Thursday, May 3, 2012

Floating-rate debt update

As reported in the WSJ, the Treasury delayed it's decision on floating rate notes.

I was interested to note in the article that the Treasury seems to be struggling with the same issue that occupied my post on the subject yesterday -- just how will the "floating" rate be set?

The Treasury is searching for an index, and considering the overnight Federal Funds rate, Libor, the general collateral Repo rate, or an index based on treasury bill rates. All of these have various problems outlined in the article.

A second indication of the problem with any index shows up in the article: The unsettled debate whether to let floating rate debt auction at a price greater than face value. That means Treasury also envisions the security trading less than face value.

I'm interested that what's missing is the most obvious mechanism: The price is exactly $100 every single day, and an auction mechanism sets the rate daily at whatever it takes to maintain that price. Any other mechanism means the security is not protected from capital losses, which makes it much less useful as an asset.