President Obama’s budget plan, released on Monday, projects shrinking deficits after 2011, although service on the national debt amounts to nearly $400 billion every year all by itself. What kind of interest rate does the federal government pay on its loans?
On average, 3.29 percent. Like a regular person looking for the best deal on a credit card, Uncle Sam shops around the market for the lowest interest rates available. (Potential lenders include banks, money market and mutual funds, foreign governments, and individual investors.) Based on projections of where interest rates are going, the Treasury Department periodically picks up a mixture of short-term and long-term loans. With the quick loans, the feds sell a note to someone and promise to give the money back, plus a little extra, 91 days later. They also take out long-term loans, which work a bit like an interest-only mortgage: The government pays a fixed rate of interest—every six months in this case—to the lender over as many as 30 years. When the term runs out, the Treasury pays back the entire principal in one lump sum. There’s an auction for both short- and long-term loans, with bidders competing to offer the lowest interest rate. At the end of December, 3.29 percent was the average interest rate for all of the government’s outstanding debt.
Want to loan the government some cash? The Treasury Department announces auctions in newspapers and in the financial press and also publishes a tentative calendar. You can submit a bid by mail, but it’s easier to work through an intermediary that regularly buys U.S. debt, because they use an electronic system that permits them to wait until the last moment and base their bid on the most up-to-the-second market data. The government pays the highest accepted interest rate to all the winning bidders. (In other words, you might get an even higher interest rate than you offered the government if it can’t find all the money it needs on the terms you offered.)
Just like individuals and businesses, the government has a credit score. Most ratings agencies use a letter system rather than the numbers used for individuals, because national ratings are based more on the judgment of analysts than on a strict combination of financial data. These private ratings agencies base their decisions on a country’s economy, political stability, and repayment history. But the market for U.S. debt is so large and robust, and information about the country’s budgetary and political climate so widely available, that Uncle Sam’s debt-holders pay little attention to his AAA rating. (For what it’s worth, the ratings analysts have warned the government that its grade could slip if we don’t fix Social Security and Medicare.) Credit ratings for smaller countries, where information is scarce and uncertainty is great, are somewhat more influential. Argentina is struggling with a B3 rating—junk bond status—eight years after defaulting on its loans and cannot obtain financing in the private markets. Low credit ratings can also affect the economy as a whole, reducing tax revenues. After Greece saw its rating downgraded in December, there was a broad sell-off in its stock market.
A slightly more useful and real-time indicator of a country’s creditworthiness is the sovereign credit-default swap market, in which investors essentially take out insurance against a country defaulting on its obligations. According to those data, the United States is a slightly safer investment than Hong Kong but riskier than Germany. The state of California is almost as poorly regarded as beleaguered Greece.
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Explainer thanks Stanley Collender of Qorvis Communications and J.D. Foster of the Heritage Foundation.
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