Treasury yielding 0%: absolute risk averse of the investors

Yesterday, the Treasury auctioned $30B worth of 4-week bills with 0% interest to the investors. For the off-run 3-month treasury, the yield briefly was pushed to negative territory. Basically investors are lending money to the Treasury (Uncle Sam) for free, or even paying the government for storing their cash (in the case of the negative yield 3-month bills), while demanding high interest rate to lend to corporations and individuals even with good credit. In a finance lingo, the credit spreads are unusually wide. That means investors are absolutely risk averse.

We are in an uncharted territory here. Last time when the Treasury auctioned short terms yielding 0% was late 1930s and early 1940s, during the great depression. This is certainly not a good sign.

When the private sector is not willing to take any risk, which is reflected in the ultra low interest rates on public debt and exorbitantly high interest rates on other debts (commercial, local municipalities, and individual loans), should the government step in to provide credit for the economy, as Keynesian economists would propose? I think the answer is absolutely yes.

The banks are not doing the lending. They took the cash from the Treasury's TARP (Troubled Assets Relief Program, widely known as the $700 Wall Street Bailout), and stuffed it in their vault. Homes are continuing to default. Businesses cannot get loans. Individuals cannot buy a house even they can afford (the credit standard has tightened too much). The result is that real economy is suffering. The Treasury bailout did not benefit the main street. It only fattened the pockets of the financial institutions.

Now it is the time to give money to the main street, to the real economy that creates real value to the country, not the paper-flipping Wall Street firms. How do we do that? I think the Obama economic stimulation plan is a good start. But it is not enough. And it is not quick enough. Let's put cash to work, right now!

First, the Treasury should use its cheap financing option to pump cash directly to the mortgage market, by buying high quality mortgage loans. (In my previous post, I argued that this action would even make money for the Treasury). Along the same line, the Federal government should aid the State and local governments by directly giving low interest loans to them to meet their budget shortfalls because they cannot borrow in the municipal bonds market. And yes, the Treasury should rescue the auto industry. Not only that, it should also help other domestic companies who cannot borrow from the commercial paper or corporate bond market.

The Treasury needs to act quickly. TARP is not working. Credit for the real economy is still frozen (although inter-banking lending has loosened). By real economy, I mean those "goods-producing" companies, not those trading financial papers (Wall Street). According to some estimates, there will be $800B corporate debt that needs to be refinanced in 2009. And $200B faces refinancing in the next quarter! If the credit spread does not narrow, many companies will be put to the brink of bankruptcy. The ripple effect throughout the economy would be unthinkable.

We need to end this lame duck government sooner than Jan 20. Can we amend the Constitution to allow Obama to swear in right now?