (perpetual bonds) which never mature. I am not sure why anyone would lend money on terms which do not require it to be paid back - especially to a country which has produced Oscar Wilde, Mick Jagger, Eddie Izzard, and Ozzy Osbourne - but I can fully understand the government's willingness to borrow on such terms. When you think it through, as you go to longer and longer terms and value the bond in terms of discounted cash flow, the value of a repayment 100 years from now becomes a very small part of the total value of the bond and so a perpetual bond is not really that different from a 100 year bond.

And, of late, there has been a voracious appetite for Treasury bonds which seem to have become especially attractive to investors now that the United States has had its credit rating reduced. The successful issuance of perpetual bonds by the Treasury would help clarify the real nature of the "national debt" as something which never really has to be "paid back." To the degree that consols were held by the Federal Reserve, the Wizard of Oz would appear from behind the curtain. Each month the Treasury would pay interest to the Fed and the Fed would remit the funds received to the Treasury and it would never end unless and until the Fed voluntarily sold the bonds to private parties.

This might put the whole "national debt" hysteria in perspective and allow us to focus on our real problems - an educational system that is increasingly dysfunctional, a level of oil imports which constantly threatens us with a recession whenever there is unrest in the Middle East, a trade deficit which leads to global financial imbalances, and an immigration policy so bad that it takes enormous amounts of creatvie energy to imagine anything that could be worse.

The Treasury should start by issuing small amounts of 50 year maturity bonds and, if this is successful, move up to 75 and 100 year durations. If consols are successfully issued, they should include call protection so that, after a duration and perhaps at a modest premium to par, the Treasury can call the bonds if interest rates go down even more. If the investors of the world want to buy long term Treasuries, we should not disappoint them.

Disclosure: I am long AFC, ARCC.