The Crimsonic Whatever Solves The Debt Crisis
January 16, 2013, 7:21 am
Filed under: Uncategorized

Matt Levine of Dealbreaker went and researched my half-baked ignoramus super-coupon-bond idea to solve the Debt Ceiling Crisis™ and came back to report that…it could maybe work? What? Did not expect that.

Hey, if that could fly, I’ve got more of ’em: US Treasury sells bonds packaged with (long-protection) levered-super-senior credit insurance. US Treasury sells bonds overlaid with S&P puts. Heck, US Treasury just sells annuities (i.e., just creates & sells naked IO STRIPS directly, I guess). Take that, “debt ceiling”: no limit whatsoever on that last one! (I guess!)

Stop me when this gets absurd. I expected to be stopped well before this so I’m really playing with house money here.

2 Comments so far
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Somehow I doubt the market reaction would be as benign as Matt thinks. You see, folks might get used to the idea that T bonds yield 18%, not 1%. This might have an effect on future bond auction prices. It might also have an effect on inflation expectations. It might also have an effect on the future solvency of the U.S. Government.

Because, if the debt ceiling is actually raised, they are going to have to sell 1% bonds after the 18% bonds…

Comment by Dave

Agreed the market wouldn’t just absorb these seamlessly. But not for that reason…the bond wouldn’t yield 18% it would yield same/similar to its vanilla similar-duration counterparts. At least, that’s the idea (otherwise the whole thing doesn’t work from the get go obviously).

You might expect higher yields due to (a) unsure/weirdo nature of the bonds (b) default-risk concerns (c) liquidity/less usefulness as collateral etc, but surely those factors wouldn’t be enough to bring them down to par?

I guess you could be saying that the optics of everyone seeing nominal “18%” etc coupons could drive up yields over time. Maybe – interesting point.

Inflation expectations: actually I thought increasing inflation expectations was supposed to be a good thing (maybe i need to reread my Scott Sumner)…also a nice synergy with TIPS sales there…

Solvency impact of having to pay these giant coupons is another valid objection that I answer with a ‘maybe it’s ok?’ when I think about it. After all, on paper anyway there’s no difference between a “10% coupon” on 100mm bond, and just 10mm bond principal maturing that same year. you could envision Tsy replacing a ladder of 2/5/10y vanilla issuance (thus squeezing the market and driving yields down?) with a Premium Bond maturing (later….) in a way that kinda-sorta leaves you with same net cash flows – no solvency impact – but for much smaller face value outstanding (more debt ceiling room). Obviously this does lead to trouble further down the road…

I had figured there might be tax implications I’m too ignorant to take into account but someone in DB comments shot that down too.

I dunno. Worth keeping in mind this wasn’t even really a real actual suggestion, just a query why it wouldn’t be allowed. Kind of disturbing that it’s actually been looked to and the answer seems to still be ‘maybe?’

Comment by The Crimson Reach

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