Lew’s Testimony on Debt Mirrors SEC's Definition of Ponzi Scheme

Terence P. Jeffrey | October 13, 2013 | 4:30pm EDT
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Treasury Secretary Jacob Lew (AP Photo/Evan Vucci)

When Treasury Secretary Jacob Lew testified in the Senate Finance Committee on Thursday, urging Congress to enact a new law allowing the administration to increase the federal debt, his description of how the Treasury handles that debt mirrored the Securities and Exchange Commission’s definition of a Ponzi Scheme.

“A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors,” says the Securities and Exchange Commission.

“With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue,” explains the SEC. “Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.”

On Thursday, Lew candidly told the Finance Committee that the U.S. Treasury will not be able to pay off current government debt-holders when their debt is due if the Treasury is not able to turn around and issue an even greater amount in new debt to get the cash it needs to do so.

“Every week we roll over approximately $100 billion in U.S. bills,” Lew testified. “If U.S. bondholders decided that they wanted to be repaid rather than continuing to roll over their investments, we could unexpectedly dissipate our entire cash balance.”

“There is no plan other than raising the debt limit that permits us to meet all of our obligations,” he said later.

“Let me start by saying what I think should be obvious: that if we don't have enough cash to pay all our bills, we will be failing to meet our obligations, and under any scenario we will be defaulting on obligations,” said Lew.

“Let me remind everyone,” he said, “principal on the debt is not something we pay out of our cash flow of revenues. Principal on the debt is something that is a function of the markets rolling over.”

Lew’s contention that the federal government cannot pay its current debt-holders unless its gets cash by selling new debt to make those payments is demonstrated by the daily accounting statements published by the Treasury.

The Daily Treasury Statement for Sept. 30, 2013—the last day of fiscal 2013—shows that during fiscal 2013 the Treasury had to pay off $7,546,726,000,000 in Treasury securities that had matured.

That $7,546,726,000,000 in maturing Treasury securities was more than 3 times as much as the $2,419,221,000,000 in total tax revenue the Treasury collected in fiscal 2013.

To get the cash to pay off the $7,546,726,000,000 in maturing Treasury securities—and also cover new federal spending over and above the $2,419,221,000,000 in tax revenues collected--the Treasury needed to turn around and sell $8,323,949,000,000 in new Treasury securities.

That means that to service the existing debt and cover existing federal spending programs, the government needed to increase the net value of extant U.S. Treasury securities held by the public by $777.233 billion in fiscal 2013.

Even if Congress had cut federal spending by $777.233 billion to spare the Treasury the need to sell that much new debt, the Treasury still would have needed to find investors willing to buy $7,546,726,000,000 in new Treasury securities in fiscal 2013 to pay off the $7,546,726,000,000 in old securities that matured during that time.

Why was the Treasury forced to pay off such a massive volume--$7,546,726,000,000—in Treasury securities in one year? Because the Treasury keeps churning a large portion of the government’s publicly traded debt in short-term bills and notes.

The upside of that is that the Treasury has been able to sell those shorter-term bills and notes for a lower interest rate than it needs to offer to sell longer-term bonds.

The downside is that to constantly churn its short-term securities the Treasury needs to find a constant stream of buyers willing to invest massive sums in U.S. government debt on the promise of a very small return.

As of Sept. 30, according to the Treasury, the U.S. government had $11,577,400,000,000 in outstanding publicly traded debt. Only about $1.3 trillion of that was in 30-year bonds, earning an average interest rate of 5.101 percent. Another approximately $936 million was in Treasury Inflation-Protected Securities, earning an average interest rate of 1.084 percent.

But the lion’s share of that publicly traded debt—$9.3 billion or about 80 percent--was in Treasury notes (about $7.8 trillion), which mature in two to ten years, and Treasury bills (about $1.5 trillion), which mature in anywhere from a few days to 52 weeks.

In September, according to the Treasury, the average interest rate on Treasury notes was just 1.808 percent, and the average interest rate on Treasury bills was a miniscule 0.074 percent.

As a result of these low rates on bills and notes, the average interest rate that the Treasury paid in September on all of the U.S. government’s marketable debt (bonds, TIPS, notes and bills combined) was just 1.981 percent.

Back in January 2001, according to the Treasury, the average interest rate on all marketable Treasury securities was 6.620 percent—or about 3.34 times what it was this September.

In fact, in January 2001, the average rate even on short-term Treasury bills was 6.059 percent. That is 81 times higher than the average rate this September.

“Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out,” said the SEC description of such schemes.

“At our auction of four-week Treasury bills on Tuesday, the interest rate nearly tripled relative to the prior week's auction, and it reached the highest level since October 2008,” Lew said in his testimony to the Senate Finance Committee.

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