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Mnuchin's Ultra-Long Bond Bid Hits Wall Street Reality

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(Bloomberg Gadfly) — Steve Mnuchin, just getting his feet wet as the new U.S. Treasury secretary, isn’t giving up on the idea of ultra-long bonds.

The Treasury Department released a questionnaire to primary dealers on Friday, asking for detailed responses about their appetite for 40, 50 or 100-year bonds, as Bloomberg’s Alex Harris reported on Tuesday. While this isn’t the first time that the agency has floated the idea of such long-dated debt, this is its most detailed and specific inquiry in recent memory.

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Theoretically, this makes sense. The U.S. is going to need more money in years to come, barring some drastic and unexpected change to the nation’s budget. Other countries have sold such debt easily. And investors are clearly interested in longer-dated bonds, as illustrated by falling yields on 30-year notes.

But in practice, selling 50-year bonds would require the U.S. to either force big Wall Street banks to take on more risk than they’re comfortable with or to pay big lenders to distribute the nation’s bonds. Both options are politically untenable.

The challenge that the U.S. would face in issuing 50-or 100-year bonds demonstrates just how different this $13.9 trillion market is from others around the world. It’s the biggest debt market. Traders expect the notes to be issued and traded with regularity. And the nation relies on big banks to facilitate an auction process that includes investors submitting bids and receiving allocations based on how high their bids were relative to others.

Primary dealers, which include banks such as JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp., provide a backstop to the market and are required to bid at each auction.

For them to participate in an auction of ultra-long debt, they’d have to accept the risk of owning a relatively illiquid 50-year bond without being able to hedge against losses going out beyond 30 years. This is a substantial risk, especially when regulators have spent years trying to curb banks’ bold bets. (Longer-term investors, such as pension funds and insurers, are the most likely buyers of ultra-long debt and are more likely to hang onto the bonds until they mature, leading to less activity in the notes than on shorter-maturity debt.)

The other option would be to pay banks to distribute the debt, the way that companies pay a fee to underwriters to shepherd their bond sales into the hands of investors. But it’s hard to see how the notion of the U.S. government paying big banks directly would fly in the current political environment.

These are the questions that would have to be sufficiently addressed even before a discussion about whether enough demand would exist and whether the U.S. could issue enough of the bonds to make them a stable and somewhat liquid part of the market. And then, of course, there’s the discussion about whether they would be a cost-effective way for the nation to raise money.

As Bloomberg News’s Brian Chappatta and Alex Harris reported in December, Mnuchin’s ultra-long bond idea is probably an ultra-long shot. Still, it’s clear the new Treasury secretary is serious about it. He’ll find himself bumping up against the idiosyncratic nature of the Treasury market before he can even get to the meat-and-potatoes of supply and demand.


— Read The Asset-Management Pressure Cooker on ThinkAdvisor.