Thoughts on the Risk-Free T-Bills

The finance professors at New York University’s Graduate School of Business Administration all had experience on Wall Street, just steps away from our classrooms, when I earned my M.B.A. there in the mid-1980s.

They taught me that the yield on U.S. Treasury bills represented a “risk-free” rate of return. A T-bill’s short term to maturity immunized it from serious loss of value if interest rates happened to rise, they said, while the U.S. government’s vast financial strength made default unthinkable. Thus, the rate the government paid on T-bills was a pure representation of the cost of money in the short term. We could use this rate as a building block to determine the cost of capital for all sorts of purposes, by adding premiums for various types of risk.

I found it difficult to accept that anything could be “risk-free.” I was a journalist in those days, and journalists are naturally skeptical, especially of absolutes. It’s tempting fate to call something the “safest” or “fastest” or “best” of its kind. An “unsinkable” ship sank in 1912. The New York Mets won a World Series in 1969. Anything can happen, and if you wait long enough, it probably will. So it seemed dangerous to assume that anything could be truly risk-free. My teachers may have been wizards on Wall Street, but I suspected they underestimated the world’s ability to surprise us.

Someone on Wall Street finally agrees with me. With its announcement this week that it is adopting a negative outlook for the credit rating of Treasury debt, Standard & Poor’s now acknowledges the risk that my finance professors once called unthinkable: that a time may come when the government of the United States of America fails to pay the interest and principal on its debt in full and on time. In recognition of this possibility, said the S&P analysts, the national credit rating could be reduced from AAA sometime in the next 6 to 24 months.

This does not mean that default is inevitable, or even likely. In all probability, any cut in the federal debt rating will still leave it in the AA range, well within the “investment grade” category. I happen to think a federal default is exceptionally unlikely, because I do not believe there is more than a 1 or 2 percent chance that the Federal Reserve would let it happen. For all the Fed’s vows that it will never “monetize” the national debt by just printing money to pay it off, I am firmly convinced that if push ever comes to desperate shove, the Fed will do exactly that. It will opt for a period, even a long period, of high inflation over the even more destructive consequences of a national default.

But my professors were wrong; the idea of any debt obligation as “risk-free” has been exposed as a myth. There is no such thing as risk-free in this world. All we have are comparative risks, some larger, some very small, in a set of relationships that constantly change.

Dinosaurs ruled the world, until they didn’t. So did Romans. Chances are good that they once thought of their positions as risk-free, too.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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