Investors Buy U.S. Debt at Zero Yield By VIKAS BAJAJ and MICHAEL M. GRYNBAUM

December 10, 2008
Investors Buy U.S. Debt at Zero Yield By VIKAS BAJAJ and MICHAEL M. GRYNBAUM

When was the last time you invested in something that you knew wouldn't make money?

In the market equivalent of shoveling cash under the mattress, hordes of buyers were so eager on Tuesday to park money in the world's safest investment, United States government debt, that they agreed to accept a zero percent rate of return.

The news sent a sobering signal: in these troubled economic times, when people have lost vast amounts on stocks, bonds and real estate, making an investment that offers security but no gain is tantamount to coming out ahead. This extremely cautious approach reflects concerns that a global recession could deepen next year, and continue to jeopardize all types of investments.

While this will lower the cost of borrowing for the United States government, economists worry that a widespread hunkering-down could have broader implications that could slow an economic recovery. If investors remain reluctant to put money into stocks and corporate bonds, that could choke off funds that businesses need to keep financing their day-to-day operations.

Investors accepted the zero percent rate in the government's auction Tuesday of $30 billion worth of short-term securities that mature in four weeks. Demand was so great even for no return that the government could have sold four times as much.

In addition, for a brief moment, investors were willing to take a small loss for holding another ultra-safe security, the already-issued three-month Treasury bill.

In these times, it seems, the abnormal has now become acceptable. As America's debt and deficit spiral from a parade of billion dollar bailouts and stimulus packages, fund managers, foreign governments and big retail investors reckon they will get more peace of mind by stashing their cash, rather than putting it toward any of the higher-yielding risk that is entailed in stocks, corporate bonds and consumer debt.

The rapid decline in Treasury yields — which since summer have headed toward lows not seen since the end of the World War II — also renders the Federal Reserve less effective, as investors and banks stuff the money that the central bank is pumping into the financial system into Treasuries, rather than fanning it out across the broader economy.

"The last time this happened was the Great Depression, when people are willing to accept no return on their money, or possibly even a negative return," said Edward Yardeni, an independent analyst. "If people are so busy during the day just protecting the cash they have, it's not a good sign."

Stocks fell sharply as investors digested the implications. The Dow Jones industrial average dropped 242.85 points, or 2.72 percent, to 8,691.33, and the Standard & Poor's 500-stock index declined 2.31 percent, to 888.67. The Nasdaq composite index lost 1.55 percent, to 1,547.34.

If there is a silver lining to the Treasury market's gyrations, it is that the United States can borrow money more cheaply from investors, whether they be the governments of China or Japan, or big fund managers. That could help Washington finance various programs intended to revive the ailing economy.

Borrowing by the Treasury has already ballooned since Congress approved the $700 billion financial rescue plan, and policy makers expect the federal budget deficit to swell further next year as the Big Three automakers and other industries look for support.

"That sucking sound is all the world's capital going into the U.S. Treasury market," Mr. Yardeni said, "which means the Treasury and the Fed can tap into that liquidity pool to finance TARP and offer mortgages at 4.5 percent."

While that may offset some of the expense of the bailouts, economists say the fact that the United States must borrow so much to prop up large parts of the economy is a big cause for concern.

There are several explanations for the flight to safety in the bond market. The world of short-term money market funds, for instance, is still reeling from troubles at the Reserve Primary Fund, a money market fund frozen in September after it lost money on investments in Lehman Brothers. Since then, individual and large investors have put more than $200 billion into money funds that only invest in safe Treasury bills, according to iMoneyNet, a financial data publisher. At the same time, investors have withdrawn nearly $400 billion from prime funds.

That has forced portfolio managers to buy Treasury bills, driving down yields. "That group of investors has to invest in something," said Max Bublitz, chief strategist at SCM Advisors. "They don't have the luxury of saying, 'I will stick it in the mattress.' "

Yields for longer term Treasury securities have also slumped, with the 10-year now yielding 2.64 percent, down from 2.7 percent Monday and 3.75 percent a month earlier. That decline appears to reflect several other forces. Many investors are seeking safety because they believe that the economy is in its worst recession since the Depression. Rather than inflation, which was a worry for some a few months ago, many are now worried about deflation, or falling prices.

Thomas H. Atteberry, a bond fund manager, said at current prices the market is predicting that the United States will suffer the kind of "lost decade" that Japan suffered in the 1990s.

"I have a hard time justifying that," said Mr. Atteberry, a partner at First Pacific Advisors. "The Fed seems much more upfront about boosting its balance sheet by creating money."

Another reason, analysts say, that Treasury yields may be falling is that foreign investors are using American government securities to protect themselves against the falling value of their own currencies. Many investors are also pulling money out of mutual funds and hedge funds, forcing portfolio managers to sell more risky assets and hold Treasuries, which are easier to sell.

And some fund managers are simply looking to dress up their portfolios before the year ends.

"There is no doubt that there is potentially some hoarding of cash in anticipation of potential redemptions," said David Kovacs, a strategist at Turner Investment Partners. "People want to own it to show that they played it safe by year-end."


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