GSE bailout could lower U.S. credit rating

Thursday, July 10th, 2008
Categorized as: US Credit Rating

According to a report by Standard & Poor’s, quoted in The Fannie and Freddie doomsday scenario in Fortune magazine (see final paragraph):

The doomsday scenario could cost taxpayers more than $1 trillion, says the S&P report. The report went so far as to say that a government bailout of Fannie or Freddie could force the agency to lower its rating on the creditworthiness of the United States.

As reported here previously, the rates offered by government-issued inflation-protected securities tend to correlate with the government’s credit rating. A lowered credit rating would lead to higher fixed-rates for TIPS and I bonds because of the higher risk.

Fannie Mae and Freddie Mac stock prices have been cliff diving this week. Many experts suspect the U.S. government will have to intervene to keep the companies afloat. These companies now provide well over 90% of the financing for U.S. mortgage loans; without mortgages housing prices would simply collapse.

Rate this post (1 to 5 stars):  1 Star2 Stars3 Stars4 Stars5 Stars
(Average rating: 5.00 stars)
Loading...

FDIC Insured Certificates of Deposit can pay 1 or 2% more than savings bonds when held for a similar length of time. See top CD Rates Below:

27 Comments

On July 11th, 2008 John said:

You mentioned higher fixed-rates due to higher risk. Is it possible for the US Government to default on I bonds purchases? Is it possible to lose the money you invested? What are these higher risks?

On July 11th, 2008 Tom Adams said:

John – default is technically possible. There are other countries that have defaulted on their debt.

For international investors, “sovereign” credit ratings provide a way of comparing one country’s debt with another’s.

Tom Adams

On July 11th, 2008 Steve said:

Indeed! Yet, the US is not Argentina. Just like Bear Sterns was not allowed to go belly up, so I’m fairly confident the international community wouldn’t allow us to default. It’s a matter of size. There could be considerable pain, though.

On July 11th, 2008 Tom Adams said:

Steve – not Argentina, true, but it’s not our fathers’ U.S.A., either.

We’ve been a debtor nation for most of my adult life and in recent years we have been paying the bills by borrowing. Eventually that behavior catches up with you. Are we to eventually yet? Nobody knows.

Tom Adams

On July 11th, 2008 mike said:

It is very sad that most people don’t realize that it is possible to lose money in savings bonds and US treasuries. The risk of default is always there, regardless of how small it is. In the Russia, government defaulted on their debt, and they confiscated all foreign currency deposits in the local banks. This is why people keep their money under mattresses in Russia.

However, people are mostly to blame for the recent economic slowdown. We demanded lower interest rates, higher minimum wages, and every possible assistance and subsidy. The politicians are eager to please, but in the process, they distort the market.

On July 12th, 2008 Rick said:

If the U.S. government should default on its debt, who would fare better? Would it have been safer to have deposited funds in a local bank or credit union savings and/or checking account? Would it instead be safer to just hold on to Series EE & Series I bonds and wait out the crisis? Or would it be safer to just hold cash assuming that cash would still hold some value in such a scenario? What is your recommendation at this point?

On July 12th, 2008 david said:

my banker/friend would roll his eyes every january when i would buy the i bond limit for my wife and i and tell me to talk to the investment advisor at the bank they had better deals.he aint joking today my 1 mill is paying 6500.00 a month and his bank cant loan a dime.

On July 12th, 2008 Tom Adams said:

Rick – at this point my advice is simply: don’t panic.

U.S. government securities are still considered the safest of all investments for two reasons:

If the U.S. defaults, there will be financial wreckage everywhere and it’s impossible to predict what, if anything, would be left standing.

Instead of defaulting, the government has the ability to just print money. This would cause inflation, but it’s a slow death rather than a quick one and should provide time to figure out other options.

Also, you might be interested in this quote from one of my favorite books from the 1980s, Your Best Interest:

The great problem with the standard method of accounting for wealth is that funds used for adventures are classified as expenses. If you travel to the Taj Mahal, for example, the cost of your trip is deducted from your “wealth.” No offsetting asset appears on your books, as might happen if you had spent the money on a pickup truck instead. The spreadsheet summary makes it look like you are poorer for having traveled. But don’t let the accounting system make your decisions for you. The Taj Mahal will take your breath away.

Likewise, funds used for education disappear from your net worth. But your real net worth as a person will be higher, not lower, when your knowledge and understanding increase. You may even be able to increase your monetary net worth because of what you learn. The “interest” earned by funds spent on education probably exceeds any other investment you can make – but it won’t show up on your balance sheet.

One problem with the assets that do show up in the biographies accountants write is that they can be lost. Investments may turn sour. Farmland may erode away. Your partner might go bankrupt. But you’ll never lose investments in adventures and education. Not even a bankruptcy court can repossess your journey to the Pyramids.

So remember death. Assets are nice, but education and adventures are something not even the angels can take away from you.

Tom Adams

On July 12th, 2008 Steve said:

David:
how do you get 12.8% annual from Treasuries ? I’d be interested to know.

Mike:
You are totally correct. Minimum wage is responsible for everything: Bear Sterns and IndyMac, gas prices, RE crisis, Enron and 9/11.

On July 13th, 2008 david said:

hey steve,the total is north of 1,700,000 in paper and t.d.with some paying over 7 percent and many to pay 6-7 shortly,the math is quite easey.

On July 14th, 2008 Rick said:

I am curious as to whether anybody ever lost money holding (or had problems redeeming) a U.S. Liberty Bond (or the prevailing U.S. Bond in use at the time) during the Great Depression of the ’30s.

On July 14th, 2008 Steve said:

Thanks David.
I had calculate based on 1 mil and I was worried I had missed something about Treasuries.

On July 15th, 2008 John said:

Tom, thank you for reminding everyone not to panic and for the solid reasons why.

On July 15th, 2008 Tom Adams said:

Rick – US treasury securities weren’t widely held by the public before the Series E Savings Bond was introduced in May 1941. Otherwise, I have no specific knowledge to answer your question.

Tom Adams

On July 15th, 2008 Nik said:

Some may find this interesting: ~~ Fifty BILLION Zimbabwean dollars now equals one US Dollar. The country is on the edge of financial collapse because they can no longer afford to buy the paper to print new currency on.

On July 16th, 2008 Rick said:

According to the U.S. Supreme Court’s opinion on SMYTH V. UNITED STATES, 302 U. S. 329 (1937), the U.S. Treasury could unilaterally move up the maturity date of all Liberty Bonds to June 15, 1935. I wonder if the I bonds will encounter the same fate as the Liberty Bonds since the I bonds are also paying out favorable rates as the Liberty Bonds did.

On July 16th, 2008 Tom Adams said:

Rick – I don’t know anything about that case. Are you saying the Supreme Court let the Treasury break the contract? Or was there disagreement about what the contract said that was decided in favor of the Treasury?

Part of the contract with I bonds is that they aren’t “callable,” which means the Treasury can’t pay them off early without breaking the contract.

Tom Adams

On July 16th, 2008 Rick said:

Hi Tom. What I’m saying is that according to the U.S. Supreme Court decision in 1937 in Smyth V. United States, 302U.S.329, the U.S. Supreme Court concurred with the U.S. Treasury Department’s decision to move up the maturity date to June 15, 1935 on all existing Liberty Bonds. See:

http://supreme.justia.com/us/302/329/case.html#3

On July 17th, 2008 Tom Adams said:

Rick – I’ve looked at the case. These were callable bonds. The dispute has to do with whether the payment was to be in gold or paper. It doesn’t appear to me that either side questions that the original contract said the bonds were callable.

I bonds, on the other hand, aren’t callable. In this context, “callable” means that the fine print under which the bonds were issued says that the issuer (the Treasury) can insist on paying the money back and canceling the debt whenever it wants to. For I bonds, the fine print says the Treasury can’t do that.

Tom Adams

On July 26th, 2008 Mike McCune said:

Tom, The Treasury will do whatever it wants to do. Bill Clinton’s Treasury regime, barely a month into office, lowered the EE rate floors from 6% to 4% not only on new issues, but also retroactive on all previously issued EE bonds!

The US government has long been able to get favorable terms for its borrowing, but the question is: for how much longer? And another question arises: Where else is the perception of safety as high for your excess money? Thanks. -Mike.

On July 28th, 2008 Tom Adams said:

Mike – I’ve never heard that claim before about the retroactive change in rates. The Treasury’s Savings Bond interest rate data only goes back to 1996, however, so I can’t check it. Do you have another source for that?

Tom Adams

On July 28th, 2008 Bill Harrell said:

Wall Street Journal – 01 March 1993

In a move considered long overdue by some experts, the Treasury Department is cutting the guaranteed minimum rate on US Savings Bonds to 4% from 6%, effective on bonds sold from Mar 1, 1993 on.

Bill

On July 29th, 2008 Tom Adams said:

Bill – thanks for your help.

Mike – I think you’ve misunderstood what the Treasury did.

The change in the “guaranteed minimum rate” from 6% to 4% applied to new bonds and older bonds entering new “maturity periods”. This was always part of the deal with these bonds. Here’s more information.

It doesn’t mean the Treasury can do whatever it wants. Once a bond is issued, the Treasury has to – and does – follow the rules in effect at the time the bond was issued.

Tom Adams

On July 29th, 2008 Rick said:

I have several Series EE bonds which I purchased during the period 1983-1991 and according to my records, it appears that these particular bonds have never commanded an interest rate much higher than 4% (4.18% Max.) for years. Does this mean that these bonds will eventually pay out at a guaranteed minimum interest rate of 6% if held to maturity or some point in time?

On July 30th, 2008 Tom Adams said:

Rick – Savings Bonds of that vintage have a series of “maturity periods”. The first period starts when you buy the bond and ends when the amount you invested has doubled (when the bond reaches face value).

For bonds purchased from Nov 82 to Oct 86, this was 10 years (an effective rate of 7.05%). For bonds purchased from Nov 86 to Feb 93, this was 12 years (an effective rate of 5.86%).

At the end of the first maturity period, a second 10 year period begins. At the end of that one a third one begins and lasts another 10 or 8 years – until the bond stops earning interest.

The rules for these bonds have always said that at the beginning of the second and third maturity periods, the Treasury has the right to change the “guaranteed minimum rate” for that maturity period.

For maturity periods beginning Feb 1993 and before, this rate was 6%. Since then it’s been 4%.

So, if you have any bonds from Jan or Feb 83, they would have doubled in Jan or Feb 93 and been reset to 6% until Jan or Feb 2003, when they would been reset to 4%.

Other bonds of your vintage would have entered new maturity periods after the rate had been lowered to 4%. So that’s the minimum rate they’ve earned since then. The rules on these bonds allowed higher rates if interest rates went up, but that didn’t happen.

Tom Adams

On July 30th, 2008 Mike McCune said:

Tom, Yes, I have realized that I must have misunderstood the terms of EE bonds when I bought them in the late 80’s. I was quoted rates over the 1.800.4USBONDS phone line of over 7% with a 6% guaranteed rate floor only to find (thanks later to the savings bond wizard)they never paid over 6%, and then after 12 years and reaching face value, dropped to 4%. Ok, I live and learn.

I am confident that savings bonds are risk-free in the sense I will be able to liquidate them when I need to, but who’s to say a new regime this Fall won’t drop the “guaranteed” rate floor again – perhaps to 2%? Thanks.

-Mike.

On July 31st, 2008 Tom Adams said:

Mike – I think it’s amazing that they’ve left the guaranteed minimum for these older bonds at 4% until now.

Right now the Treasury can get away with 1.4% on new EE bonds but is still paying 4% on the older ones?

My guess is that you’re right. We’ll get a new administration next year that is a lot more competent than the current bunch – who sort of stumble from natural disaster to disasters of their own making then do exactly the wrong thing.

Tom Adams

Comments Closed

June 1, 2010

After six years, over 400 posts, 3,680 real comments, and over 90,000 spam comments (thank you, Akismet, for making managing a blog with comments possible), I am closing public comments on Savings-Bond-Advisor.com. I will contine to update the main articles on this site, but not the comments.

Virtually every question about Savings Bonds has been asked and answered on this site multiple times. Use the search feature (see the box in the gray area near the top of this page) or the detailed menu on the lower part of the home page to find the information you're looking for. If you have a copy of Savings Bond Advisor, you can ask me a question here.

Tom Adams

Savings Bond Calculator



Help

Savings Bond
Questions

Get an answer to your questions from the Treasury's Savings Bonds team.

Click below to ask a question.

Ask the Treasury

TreasuryDirect

Invest online in Savings Bonds or
marketable Treasury securities.

Deal directly with the U.S. Treasury.

More info

Enroll

Log in