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All that you have heard about in the media over the past few weeks is the ongoing “ debate “ between the Tea Party/Republicans and the Democrats over the debt ceiling being raised, with the slight news interruption of Amy Winehouse killing herself. No major loss there but you wouldn’t know it by the news coverage. Hell, you would have thought that she was in the Elvis category with all of the coverage.
Debt Ceiling: Who do we pay all of that money to? Lucky for both you and myself, Dr Teeth has done some of the research for us.
Treasury Notes 43% of the Debt
aka T-NotesA T-Note is the most commonly traded product, which the government uses to raise money. A T-Note has a face value attached to it (in multiples of $100 dollars). An individual T-Note also has a set amount of time till it reaches maturity (from one to ten years).
Treasury sells these notes at an auction. A ten year $1,000 note may cost $991 dollars, when Treasury issues it. So if no other interest was accumulated, you would make $9 dollars profit in ten years time.
But a note also gets an interest payment every 6 months. This is a fixed rate at the time the bond is issued. So when the bond matures, the owner gets the face value plus the accrued interest.
So if Treasury issued $2 trillion dollars in 10 year/$1000 dollar T-Notes at 4.25% interest, each t-note would be worth $1,425 dollars in 2021.
This means the Treasury would have to pay out $85 billion dollars in interest on the $2 trillion dollars auction in 2021. They would also have to pay the difference between the auction value and the face value of the bond.
What do you mean auction value?
Well, remember when I said that a $1,000 T-Note may only cost you $991 dollars. This is because Treasury holds an auction for these notes. The highest bidder wins.
So if you want to buy 500 T-Notes, you will make a bid on them. This bid could be less than the face value of the T-Note, or even more than the face value. The highest bidder gets the T-Notes first.
Right now, a 10 year $100 dollar T-Note costs $99.277862 dollars, based on last auction value on May 16th. They return 3.125%.
So the current price of a T-Note will require the government to pay an additional $0.72 cents per $100 dollars on top of the interest.
T-Notes Summary
I know this section has been long, but this answers 43% of the question.
We owe 43% our debt to any holder of a fully matured T-Note.
This is the means by which most foreign nations end up owning US debt. If the US were to default on these notes, it would cripple the global economy.
Intragovernmental Holdings 32% of the Debt
aka Government Account Series (GAS)If you've ever heard anyone say we owe ourselves money, this is what they mean. We owe the GAS to ourselves.
More specifically we owe the Social Security Trust Fund, the Medicare Trust Fund and the Federal Bank this money. This is an internal accounting fund, which for obvious reasons doesn't charge the government interest.
There is some debate as to whether portions of this can be refinanced, but we can't just pretend it doesn't exist. Unless we maintain this, no social security checks can be issued and no Medicare claims can be paid.
So between these two, we are looking at 75% of all US debt.
Treasury Bills 11% of the Debt
aka T-BillsT-Bills are somewhat similar to T-Notes, but are used to generate short term revenue. T-Bills have a face value just like T-Notes. However, T-Bills differ from T-Notes in two major ways.
T-Bills do not pay interest.
T-Bills are short term investments (28 days, 91 days, 182 days or 364 days).
A T-Bill auction is held weekly. The highest bidder wins just like with T-Notes. The only profit earned at maturity is the difference between the auction value and the face value.
This is quick cash for both the government and investors. Even though the profit margin is small, it is a very safe place to put your money for a financial quarter or two.
If the government were to default on T-Bill payments it would send shock waves through bond markets. Remember even at 11%, we are still talking about $1.5 trillion dollars in market value.
This would not be as large of an impact as the housing meltdown, but defaulting on T-Bills would destroy any possibility for short term financing in the future.
Treasury Bonds 7% of the Debt
aka T-BondsThese used to be the standard in the US, but since 2000 the Treasury has focused more on shorter term financing. T-Bonds work like T-Notes, except that they are issued for longer terms of maturity (30 years).
The treasury still holds an auction quarterly of these bonds, and many are still outstanding. Japan and Europe are both fond of 30 year maturity, so we maintain T-Bonds for their benefit.
I think 93% is enough for this diary.
There are other ways the Treasury raises money, but I've covered the vast majority.
If the debt ceiling is not raised, all auctions will have to cease. Treasury will not be able to issue any new notes, bills or bonds. As these hit maturity, it will deplete the coffers of the US.
If Treasury chooses not to honor the face value of T-Notes, T-Bills or T-Bonds, the US will effectively lose its ability to bring buyers to auction in the future.
If the US credit rating is downgraded, many funds will not be able to maintain T-Notes, T-Bills or T-Bonds in their portfolios. The SEC requires a disclosure of risk in any perspective, so by definition Treasury securities would only be a part of high risk funds. Other markets around the world have similar restrictions.
Because these treasuries would be higher risk, the interest rate offered at auction would need to be much higher, which would result in a higher cost to finance out debt.
In Greece the credit downgrade led to an auction without buyers. Because no one wanted to buy Greek debt, the bottom fell out. We don't have the same monetary restrictions as Greece, but the result would eventually come out the same.
Originally posted to Dr Teeth on Tue Jul 26, 2011
Also republished by Community Spotlight.
