CSBs need drastic overhaul

The writing may be on the wall for the venerable Canada Savings Bond program.

Finance Minister Ralph Goodale denies that Ottawa will phase out this high-profile method of financing, but the conclusions reached by an independent study of its effectiveness raise serious questions about its future viability.

At the very least, look for radical changes in the existing CSB program to be unveiled in the coming months. Whether they will be enough to ensure its long-term survival is problematic, however.

On Sept. 2, the Department of Finance released the details of a study by Cap Gemini Ernst & Young (CGEY) that it had been sitting on for several months. It flatly recommended winding down the CSB program, for several reasons. They include:

· Reduced importance to government financing. Only 5 per cent of government debt is now held in Canada Savings Bonds and Canada Premium Bonds (CPBs), compared to 7 per cent in 1996.

· Public disinterest. In 1987, Canadians held 8.3 per cent of their investable assets in CSBs. By last year, the figure had fallen to a mere 1 per cent.

∓183; Reduced borrowing needs. The federal government has been operating with a surplus for several years, thus reducing its total borrowing needs.

· Costs. Even though the interest rates paid on CSBs and CPBs are low, the high cost of operating the program makes this form of debt financing expensive.

· Alternative investments. A generation ago, there were few investment alternatives for ordinary investors. Now they have a huge range of choices, backed by the marketing clout of the big banks, mutual fund firms, and brokerage houses.

From the government’s perspective, the best course is to simply let the whole program wither away, CGEY concluded. In simple terms, that would mean not issuing any more new CSBs and CPBs and letting the existing ones run to maturity.

However, that’s not going to happen, at least not right away. In releasing the CGEY report, Mr. Goodale said that the fall CSB campaign will proceed on schedule while the government undertakes a complete review of its options with a view to “updating and improving” what is known technically as the Retail Debt Program.

Unfortunately for CSB lovers (the few that remain), it’s difficult to see just how the government can achieve this. The big attraction of CSBs and CPBs is their safety, which is why people buy them even when interest rates are low. For example, the CSB issue of April 1/04 carried a one-year interest rate of only 1.25 per cent with no future guarantees, but some people bought them just because of the security they provided.

Other vehicles for security
However, you can get almost the same degree of safety from other securities, such as GICs which are insured by to $60,000 by the Canada Deposit Insurance Corporation. Government of Canada stripped bonds, T-bills, and CMHC-guaranteed mortgage-backed securities also offer a high measure of safety, usually with better returns.

Next page: Radical ideas needed

Higher interest rates would certainly attract retail investors back to CSBs, but why should Ottawa pay more for debt financing than it needs to when institutional investors will snap up every bond the government offers?

Finance Department officials must still be shaking their heads at the generosity the government showed in 1997 when it offered multi-year guaranteed rates on the first issue of Canada Premium Bonds that paid 8.5 per cent for the final 12 months, which ended April 1 of this year.

Those who bought the P7 and P8 series, issued in March and April 1999, are currently collecting interest at the rate of 4.75 per cent and that will jump to 6 per cent next year.

Obviously, a return to rates like that would attract a lot more business. But there is no way that is going to happen. Even if interest rates continue to move higher in the coming months, the Department of Finance is not likely to offer any more long-term, high-rate guarantees.

If Mr. Goodale really wants to retain the CSB program because of its high visibility and promotional value, there is one option he might look at to re-energize it. That would be to take a leaf from the American book and make the interest payments on CSBs and CPBs tax-free. Tax-free municipal bonds are very popular south of the border and they have enabled U.S. towns and cities to raise money at well below market rates.

Adopting a similar treatment for CSBs and CPBs and extending the concept to Canadian municipal bonds would certainly attract investor interest, although it would no longer make sense to hold such securities in a registered plan.

Personally, I would be sorry to see the CSBs go. For generations of Canadians, they were our first introduction to savings and I can still remember the pride I felt as a kid when I was able to buy my first CSB with my own money.

But if they are going to survive, Mr. Goodale and his brain trust will have to come up with some truly radical ideas. Otherwise, despite his reassuring words, this year’s campaign could be the last.