While very few arrangements are optimal, I personally don't see how this is a good example. It seems like your assessment, as so far elaborated, is equivalent t

While very few arrangements are optimal, I personally don't see how this is a good example. It seems like your assessment, as so far elaborated, is equivalent to "the government should not issue bonds." My opinion on equilibrium: government should always be providing the most secure credit, at some level of issuance, that wouldn't be true, best not to get there.