The Clinton Administration's move to lower the government's borrowing costs by adjusting its issuance of Treasury securities already has noticeably affected consumers and borrowers.
The Treasury announced Wednesday that it would reduce sales of its 30-year bonds and boost sales of short-term Treasury bills. Within hours of the announcement, rates rose on adjustable mortgages but fell on new fixed-rate mortgages. Industry experts predict that the Treasury action will also affect stocks, bonds and certificates of deposit.
"Everything will be affected," said David Lereah, chief economist at the Mortgage Bankers Assn. in Washington. "Because the government is so big and Treasury borrowings are so significant, any move they make has reverberations throughout the financial community. Everything adjusts."
How will the changes affect you? Here are answers to some common questions:
Q. What exactly is the government doing, and why?
A. It's drastically cutting back on sales of 30-year bonds, eliminating seven-year Treasuries and boosting its use of short-term borrowing through Treasury bills and notes.
That lowers the government's borrowing costs because short-term bonds pay less interest. The government must pay nearly 7% to buyers of 30-year bonds, but can pay less than 3% on three-month Treasury bills. Theoretically, the government can cut its borrowing costs in half on every dollar it can shift into short-term securities from long-term bonds.
However, the move may not cut the government's costs as much as might be expected. That's because the market for short-term securities will be glutted with a new supply of bonds, and the long-term market will lose supply. Since there is a finite demand for 3% bonds, yields on short-term bonds may rise to attract buyers--reducing the government's savings.
Q. Why does that affect other investments?
A. Because Treasuries are used as a benchmark to determine the appropriate interest rates on nearly all interest-sensitive products. They are a perfect benchmark because there is virtually no risk of default on Treasury securities. Consequently, anything that has default risk--such as municipal or corporate bonds--would pay higher rates, while investments that are more convenient, such as bank passbook savings accounts, would pay less.
Q. How will this affect other types of bonds?
A. Yields on various bond investments are likely to move in tandem with Treasury rates. In other words, yields on short-term bonds--including municipal and corporate issues--are likely to rise, while yields on long-term securities are likely to fall.
Also, if you already own long-term bonds, they're likely to be worth more.
Q. Does that mean I should buy more short-term bonds as well as municipal and corporate bonds?
A. Not necessarily. Rates on short-term debt may be a little better, but asset allocation decisions should still be based on your age, assets, investment goals and ability to tolerate risk.
Q. Will the process change for buying Treasuries directly from the government?
A. No. But auctions for 30-year bonds will be held only twice a year.
Q. How will this change affect certificates of deposit and other savings vehicles?
A. In the same way that it affects bonds. If short-term Treasury rates rise, banks will probably have to boost their short-term deposit rates to remain competitive.
Q. How will it affect stocks?
A. Some speculate that stock prices may be affected in a backhanded way. That's because corporations may start financing their debt with relatively cheap, long-term bonds. If that reduces and stabilizes their borrowing costs, that could make them more profitable and subsequently boost stock prices. But with so many "ifs," few suggest that you buy stocks using such a speculative analysis.
Q. How will it affect loan rates?
A. Loans that are tied to short-term bonds, such as adjustable mortgages, have already moved up a bit, and they're likely to jump more dramatically as the Treasury gets closer to its August issuance of new securities. Meanwhile, rates on loans tied to longer-term bonds, such as fixed-rate mortgages, are dropping.
One example: Bank of America said Wednesday that phased-in rates on its adjustable mortgages have risen to 6% from 5.93%. (A phased-in rate is what you get once the introductory "teaser" rate expires.) Rates on conventional fixed mortgages have fallen to 7.625% (plus 0.75 points) versus 7.75% (plus 0.875 points) a week ago. (Points are an up-front fee that is calculated as a percentage of the loan amount.)
At the same time, initial rates offered on adjustable jumbo loans--those for more than $203,150--have risen 0.25 percentage points. And, while the rate on Bank of America's fixed-rate jumbo hasn't changed, the company has cut the up-front points charged on this loan dramatically. The company's 8% jumbo mortgage now requires a charge of just 0.25 points versus 1.25 points a week ago.
Many other lenders made similar adjustments on Thursday.
While Treasury rates are not the only factor affecting mortgage loan rates, they are generally the most important factor, industry experts say. Millions of consumers will feel the shift, experts add, because an index based on the one-year Treasury bill has gained widespread use in setting rates on adjustable mortgages.
Q. That doesn't sound like a very big change. What does it work out to in dollars and cents?
A. On a $100,000 mortgage loan at Bank of America, you would pay $51.36 more annually on the adjustable, and you would save $404 annually on the fixed. (You would also save an extra $125 for the lower points on the fixed mortgage.)
If you borrowed $500,000, you would save $5,000 in points on the fixed-rate loan. You would pay about $910 more in the first year on a jumbo adjustable-rate loan for $500,000.