Janet Yellen's Short-Term Thinking Could Cost the U.S. Big
The Treasury Secretary’s debt decisions during the pandemic locked in low rates—but only for two years. Now, taxpayers are paying the price.
Janet Yellen gets low marks from most financial experts for her term as Treasury Secretary. The Treasury Secretary's primary role is managing U.S. debt issuance, determining the mix of loan terms and debt structures to minimize interest costs. During the pandemic, interest rates were very low—below 1 percent in most instances—and instead of locking in those low rates for 10 or 30 years, she chose to mostly issue debt in short maturities, usually two years and under.
When interest rates inevitably rose in 2022, the U.S. government was forced to refinance at significantly higher rates, which cost taxpayers hundreds of billions of dollars. It was an error of judgment that most of us cannot even comprehend—if interest rates are close to zero, you lock them in for as long as possible. It's no different than refinancing your mortgage at 2.5 percent, as millions of homeowners did during that time period. It's common sense.
Why did Yellen fail to do this? Part of it could have been bad forecasting—perhaps she thought that rates would remain low indefinitely, so there was no particular urgency in terming out the debt. She may have believed she was actually saving money by issuing debt in T-bills and 2-year notes instead of long-term bonds because the interest rates on longer maturities were about half a percent higher. Or, perhaps she couldn't do the hard thing politically—if she had termed out the debt to 10-year notes and 30-year bonds, it would have caused long-term interest rates—and by extension, interest rates on mortgages—to rise slightly, and she couldn't bear the political risk. Now, incoming Treasury Secretary Scott Bessent (who is almost certain to be confirmed) will be faced with the prospect of terming out the debt to longer maturities in the event that rates rise even higher than they are currently.
This will be painful. The United States finances itself through debt auctions. As Bessent sells more bonds at 10-, 20-, and 30-year maturities, the increased supply of bonds will cause long-term interest rates to rise, which will mean that we will all be paying higher interest rates on mortgages and other long-term borrowings. But the failure to do this could be catastrophic. The debt is a national security issue—at 123 percent of gross domestic product, we are at risk of a financing squeeze, where short-term rates rise rapidly and lead to a debt spiral from which there is no escape. This is what happened to Southern Europe in 2012—short-term rates rose, leaving Portugal, Italy, Greece, and Spain no choice but to conduct a program of austerity to get interest down—but what really got interest rates down was then–European Central Bank Chairman Mario Draghi's pledge to do "whatever it takes," up to and including monetizing the debt in order to reduce interest rates.
We don't want that to happen here. Interestingly, during the first Donald Trump administration, Treasury Secretary Steven Mnuchin floated the possibility of issuing 50- and 100-year bonds to lock in low interest rates for up to a century. The Treasury Department consulted with potential buyers of the debt, such as public and private pension funds, and determined that there was practically no demand for ultralong bonds.
Mnuchin likely regrets not pursuing the idea, but even if he did, the market for such debt would have been very illiquid and would not have accommodated large sales. Mnuchin did reissue the 20-year bonds, but that has been mostly a failure. Despite selling about half a trillion dollars' worth, these bonds consistently carry slightly higher interest rates than 30-year bonds, resulting in a net loss to taxpayers.
Right now, the average maturity on U.S. debt is a bit over 70 months. It has been lower in the past, including the high-rate period of the 1970s, but the overall debt burden was much lower back then. Ideally, the average maturity of U.S. debt should be longer. Many market participants are worried about a return of inflation and higher interest rates, so it's imperative that the incoming Trump administration locks in 4 percent to 5 percent interest rates as soon as possible. Of course, it is possible that Bessent locks in current interest rates, and then interest rates actually decline, saddling the U.S. with even higher interest expense. But it is still the prudent thing to do.
Of course, if the debt were not 123 percent of GDP (higher than all other countries save for Italy and Japan), this would not be a pressing issue. If the Trump administration wants tax cuts, that will add to the deficit in the short term. We can see with the benefit of hindsight that the supply-side tax cuts of the 1980s worked, leading to surpluses—but it took 20 years. A drop in tax revenue must be met with an even bigger drop in government spending, and it is hard to cut $2 trillion in government spending (as Elon Musk proposed last year, though he has now backtracked on that goal) without cutting entitlements. Social Security and Medicare must be reformed, but to do so would take an incredible amount of political will, and that political will is typically not present if there isn't a crisis.
Even a rise in interest rates to 6 percent or 7 percent, from about 4.5 percent currently, would be catastrophic for U.S. finances. The budget cannot tolerate those levels of interest rates, so inevitably, the executive branch would put pressure on the Federal Reserve to monetize the debt—buying back bonds with printed money, which would be the starting gun for very high levels of inflation. We have a window of about two years to figure this out.
