According to “The House of Morgan” by Ron Chernow p. 490/91
" In the early 1920s, Truman had been dumbfounded when his government bond dropped in price after Ben Strong raised interest rates. He didn’t see this as bad luck but as a sinister betrayal of the bondholder, and it made him disposed to fix interest rates. The Fed was now spending billions of dollars to keep prices high and yields low on Treasury bonds. Along with Allen Sproul of the New York Fed, Leffingwell thought this a waste of money and wanted to return to free market interest rates."
I’m not sure who the bond holder is in the above and who the issuer. It’s his government bond. So is he the bondholder or the Fed.? Then it says "the sinister betrayal of the bondholder, so it sounds like the NY Fed is the bondholder, so who is the issuer? What mechanics are being discussed and why was Truman upset with the system as it stood in the 1920s.
I am not aware of the circumstances behind the story you quoted, but here’s what I think happened. Truman probably purchased and held a government bond. Let’s say that the bond had a face or par value of $1,000 and paid 5% interest annually. If the the interest rate on future bonds issued remained at 5%, Truman’s bond would continue to be valued at $1,000 until it matured, when the government would pay him back his $1,000. However, the story states that Strong raised interest rates, presumably for macro-economic purposes, e.g. to control inflation. When that happens, newly-issued bonds now pay (let’s assume) 6% interest. As a result, Truman’s bond is now worth less than the newer bonds, because why would a bond buyer buy a 5% bond when 6% bonds are available? Thus Truman’s bond is now worth less than $1,000 , which he perceived as a betrayal. The thing to point out is that Truman would still get the $1,000 back from the government if he didn’t sell his bond and just held it to maturity. So the value of Truman’s bond appreciates gradually back to $1,000 as it comes closer to maturity. At the end, he simply just received lower interest payments along the way.
ETA: the bond holder in this case are the folks who held the same 5% bind as Truman, and the implication is that they were all screwed when the interest rate was raised. Truman was clearly not a monetary policy expert.
Truman owned bonds in the 20s. Ben Strong raised interest rates and the bonds dropped in value. Truman saw this as the Fed betraying the bondholders so as president 20 years later he was predisposed to maintaining fixed interest rates.
Yes. Truman may have drawn the wrong conclusions from Ben Strong’s successful effort to stabilize prices in 1921 — it ushered in a roaring era of prosperity, albeit one that ended badly. (And the ending might not have been so bad if Strong hadn’t died in 1928, leaving the Federal Reserve without a smart Strong hand at the helm.)
Whether the bonds paid annually, or at maturity, it does not matter.
Harry buys a bond for $1000. It provides $50 a year, plus in say, 20 years, he gets his $1000 back.
Or, Harry might need his money back early, so he could sell his bond to someone else - for the $1000 it’s worth, plus it pays $50 a year extra like everywhere else.
Strong starts selling bonds that pay $60 on $1000.
If Harry holds on to his bond, he’s making $10 less per year than his neighbor who just bought a new bond.
If Harry needs the money and sells, he has a bond that pays $10 less, until the 20 years are up. People won’t pay the same $1000 as for the 6% bonds.
Harry has to discount his bond, say $10 for each year left on the bond.
(Actually, there’s compounding to consider, so not quite…)
Harry now has a bond that pays $1000 in a few years that he can’t sell for $1000.
Harry gets pissed off, gets into politics.
meanwhile, the country has gone on a buying spree until the banks collapse.
A few responses have already correctly outlined the basic situation of the 1920’s, but just to reiterate. The federal govt was the bond issuer, Truman was the buyer, the Fed was the institution whose policies Truman blamed for an increase in market interest rates. That increase made his previously purchased bond worth less than face value prior to maturity (let’s assume it was worth face when issued). Or alternatively it imposed on him the opportunity cost of lower earnings on the bond for the rest of its life than he could have gotten by waiting and purchasing a higher rate bond for face value after rates had gone up. Those are two sides of the same coin.
The part of that quote that’s more puzzling IMO is the part where post WWII Fed policy, which indeed seek to hold US interest rates low seems to be attributed solely to Truman’s past experience as a bond investor. That’s questionable. Another big reason was simply to make it easier for the US to pay down the mountain of debt it had incurred during the war. It was so called ‘financial repression’, where and if a govt or central bank is able to hold down rates to lighten its own debt load. I can’t hold down mortgage rates, and a smaller country which depends on foreign capital can’t hold down its borrowing rate either. But a big enough country issuing in its own currency might have considerable leeway to do that.
The other related questionable implication is that this was ‘costing’ billions of dollars. This might be the common confusion (as seen in many accounts of Fed action in and after the 2008 crisis) about the government spending money v the Fed creating money. Not the same thing.
There can certainly be downsides to an interest rate policy partly aimed at limiting the govt’s own cost of debt service, as arguably might become a Fed consideration from now, perhaps even is already (the US fiscal deficit would be much bigger than it is if rates were close to historic averages given the big run up in debt in recent years), though is not openly admitted as being one. But that quote oversimplifies the post WWII situation IMO.
Paul Volcker successfully carried out similar measures to tame inflation in 1981.
The problem with the Fed in the 1920s is that it did not reduce rates and expand the money supply when bad economic times hit after the stock market crash in 1929. Tight money persisted well into the Great Depression and was a major contributing factor to its severity.
Note that for normal bonds it is unlikely that the amount paid for the bond is exactly the same as the bond’s face value, even when the bond is issued. Bonds are typically sold at a discount or premium to face value, and the face value is only what the bond is “worth” immediately before maturity, except by coincidence.
So basically a $1000 bond is discounted by the interest rate to its Net Present Value, rather than being sold for face value?
I’ve seen various schemes; the consumer Canada Savings Bonds, for example - you pay $1000 or whatever. You redeem it for $1000 plus accrued compounded interest at the end of its term (say, 5 years). Unlike some commercial bonds, you could redeem these any time, which meant if interest rates went up, people would cash in and rebuy the more lucrative bonds.
There’s also business bonds with a “coupon” for each interest payment, typically quarterly. You buy it for $1000, for example, get a $1.25 payout on the 5% interest every quarter until maturity, typically 10 or 20 years. I had a friend in university whose father was in a firm that pioneered the technique (seems obvious) of buying bonds, stripping the coupons off the principle note, and selling each separately.
Some companies like to sell bond, fixed amount, rather than give shares to raise money for projects.
If you already know the yield curve, that is the way to value a bond, yes. Just take each cash flow, discount it to get a present value, and some them all up.
But conversely, if you don’t know the yield curve, but have market prices for a series of bonds (i.e. determined by what people are paying for them on the open market), you can use those prices to infer the yield curve.
Yeah, callability features make these things more complicated. Another case where that happens is in mortgage backed securities, because the mortgagor has the right to pay off the loan at any time, and is most likely to if interest rates are low (because they are refinancing their homes at a lower rate).
Most bonds (by some definition of “most”) have some kind of coupons. In US Treasuries they are picked to be the interest rate that makes them worth close to face value at issue, rounded to the nearest eighth of a percent.
In fact, there are “perpetual bonds” which are basically only coupons.
Not really. There are things called (in the US) zero-coupon bonds that work that way. There is no coupon. Hence no periodic interest payments. The issuer offers it for sale today for, say, $800 and promises to redeem it in 10 years for $1000. Meantime between now and then it just sits there.
Of course you’re free to buy or sell them to anyone for any price you can agree to at any time between now and then. During the whole time the bond is live you can expect the price to move opposite to the change in rates on other investments of comparable term & risk.
What (I think) leachim was talking about is something completely different.
Namely that because interest rates are moving all day every day, when some agency or corporation decides to issue (i.e. sell brand new) a bunch of, say, 5% 10 year bonds in $1000 denominations with a quarterly coupon, they may find nobody will pay exactly $1000.00 to buy one. Because interest rates on the day they go on sale are not exactly 5.00000% percent, people may be willing to pay $1005.00, or only $995.00 for the stream of payments being offered. Treasuries (gov’t or corporate) try to pick headline interest rates that match current reality. So a $1000 face bond with a coupon will usually sell *ab initio *for pretty close to $1000. But any differences in rates will show up as a corresponding discrepancy in the price people will actually pay to buy them as new issues.
And, just as with zero coupon bonds, a bondholder is free to sell or buy a coupon bond to/from other bondholders at any time at any price they can agree on. Which price will generally move opposite to the direction rates are moving. Over time the closer we are to the maturity date the closer the trade price will move to the redemption value.
T-bills (US treasuries with maturities one year or less) are like this. They pay out exactly once and the “interest” is entirely in the form of being sold at a discount. Other securities do pay coupons, and they often sell at a discount or premium to its par value depending on whether the coupons are greater than or less than prevailing interest rates.
You can look up the results of recent treasury auctions at treasurydirect.gov (example) and the price is not exactly at par, even at issue.
But all (non-callable, fixed coupon) bonds can be valued just as the sum of the NPVs of its coupon and principal payments. Zero coupon bonds are not special in this regard (other than said sum having only one term).