TREASURY UNVEILS NEW BOND : SECURITY WILL TIE RETURNS TO INFLATION.
In an effort to get Americans to save more, the Treasury announced plans Thursday to issue a new type of government bond that would protect average investors from inflation as well as help the government finance the national debt.
The new bonds would offer returns that would rise and fall in line with inflation - a feature the Treasury said should make Americans more willing to buy government bonds to pay for their retirement or their children's education. The bonds would be backed by the government and priced so that unexpected increases in inflation would not erode their value.
``We will be offering a unique investment vehicle, an opportunity for middle-income people to save for retirement or their kid's education,'' said Treasury Secretary Robert Rubin. ``We are trying to better serve citizens by creating a vehicle that provides inflation protection, a real rate of return and the backing of the government. Over time, this will be well used by Americans seeking to save.''
Rubin said the bonds would not be issued until later this year, at the earliest, and that many decisions still had to be made: How many bonds to sell, what inflation index to use in setting the prices for the bonds, whether to sell 10-year or 30-year bonds, or both. He said the Treasury would soon meet with Wall Street executives, mutual fund companies and average investors to sort out these issues.
However these issues are decided, Rubin said, the new bonds are expected to help cut the cost of borrowing and enable the government to turn to the growing retirement market to help finance the national debt. Currently, a total of $675 billion is invested in 401(k) plans, or self-directed retirement plans, according to Access Research of Windsor, Conn., and these bonds are expected to be marketed as a new option in such plans.
Right now, government bonds are not a popular option for 401(k) plans and other forms of long-term savings. Government bonds generally offer lower returns than stocks or corporate bonds. And while these other investments may be riskier than government bonds, their higher returns have been a way that average Americans have tried to protect their savings from inflation.
``This new security is a good idea that makes great sense,'' said Allen Sinai, chief global economist at Lehman Brothers, an investment banking firm. ``If the inflation index goes up, so do their returns. This makes these bonds safer for investors than bonds without this protection. I would expect this to turn out to be a very popular item.''
These inflation-indexed bonds are also expected to be a popular item for the many brokerage and money market firms that package 401(k) plans and college savings plans. ``It's an excellent idea,'' said Paul Boltz, chief economist at T. Rowe Price, a Baltimore mutual fund company. ``We always tell investors that they have to take inflation into account in their long-term savings. This is one way for them to have it covered.''
The Treasury is proposing that these bonds be sold in denominations as low as $1,000. Mutual fund companies and brokerage firms, however, may decide to buy some of these bonds in bulk and repackage them in even smaller amounts for their customers.
The Treasury still is trying to decide how to structure the bonds. In its simplest form, the principal value of a $1,000 bond would rise to $1,030 at the end of the year if inflation is 3 percent that year. If inflation is lower, the figure could be lower; if inflation is higher, the number could be higher. In addition, the coupon - the interest paid every six months on such bonds - would rise in line with the inflation index being used.
The Treasury also is considering other options for these bonds: One would be a zero-coupon bond, in which a person gets all his money back at the end of the bond's life along with an inflation premium. Other possible types of bonds would pay interest and some principal each year.
The bonds are a departure from the Treasury's reliance on issuing only fixed-rate securities - ones with a set interest rate that does not change over time. The Treasury estimates that it can cut its own borrowing costs and save taxpayer money with these bonds because they will, in general, be issued for lower rates than comparable fixed-rate securities because they offer this inflation protection.
``We hope to save money for the taxpayers with these bonds,'' said Darcy Bradbury, the Treasury's assistant secretary for financial markets.
But if inflation rises, the bonds could prove to be much more expensive for the government over their lives than conventional bonds.
Currently, Britain and Canada are the largest issuers of such bonds. In Britain, such inflation-indexed bonds represent about 15 percent of the government bond market. Money managers said similar securities had been issued in Australia, New Zealand and Sweden.
Treasury officials said they hoped the proposed new bonds would encourage people to save more. ``Most economic experts believe that a higher savings rate is good for the economy,'' said Lawrence Summers, the deputy Treasury secretary.