J. Scott Applewhite, Associated Press
A wide range of institutional and private investors hold debt issued by the U.S. government. This debt may be in the form of U.S. Treasury bills, notes or bonds, with the difference between these different securities being their maturities. All are used to borrow money from external sources to fund the growing government debt balance.
Many types of entities hold U.S. debt based on its historic “riskless” profile. Pension plans, banks, insurance companies, foreign central banks, sovereign wealth funds, endowments and an array of bond mutual funds are all potential holders of very large amounts of U.S. government debt. In addition, U.S. debt is used for municipal bond defeasance, as collateral for a range of derivatives contracts and other financial instruments.
As demonstrated again in the most recent threat of default on U.S. debt, concentration of holdings of these bills, notes and bonds carries with it significant exposure to the political desire of the U.S. government to make the timely contractual payments of interest and principal.
One option to manage and potentially mitigate one type of risk associated with owning U.S. government debt would be to own a somewhat diversified portfolio of bonds issued by AAA-rated non-sovereign issuers. One index of publicly traded, AAA-rated, non-sovereign bonds reports a current yield to maturity of 2.8 percent, which is about 0.7 percent higher than the yield on comparable duration U.S. government notes.
This U.S. dollar denominated index includes bonds issued by such companies as Microsoft, Exxon and Johnson & Johnson. A material benefit of owning AAA-rated corporate bonds is the diversification of the management teams making decisions. A reasonable expectation of these corporate debt issues could be as long as these companies are able to service their debt they will do so. A desire to make the debt servicing payments should not be a material concern of those investing in these corporate debt instruments.
In contrast, the recent discussion about servicing debt issued by the U.S. government leaned toward the subjective desire to make the required payments on the debt, not the ability to make the contractual payments.
Given the sheer size of U.S. government debt outstanding and the need for a very wide range of entities to own highly rated debt, it is not likely these debt owners will all migrate out of their U.S. government debt holdings in a short period of time. Quotes from various foreign government leaders in the last few weeks have indicated a level of concern and frustration with the U.S. and its intention to make payments on its debt. Our political leaders have addressed the current crisis, giving investors a few months before the next potential default event.
Kirby Brown is the CEO of Beneficial Financial Group in Salt Lake City.