Vail Valley Voices: A 5 percent savings bond proposal | VailDaily.com

Vail Valley Voices: A 5 percent savings bond proposal

Sal Bommarito
Vail, CO, Colorado
newsroom@vaildaily.com

At this time, investors who depend upon safe fixed-income returns

have very few options. The group includes retirees, public pension funds, union pension funds and not-for-profit institutions such as college endowments.

The demand for quality has sucked out the yield in the Treasury market, the historical go-to investment for so many investors.

Besides a low current yield, ownership of long-term treasuries will result in paper losses (prior to their maturities) as interest rates increase down the road in response to current monetary and fiscal stimulus efforts.

The aforementioned investors need federal government support at this time, or their savings-investment portfolios may be in jeopardy.

And the federal government could use the groups’ money to support current proposals to jump-start the economy.

Both parties would benefit by

a new investment program that resembles the nation’s savings-bond

program.

No-limit investments, coupled with a guaranteed 5 percent rate (if the savings bonds are held for a minimum of three years) and deferral of taxes on interest income until the bonds are redeemed, would result in a flood of new money for the federal government.

The current day model of the proposed security is the EE Bond, which earns interest of 90 percent of the average yields of treasuries for the preceding six months – an unattractive option. Investors may only purchase $20,000 of bond value annually (a combination of EE and I bonds in paper and electronic form). EE Bonds holders pay taxes when the bonds are redeemed; the bonds are free from all state and local taxes.

The questions that need to be addressed about this proposal include:

• What will the federal government do with the proceeds of the bond sale?

The federal government could use the money for any number of stimulus strategies and/or in its efforts to stabilize the banking system. My suggestion would be to use the proceeds to capitalize a “toxic bank” that would buy and warehouse underwater mortgages from commercial banks. Any gains in the toxic bank portfolio would accrue to U.S. taxpayers, thereby reducing the effective cost of the bond rate paid to investors.

• Is a 5 percent rate appropriate (the bonds would pay a lower rate if they were redeemed before a three-year holding period)?

A 5 percent rate of return guaranteed by the federal government

would be very attractive to eligible investors who would not include corporate entities, investment companies, hedge funds, foreign entities or foreign citizens. The relatively attractive rate would ultimately ease the pressure in the Treasury markets as investors demand more and more safety, even though the securities have virtually no yield. For retirees and other fixed-income-dependent investors, the new security would be very attractive.

• What are the budget implications to the federal government if it borrowed at 5 percent and enabled investors to defer taxes on the income from the bonds?

The budget implications are significant, as the 5 percent rate is substantially greater than the Treasury’s current borrowing costs for three- to seven-year money. Also, the tax deferral will delay the receipt of much-needed funds to decrease the skyrocketing budget deficit. However, this safe alternative for individual investors would protect a very vulnerable group in our economy.

• Would the program cannibalize other U.S. Treasury fundraising efforts?

The program would cannibalize certain Treasury efforts to raise money. But the impact would not be severe because many of the largest investors in treasuries would be unable to buy the proposed bonds.

• Would the program encourage too much savings on the part of American consumers?

The program would encourage savings and further deleverage the American consumer. But this phenomenon may be good for our economy in the long run, and the investments are guaranteed by the federal government (as opposed to the other assets purchased by consumers recently, such as common stock and real estate).

• How much could be raised from the program?

The program would generate significant interest at 5 percent and even more if the rate were greater. Unfortunately, the commercial bank CD market could be impacted by this program.

This is an old strategy that may have a very good application during these trying times. Confidence, security and government support are very important to many investors currently. This proposal would do a great deal to rein in the huge number of investors who have too few options for their savings at this time.

Sal Bommarito is a New Yorker who has skied Vail for 20 years. He will periodically report on national issues that affect Vailites. A former investment banker, he recently published four novels.


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