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Wednesday, 10 December 2008

Point of no return

Interest on T-bills hits zero

NEW YORK - INVESTORS are so nervous they're willing to accept the same return from government debt that they'd get from burying money in a coffee can - zero.

The Treasury Department said on Tuesday it had sold US$30 billion (S$45 billion) in four-week bills at an interest rate of zero percent, the first time that's happened since the government began issuing the notes in 2001.

And when investors traded their T-bills with each other, the yield sometimes went negative. That's how extreme the market anxiety is: Some are willing to give up a little of their money just to park it in a relatively safe place.

'No one wants to run the risk of any accidents,' said Mr Lou Crandall, chief economist at Wrightson ICAP, a research company that specialises in government finance.

At last week's government auction of the four-week bills, the interest rate was a slightly higher but still paltry 0.04 per cent.

Three-month T-bills auctioned by the government on Monday paid poorly, too - 0.005 per cent.

While everyday people can keep their cash in an interest-earning CD or savings account at the bank, institutional investors with hundreds of millions of dollars on their hands often use government debt as part of their investment strategy.

In the Treasury market, the US government, considered the most creditworthy of borrowers, issues IOUs of varying durations to raise money.

The zero per cent interest rate is no reason to panic. As recently as Monday, investors were plowing cash into stocks, and averages like the Dow industrials are off their lows.

And long-term government bonds, while near record lows, are still paying decent money considering the tumultuous climate. The yield on a 30-year bond on Tuesday was a little higher than 3 per cent.

There's good news in all this for taxpayers: Low interest rates on government debt mean the United States is financing its US$700 billion bailout of the financial system very cheaply. The Treasury has sold mountains of debt to pay for it.

But the trend also underlines stubborn anxiety in the financial market that could keep the economy sluggish for years to come, and it translates into stagnant returns for people who have their money in places like money market funds.

'There's a price for safety,' said Mr Peter Crane, president of money market mutual fund information company Crane Data. 'Down slightly is the new up.'

As the stock market has taken its alarming plunge, people have been moving money from riskier assets to safer ones.

According to Crane Data, funds invested purely in Treasurys have surged more than 150 per cent over the past year, to US$726 billion.

Earning zero per cent on an investment for a short while may not seem that dire for the average person. But a zero per cent rate has serious consequences for the complex credit markets.

Those markets have been dysfunctional since Lehman Brothers Holdings went bankrupt in September, scaring away investors who normally buy bonds from seemingly creditworthy borrowers. Lending, the lifeblood of the economy, has frozen up.

One corner of the credit markets is the repurchase markets, known as 'repo,' where banks and securities firms make and receive short-term loans backed by collateral, usually Treasury bills.

When those T-bills are yielding nothing, there's little incentive to deliver them on time. If the holder loses the interest, it's no big deal.

'This is a particular problem in a time like this, because people are buying Treasury securities for their security, for their safety. It's important that they're delivered,' Mr Crandall said.

And high demand for government debt rather than corporate debt could stifle economic growth.

Corporate bond rates have been surging to record levels compared with Treasurys, which makes it more expensive for companies to raise money.

And when companies can't raise money, they often have to cut costs, sometimes through layoffs.

Only a few corporate bond deals have been going through lately, and most have been through the government, which has agreed to guarantee financial institutions' bond sales. American Express, for one, said on Tuesday it has issued US$5.5 billion through the government programme.

Many worry that the government will become the most attractive lender and borrower in the market - crowding out others in the private sector.

'Because they have a printing press, they can borrow ever greater quantities,' said Mr Howard Simons, strategist with Bianco Research in Chicago. -- AP

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