08/08/2011 05:53 pm ET Updated Oct 08, 2011

What to Do With the U.S. Treasury Bonds Now?

The U.S. Treasury bonds and bills (T-bonds and T-bills) have long been the beacon of security for many investors, young and old. With AAA-marked bonds, employees have invested in T-bonds in preparation for guaranteed retirement; parents have bought T-bonds to secure funds for their children's education; managers of countless mutual funds have sought T-bonds and T-bills to diversify their portfolios without adding on risk. With the now-lower rating on the U.S. government debt assigned by the major rating agency, the Standard & Poors, the bonds and bills investors find themselves questioning as to what to do with their investments: how to find riskless replacements for the now-risky U.S. bonds?

Even though the bonds issued by the U.S. Treasury are now officially considered to carry risk of default, bonds of some other smaller and financially solid U.S. jurisdictions are still thought to be risk- and default-free. Specifically, wealthy enclaves in New York, Connecticut, parts of Texas, Virginia, and other selected areas may be the new centers of the U.S.-based financial security. Their municipal stability often rests with state constitutions: while the U.S. Constitution does not specify the government's rules for issuing and redeeming public debt, the constitutions of many U.S. states explicitly mandate the steadfast procedures for issuance and repayment of obligations, making the latter more stable and transparent.

Another alternative is foreign bonds. Farther removed from the U.S., foreign bonds will suffer less of the turbulence than the U.S. municipal bonds. With the E.U. bonds out of commission due to the Union's internal problems, however, only the British and the Swiss bonds may withstand the pressures of the world's formerly risk-free rate offered by the U.S. T-bonds and bills. In fact, a new research by Srinivas Nippani and Stanley Smith of Texas A&M University and University of Central Florida, respectively, shows that as the speculation about the U.S. default intensifies, the spread between the U.S. T-bills and the London InterBank Offer Rate (LIBOR) steadily increases, with higher yield on the U.S. T-bonds capturing the heightened risk of the U.S. products. On the other hand, the London Treasury bonds remain solid in comparison.

Yet, even as the spread between the U.S. T-bills and the London InterBank Offer Rate (LIBOR) (known as "TED spread" in financial community) increases, its current level is about 18 times lower than that registered in October 2008, when the collapse of Lehman Brothers shook the U.S. economy to its core. The significantly lower levels of the TED spread indicate that at this point economists and traders collectively believe that the probability of the U.S. default still remains considerably small, and the perfect AAA rating may be restored in the not-so-distant future.