DERIVATIVES STUDY CENTER
www.financialpolicy.org 1600
L Street, NW, Suite 1200
Repaying the Federal Debt:
The
Impact on Financial Markets
and Monetary Policy
Randall Dodd
Director,
Directives Study Center
October 4, 2000
Executive Summary:
The projected U.S. federal budget surpluses raise the possibility of entirely repaying all outstanding U.S. Treasury debt. This will have immediate and long-term consequences for financial markets and monetary policy. The immediate issue for financial markets is how the Treasury will manage the issuance of new Treasury securities as it reduces it net borrowing. Towards this end the Treasury Department has developed a new debt management policy consisting of a reverse auction to buy back existing Treasury bonds and a new schedule for issuing new securities. The long-term problem for the financial markets is to adopt a new benchmark for market interest rates. Although there is no major immediate problem for the conduct of monetary policy, in the long-run the Federal Reserve must adopt a new class or classes of securities to use for outright purchases in its open market operations and it must adopt a new class of liquid security to use for its seasonal or "defensive" open market operations.
I. The Surpluses Are Coming, and Treasury
Securities Are Going
Background
The federal government is projected to operate with substantial fiscal surpluses through the next ten years and beyond. The CBO’s July 2000 projections forecast that by 2008 the federal government will be effectively free of debt as its excess cash balances will exceed the remaining amount of debt held by the public. These surpluses are already reducing the level of outstanding Treasury debt, and the size of the reduction is projected to grow in the coming years. Given these projections, the demise of the Treasury debt market introduces a new set of issues for the financial markets and the ability of the Federal Reserve to conduct monetary policy.
[See Figures 1 and 2.]
The market for U.S. Treasury securities is the largest, most liquid and most sophisticated debt market in the world. Its size rivals even that of the foreign exchange market. The market is special not only because of its size, but also because it is very liquid and is uniquely devoid of credit risk. These characteristics allow this market to establish market interest rates that are pure reflections of the term structure of interest rates, i.e. the yield curve. This process of establishing market interests is known as price discovery.
The Treasury yield curve serves through financial markets, and the economy at large, as a benchmark for interest rates. Credit markets have historically looked towards the Treasury market when trying to price the yields on corporate bonds, government agency bonds, mortgage-backed securities (MBSs), interest rate swaps and commercial paper. This process of using the market benchmark to price other related products is known as price basing.
In sum, the price discovery process in the Treasury securities markets is being used for price basing in other financial markets. In this way the Treasury market exerts a force in the economy that extends far beyond those buying and selling the securities.
The demise of the Treasury securities market, either from the complete extension of Treasury securities or the withering away of the volume of trading, would leave financial markets without a valid interest rate benchmark.
The demise of the Treasury market would also pose problems for the monetary authority. The Federal Reserve conducts monetary by adding and draining credit from the U.S. credit markets by intervening in the Treasury securities market. Its monetary target, the Federal funds rate, works by being closely tied to the Treasury bill rate at the short-end of the Treasury benchmark yield curve. Without the presence of the Treasury market as the center of U.S. credit markets, the Federal Reserve would have to conduct its open market operations in smaller, less liquid and possibly less suitable markets.
II. The Impact on Financial Markets
A. The Immediate Problem
Although the present surpluses are small in comparison to the amount of outstanding debt, and the prospects for the total retirement of all outstanding debt for still a decade away, there are already some problems presented by the reduction in outstanding indebtedness.
The current surplus requires that some debt be paid down (unless the government intends to hold increasing larger cash deposits at banks). One simple was to pay down the debt is to not roll-over the entire amount of maturing securities. This method however tends to increase the average maturity of outstanding debt because more short-term than long-term debt is retired each year. Approximately 1/30th of outstanding 30-year bonds mature each year, while one-half the 2-year notes mature and over 100% of bills mature. Lengthening the average maturity of the debt would put increasing demand on the long-end of the credit market and tend to push up interest rates in the maturity ranges where corporate bonds and mortgages are priced.
[See Figure 3.]
In order to avoid this lengthening of the average maturity of outstanding debt, the Treasury would have to drastically reduce the amount of new issuances of intermediate and long-term debt. This would mean that the size of auctions of new Treasury notes and bonds would be substantially smaller.
Herein lies the problem. The liquidity in the Treasury market is concentrated in new or most recently auctioned issues (called on-the-run issues). If the amount of new issues were to substantially decrease, then it would threaten market liquidity.
[See Figures 4 and 5.]
In order to avoid or reduce the impact of the lengthening maturity and liquidity problems, the Treasury has brought forth a new debt management policy. Its goal is to maintain, or at least mitigate any reductions in, the size of new Treasury note and bond auctions in order to ensure liquidity in those markets.
How does it work?
The Treasury Department introduced in August of 1999 its new debt management policy. The main thrust of the policy was to conduct reverse auctions in order to replace existing Treasury bonds with new issues. The new policy was printed in the Federal Register, and further addressed by senior Treasury officials in several press conferences (see Appendices 1 and 2). In addition, the Treasury Department announced policy changes to the auction schedule and the size of new issues (see Appendix 3).
In order to help maintain auction sizes while scaling back the overall amount of medium- and long-term securities, the Treasury Department plan would buyback outstanding security issues prior to their maturity, and finance these purchases by augmenting the size of otherwise reduced new note and bond auctions.
The Treasury Department plans to commence a buyback or redemption operation that would redeem outstanding securities by buying them from their owners. The method to accomplishing this would be through a reverse auction. The reverse auction would consist of the Treasury Department announcing their interest in buying specified security issues, and the market participants responding by submitting competitive offers to sell those securities. The Treasury Department will have the discretion to reject or accept all or any portion of submitted offers. Offers could be submitted by primary dealers or by other investors submitting offers through a primary dealer which would act as an intermediary. Unlike the regular auction of new issues which employ "yield based" bids, the reverse redemption auctions would be based on "price based" offers. The rationale for this is that the outstanding, off-the-run issues are already trading in the secondary market on a price-based method.
The Treasury Department will place no limit on the amount of offers or the amount of actual sales from any one submitter. Thus there would be no limitation similar to the 35% cap on any single issue awarded at an auction. There would also be no limit on the overall amount of a security issue bought and redeemed, so that the remaining quantity of an outstanding issue could be very small. Settlement will occur the business day after the deadline for submitting offers.
Another dimension of the policy change involves an alteration in the schedule of auctions and the reopening of issues. The Treasury Department plans to reduce the number of auctions in some cases, and reduce the number of new issues in others. Regarding the 30-year bond, the Treasury is planning to return to the policy pursued during the 1993-1996 period in which the usual quarterly Treasury bond auction of approximately $10 billion was changed to a semi-annual auction of an estimated $12 billion. The Treasury also plans to cut back on their auction of 1-year bills and 2-year notes. Another possible move will be to more frequently reopen issues for successive auctions so that there is a greater amount of the on-the-run issue in the market.
What are its intended benefits? Liquidity, maturity, and budget savings.
The benefits from the change in policy, as stated by the Treasury Department, include the following. One, enhance market liquidity by maintaining size and regularity of auctions of new benchmark securities. This might entail multiple auctions of the same issue (by re-opening the issue) in order to provide the market with a large supply of each issue, and thus enhance liquidity, without making any one auction too large. Two, allow the Treasury to better manage the maturity structure of debt. Otherwise, the Treasury would have to sharply curtail long-term issues in order to avoid additional lengthening the maturity structure of outstanding debt. Three, save money for the Treasury by buying back cheaper off-the-run securities and issuing lower yielding on-the-run securities.
The following economic analysis explains and supports the Treasury’s reasoning regarding the purpose and benefits of the policy change.
The recently announced change in Treasury debt management policy, taken together with the lower projected level of outstanding Treasury debt, should have the following impact on the cash and futures markets.
Most of the liquidity in the Treasury securities markets is in the newest issues which are described as on-the-run. It is feared that a diminution in the size of new issues will harm the liquidity in those key markets. The size of the issue matters because the market faces constraints on its ability to settle trades in a security issue when the daily trading volume is great in comparison to the quantity of actual outstanding securities. Another reason is that market participants do not want to be caught in a situation where there is no available supply of a security to deliver against their short positions, and it is the ability to create short positions that drives a large portion of the trading in the on-the-run market.
In order to assure market participants that there will be substantial quantities of new on-the-run issues into the future, the Treasury has introduced this policy. It will redeem outstanding off-the-run issues, which generally have less trading volume, and replace them with on-the-run issues, which have greater trading volume. This will have the net effect of increasing total trading volume and improving market liquidity in the present and into the future.
Budget savings.
Another impact of the policy will the budgetary savings to the federal government. The savings will come from two sources. The first comes from exploiting the market premium for on-the-run securities in comparison to off-the-run securities. This premium is due largely to the greater liquidity of on-the-run securities but it is also related to "specialness" in the repurchase agreement market. When the government redeems outstanding issues and rolls this debt into a new on-the-run issue it captures the on-the-run premium by buying the lower priced off-the-run issues and selling the higher priced on-the-run issues. It is Mr. Adam Smith goes to Washington: buy low, and sell dear. While this premium may range from 5 to 20 basis points on the principal of the debt, it can potentially aggregate to a substantial sum ($5,000,000 to $20,000,000 on $10 billion in principal).
The second source of savings comes from the cash-flow method of measuring the budget. The Treasury plans to buyback outstanding bonds that are trading at a premium to current interest rates – that is, the coupon yields on the outstanding issues are higher than current market yields which means that their market price is above the face value or principal on the bond. Thus for every dollar paid to retire outstanding debt, the Treasury will retire a comparatively larger portion of interest than principal in comparison to newly issued Treasury securities.
Consider a 10 year old bond with an 8% coupon. When market rates are 6%, it trades at a premium or 123.11% of face value or principal. When that amount is rolled over into a new 30-year bond, the effective interest cost on the principal (now 127.33% of the original) at 6% (assuming the long end of the yield curve is flat) would be 7.39%. Thus even though there would be no change in the present value of the government’s indebtedness, this amounts to an annual cash flow savings of 0.61% on every dollar of principal retired.
[See Figure 6.]
Impact on Market Liquidity
The above analysis explains how the policy change can be expected to improve liquidity in comparison to what would otherwise occur as a result of the diminishing amounts of outstanding Treasury debt. Over the short- to intermediate-term, the cash markets should therefore exhibit adequate liquidity.
However, the long-term implication of budget surpluses substantially reducing and possibly eliminating outstanding debt is undoubtedly a reduction in market trading volume and liquidity. The recent debt management policy change will not solve that problem.
B. Long-run Impact on Financial Markets
The long-term impact will likely be for the markets to refocus their trading volume and portfolio benchmarks. Although no other market can provide the zero credit risk offered by the Treasury securities market, there are other highly rated markets. One is the market for "agency" securities from such investment grade firms as Fannie Mae, Freddie Mac or the Federal Home Loan Bank Board. Another is the investment grade corporate bond market, or the similarly rated market for municipal securities. Last be not least is the market for dollar interest rate swaps and forward rate agreements. This point was made by Treasury Undersecretary Gensler, "As our share of the market declines, markets will over time adjust, whether it’s by re-poing non-Treasury securities or hedging with non-Treasury securities."
The migration in the volume in credit market trading and the rise of a new benchmark will depend on liquidity and that in turn hinges upon dependable market supplies, the homogeneity of the product, creditworthiness and the distribution of product along the yield curve. The Treasury market clearly dominates in each of these categories, but what is the next best?
Agency securities are liquid in that they have a large trading volume, but they are not perfectly homogeneous and they are not brought to market in regular auction cycles like Treasury securities. They are less liquid than Treasury securities in that the bid-ask spread in the inter-dealer market is three or four times larger than that for Treasury securities. Nevertheless, agencies surely have an advantage over corporate bonds and mortgage-backed securities. The former are very heterogeneous, have no regular auction cycle, and the trading volume and liquidity in any one issue is not large.
[See Figure 7.]
The most likely candidate is the swaps market. They are homogeneous, investment grade (and this will rise to AAA once a clearing house is adopted in the U.S.), trading volume is high and bid-ask spreads are low. In addition, there are many liquid maturities along the yield curve. Moreover, there are ready amounts of short-interest – investors do not have to combine reverse repos and cash market sales in order to create short positions.
There are already several indications that the swaps market is the ultimate destination for the market’s interest rate benchmark. One, the swaps rates are now quoted as all in rates and not as a spread above the Treasury rate. Two, the swaps rates are regularly quoted on Bloomberg, Reuters, and Prebon broker screens, and the Federal Reserve Board now includes swaps rates in their regular market interest rate releases. Three, when there is a sharp decline in the swaps market volume, traders in the corporate and mortgage markets are widely quoted as saying that they are having trouble pricing their instruments.
III. What are the implications for the Federal Reserve’s ability to conduct monetary policy?
The demise of the Treasury debt market should not materially affect any aspect of monetary policy except open market operations. There are two types of open market operations and they are conducted for two different purposes. The first and most familiar is the outright purchase or sale of securities in the open market in order to affect a secular expansion or contraction, respectively, in credit conditions in the economy. The second type involves the use of the repurchase agreement market for Treasury securities in order to temporarily add or drain non-borrowed reserves, and thereby expand or contract credit, in accordance with the myriad seasonal needs of the economy. The demise of the Treasury market will have much more profound implications for this second type of open market operations. Although it is of lesser interest to most macroeconomists, this seasonal or "defensive" intervention is nonetheless a very important part of monetary policy.
How will the outright purchase and sale be affected by the diminishing Treasury market? Presently the Fed primarily uses Treasury securities in order to make permanent additions to the supply of credit to the economy. In doing so, the Fed has concentrated on the short-end of the market for two important reasons. Of the $505 billion in Treasury securities held by the Federal Reserve System (FRS), $258 billion have maturities of less than one year. First, the market for bills is larger than the market for on-the-run coupon securities, and therefore the outright purchase (or sale) would less likely have an impact on securities prices (the purpose is to add money or liquidity and not to spark a rally in securities or otherwise boost the price of securities).
Second, and perhaps more important for the tactics of open market operations, the use of bills veils any changes in overall holdings because the Fed is frequently redeeming and rolling-over the short-term securities. In other words, the shorter-term securities have to be rolled over more often and this allows the Fed to come into the market more often. This frequency allows them to act without too much being made of any one purchase or sale, and thus avoids unwanted "signaling" from the purchase.
This draws attention to another special feature of the Treasury securities market: it consists of a liquid market in securities of maturities ranging from a few weeks to 30 years. In the absence of this market, the Fed would not have an alternative single market with this characteristic.
Is there an alternative market for the Fed use for secular open market operations? The Fed does not need to use Treasury securities in order to conduct monetary policy. For outright purchases that enable it to introduce money (i.e. liquidity) into the market, it can potentially buy anything. The Fed could alternatively purchase "agency" securities from entities such as Fannie Mae and Freddie Mac, mortgage backed securities, corporate or municipal bonds, asset backed securities, gold, foreign exchange or even bank loans and real estate.
Is there enough of these securities and assets to back up the U.S. money supply? Easily, because the money supply as measure by M2 is only $4,777 billion and the required reserves which back up the quantity is about $40 billion. According to the most recent Z.1 survey by the Fed Board, the Federal Reserve System Banks currently hold $505 billion in Treasury securities and $0.14 billion in agency securities. If the Fed wished to limit its purchases to credit market securities then it would find that there are $1,677 billion in agency securities, $2,355 billion in mortgage-backed securities, $436 billion in asset-backed securities (consumer debt alone), $2,107 billion in corporate bonds, $1,539 billion in municipal bonds. In addition there is the deep market in gold and foreign exchange and foreign government bonds. In short, there is no shortage of alternative securities with which the Fed can purchase outright in order to
What about the Fed’s preference for short-term credit market instruments? There is one alternative in the commercial paper market. The maturities ranges from one to six months, and the size of the market is $1.5 trillion (however it is not certain what portion of it has a liquid secondary market).
Seasonal or "defensive" interventions
Returning to the second type of open market operations, how will this affect the Fed’s ability to conduct "defensive" operations to respond to season liquidity needs. This involves not the outright purchase, but rather the use of repurchase agreements and match sales (called reverse repo and repo transactions in the private market) of Treasury securities. Repo markets, which are similar to securities lending market, require a liquid market in the underlying security. Presently, agency securities and mortgage-backed securities have liquid repo markets. This makes them possible candidates to replace the Treasury repo transactions.
Alternatively, the Fed could make more frequent use of outright purchases and sales of liquid securities such as commercial paper, which is short-term paper, and other liquid securities in order to add and drain non-borrowed reserves according to the seasonal needs of the banking system.
Conclusion
In short, the Fed can definitely continue to conduct monetary policy beyond the time with the Treasury security market has withered away. Its policy of making outright purchases of securities to expand the domestic credit supply will not require substantial alteration. It will have to make more substantial changes to the manner in which it conducts its defensive actions. If the repo market for other debt instruments grows in volume and liquidity with the demise of that for Treasury securities, then this change should not pose a difficult challenge.
The macroeconomic impact should not therefore be large. The Fed will still be able to lower market interest rates to stimulate the economy. And I am afraid they will be equally able to raise them. The Fed will still be able to target the Fed funds rate by making frequent interventions to counteract seasonal credit and liquidity needs.
IV. Policy Alternatives
1. Radically reform municipal bond market. Abolish tax-free municipal bonds and instead have them issued through the Treasury as homogenous Treasury securities back by the full faith of the U.S. government. This will provide lower tax-adjusted yields for the issues, it will provide U.S. securities to the financial market, it will kill a huge tax dodge for super wealthiest Americans, and it will make financial markets more efficient. Municipal governments can be made whole, or even better off, by offering further subsidies to their interest payments. Federal policy can then fine tune their policy objectives by increasing subsidies for educational structures and reduce subsidies for extending roads and water into sprawl areas.
2. Establish a government regulated swaps clearing house and impose reporting requirements. This will raise the credit rating of swaps and make the market even more liquid and less subject to systemic risks. It will improve market transparency, and more firmly establish the swaps market as the source for price discovery and price basing.
3. Don’t worry, be happy.
APPENDIX 1:
FOR IMMEDIATE RELEASE
August 4, 1999
LS-42
Statement by Lawrence H. Summers Secretary of the Treasury Washington, DC - August 4, 1999
This morning I have the great pleasure to announce the introduction of new tools for Treasurys management of the public debt to meet the needs of a new era of surplus.
As a joint Treasury-Council of Economic Advisors study to be released later today makes clear, we have seen a transformation in this nations public finances in recent years with major implications for all Americans.
In 1993, federal debt held by the public was projected to rise to $5.4 trillion by 1999 if additional fiscal discipline was not imposed. In fact, the stock of debt outstanding is now $3.6 trillion some $1.7 trillion lower than it otherwise would have been. And while future projections are always uncertain, if the Presidents fiscal framework is adopted there would be a further $1.7 trillion reduction in the stock of debt held by the public over the next ten years, and the complete elimination of such debt by 2015.
Reducing the supply of Treasury debt held by the public brings enormous benefits for our economy.
At the same time, the ongoing task of debt management for the Federal government will clearly be very different in the years ahead than it has been in the past when debt was rapidly increasing. With $3.6 trillion in debt outstanding, even a 3 basis point reduction in federal borrowing costs will ultimately produce savings of more than $1 billion per year. This makes it critically important to manage the debt held by the public as efficiently as we can in this new environment.
Today we are taking two new steps in support of this objective.
First, we will be reducing the frequency and scale of some of our debt auctions to reflect the reduced need for public borrowing. Under-Secretary Gensler will be describing these changes in greater detail in a moment.
Second, we are publishing for comment proposed rules for carrying out Treasury repurchases of outstanding debt securities before they mature. These prepayments in many ways analogous to a homeowner refinancing a mortgage or a company refinancing its debt would hold out the prospect for reducing federal borrowing costs over time. In effect, they would allow us to have the same kind of flexibility in managing the nations finances that families and companies enjoy: letting us refinance the debt and pay it down on the best possible terms.
Concretely, buybacks of this kind would potentially offer three advantages for federal debt management.
It has been the unanimous recommendation of Treasurys Borrowing Advisory Committee to make use of debt buybacks as a debt management tool in the future. That said, the question of how to conduct debt buy-backs raises a number of complex issues that will need to be worked out. We look forward to broad public discussion of these and other steps aimed at ensuring that Treasury manages the public debt as effectively as possible in this new and very different era when the stock of debt is at last declining rather than increasing. Thank you.
APPENDIX
2:
FROM THE OFFICE OF PUBLIC AFFAIRS
FOR IMMEDIATE RELEASE
August 4, 1999
LS-43
UNDER SECRETARY OF THE TREASURY FOR DOMESTIC FINANCE GARY GENSLER REMARKS AT THE AUGUST 1999 TREASURY QUARTERLY REFUNDING
Good morning. I am pleased to be with you today to discuss the governments refunding needs for the current quarter. We are about to record the nations first back-to-back budget surpluses since 1956 and 1957. That was before many of us in this room were born. We expect this quarter to pay down $11 billion in privately held marketable debt, bringing the total reduction to an estimated $95 billion by the end of FY 1999. Including changes in non-marketable borrowings, this will result in an overall reduction of $87 billion this fiscal year in our publicly held debt. This is a record decline in publicly held debt.
Treasury debt is taking up an ever smaller share of the capital markets. Prior to President Clinton taking office, privately held marketable Treasury securities represented 31 percent or just under a third of the U.S. debt market. Now, they represent only 23 percent, or just under one quarter of the U. S. debt market. Even more dramatically, Treasurys share of the volume of gross new issuance of long term debt has been cut by more than half. While we still have to issue debt to refund maturing securities, last year that debt represented only 18 percent of new long-term debt issuance in the United States, down from 40 percent in 1990.
The Clinton Administrations policy of fiscal discipline has been critical to achieving this success. As a result of reduced Federal borrowing, the net national savings rate has more than doubled from a low of 3.5 percent in 1993 to 7.2 percent this year. This has made more funds available for the private sector, fueling a surge in private business investment. More investment leads to higher productivity, which over the long term should produce a rising standard of living.
The significant reduction in debt over the last two years has left us with a set of challenges that we are delighted to have. We have needed to seek new debt management methods that will preserve the depth and liquidity of the Treasury markets in this era of budget surpluses. To this end, we have a number of announcements today concerning the manner in which we manage our nations debt.
First, we are announcing that we are reducing the frequency of our issuance of 30-year bonds. We will no longer issue a 30-year bond in November, but will continue to issue 30-year bonds in February and August. This allows us to continue to concentrate on fewer, but larger benchmark issues. In addition, this will enable us to counter the current lengthening in the average maturity of Treasurys debt.
Second, we will continue to examine the possibility of reducing the frequency of our issuance of 1-year bills and 2-year notes. A further decrease in the number of offerings would allow us to increase the liquidity of Treasurys remaining benchmark issues.
Proposed rules on debt buy-backs
Finally, as Secretary Summers announced, we are publishing a proposed rule that would establish a mechanism for Treasury to conduct debt buy-backs. While Treasury has not yet determined whether it will, in fact, conduct debt buy-backs, publication of the proposed rule is the first step to making buy-backs an actual debt management tool for Treasury. The Treasurys Borrowing Advisory Committee has strongly endorsed publication of this rule to provide Treasury with a full range of policy options.
We are now in our second year of budget surpluses. Thus far, we have managed the paydown of our debt by refunding our regularly maturing debt with smaller amounts of new debt. What we are proposing today would enable Treasury to repurchase debt that is not currently maturing.
This new tool would provide us with an important new means of managing the governments debt and responding to our improved fiscal condition. First, the use of debt buy-backs could allow Treasury to maintain larger issuance sizes, enhancing the liquidity of Treasurys benchmark securities. Over the long term, this enhanced liquidity should reduce the governments interest expense and promote more efficient capital markets. Secondly, debt buy-backs could enhance our ability to exert control over the maturity structure of Treasury debt. A buy-back program would provide us with the option of managing the maturity structure by selectively targeting the maturities of debt to be repurchased. Lastly, buy-backs could be used as a cash management tool, absorbing excess cash in periods such as late April when tax revenues greatly exceed immediate spending needs.
The proposed rule will be published tomorrow in the Federal Register and will be available today on the Bureau of the Public Debts website (www.publicdebt.treas.gov). Attached is a one page summary of the main features of the proposed rule. We look forward to receiving comments over the next sixty days.
Terms of the August Refunding
I will now turn to the terms of the quarterly refunding. We are offering $37.0 billion of notes and bonds to refund $28.9 billion of privately held notes maturing on August 15, 1999, raising approximately $8.1 billion.
The securities are:
1) A 5-year note in the amount of $15 billion, maturing on August 15, 2004.
2) A 10-year note in the amount of $12 billion, maturing on August 15, 2009.
3) A 30-year bond in the amount of $10 billion, maturing on August 15, 2029.
These notes and bonds are scheduled to be auctioned on a yield basis at 1:00 p.m. Eastern time on Tuesday, August 10, Wednesday, August 11, and Thursday, August 12, respectively.
As announced on Monday, August 2, we estimate that net market borrowing for the July -September quarter will be a paydown of $11 billion. This estimate assumes a $45 billion cash balance on September 30. The Treasury also announced that net market borrowing for the October - December quarter will be approximately $65 billion with a cash balance of $80 billion on December 31.
We anticipate a larger than usual year end cash balance as part of our planning related to the Year 2000. Congress recently enacted legislation to ensure that there would be liquidity of up to approximately $20 billion available to credit unions at this year end. As a result, the Federal Financing Bank has entered into a note purchase agreement with the National Credit Union Administration (NCUA) to provide that liquidity should it be needed. The NCUA has indicated that they do not believe that there will be a need to access funds under the facility, but we plan to be prepared to fulfill our obligation should the need arise.
In addition, there is more uncertainty than historically related to Treasurys forecasts of daily receipts and outlays for the period around year end. Thus we plan additional funding to provide for the possibility that the timing of receipts or outlays do not follow historical patterns. As with the credit union facility, we do not anticipate any problems, but we believe it is appropriate to be prepared. All major Treasury financial systems, including those used to collect taxes, disburse payments, and auction marketable securities are Y2K ready. The Federal Reserve has also indicated that its systems supporting Treasury programs are Y2K ready.
The additional funding in the fourth quarter will be done by modestly increasing weekly bill offerings and through cash management bills.
We also expect to issue two cash management bills this quarter to bridge seasonal low points in our cash position, one in mid-August and another in late August or early September. Both will mature after the September 15 tax date.
The next quarterly refunding will be announced on November 3, 1999.
APPENDIX
3.
Wednesday August 11, 2:44 pm Eastern Time
WASHINGTON, Aug 11 (Reuters) - Early response from financial markets to the U.S. Treasury Department's proposal to buy back some of its debt has been enthusiastic, Treasury Under Secretary Gary Gensler said on Wednesday.
``I would say that the reactions have been very positive from market participants and from economists who've looked at this,'' Gensler said in an interview with Reuters Television.
Treasury announced a week ago that it was setting up rules by next Jan. 1 to conduct buybacks through ``reverse auctions'' to take some of the higher-cost $3.6 trillion in bonds that it has sold to the public off the market. Treasury said it was not yet fully committed to do buybacks but intended to be ready early next year.
Gensler declined to specify when the first buybacks might be made or in what amounts.
``We'll have to look at the fiscal picture at the time and at the markets at the time,'' he said. ``What we're trying to do now is add this tool to our tool kit in this time of surplus and we'll try to answer those questions as we move forward.''
Longer-term bonds, carrying larger coupons, are expected to be targeted first for buybacks, but Gensler indicated Treasury's focus may be broader than that.
``One of the things that buybacks can help us in is to assure that the overall maturity structure of our debt does not continue to lengthen and that might suggest that we buy back longer-maturity securities,'' Gensler said.
``But we will also be looking at other maturity sectors as well,'' he added.
In response to questions, Gensler said that at this point Treasury was still working on establishing a mechanism for conducting buybacks. He said debt managers were not looking at potential tax incentives as a means of making it more attractive for investors to turn in securities.
``We're not contemplating that,'' he said of tax incentives.
With a shrinking volume of U.S. Treasury securities hitting the markets as government's borrowing needs contract, Gensler said Treasury's goal is to assure as much liquidity in its key ``benchmark'' securities as possible. But he said markets must adjust and are showing signs already of doing so.
``As our share of the market declines, markets will over time adjust, whether it's by re-poing (repurchase agreement) non-Treasury securities or hedging with non-Treasury securities,'' Gensler said, adding: ``They have already begun to adjust.''
Thursday
August 5, 1999
12:44 AM ET
By Glenn Somerville
WASHINGTON (Reuters) - The U.S. Treasury, its coffers brimming with cash from mounting budget surpluses, said Wednesday it may buy back government debt in a move to lower interest rates and reduce reliance on foreign borrowing.
Though no final decision on the historically rare step has been taken yet, Treasury Secretary Lawrence Summers said the government aimed to have rules in place by Jan. 1, 2000 for conducting such buybacks.
Summers compared early prepayments of government debt to a homeowner refinancing a mortgage at a lower rate in order to cut monthly payments and said there were potential ``enormous benefits'' for the U.S. economy.
``In effect, they would allow us to have the same kind of flexibility in managing the nation's finances that families and companies enjoy: letting us refinance the debt and pay it down on the best possible terms,'' he said.
With about $3.6 trillion in publicly traded U.S. Treasury bills, notes and bonds outstanding, Summers said savings of billions of dollars a year in interest charges were possible if the government's interest costs for borrowing can be reduced.
President Clinton said debt buybacks would produce benefits that were ``the equivalent of a tax cut'' for ordinary Americans and hailed his administration's success in achieving the first budget surplus in fiscal 1998 in 29 years. He said the debt could be eliminated entirely by 2015.
``In the past seven years, we've balanced Washington's books. We've cut its credit card balance,'' Clinton said. ``Now let's refinance our nation's mortgage and then wipe the ledger clean.''
Analysts agreed that buybacks could be a powerful new technique for government debt managers but noted there was no promise given that they would ever be implemented. So far, Treasury is simply offering a proposal for prepaying debt and giving anyone 60 days to comment on it.
``Treasury is giving us no indication about the intended size or timing of any buybacks,'' said economist Lou Crandall of R.H. Wrightson and Associates Inc. in New York. ``So, as to whether they'll ever actually do it and in a volume that would have a significant impact on markets is uncertain.''
Summers cited some specific benefits from paying down debt for the U.S. economy. ``It means less reliance on borrowings from abroad to finance American investment,'' he said. ``It means less pressure on interest rates and thus lower borrowing costs for businesses and for cars and homes for American families.''
The opportunity to buy back, or prepay, debt arises because the United States has begun what is forecast to be a decade of budget surpluses in which tax revenues outpace spending. Surpluses are expected to disappear around 2010 when a wave of retiring ``baby boomers'' strains the Social Security system.
In fiscal 1998 ended last Sept. 30, the government had a surplus of $69.2 billion. So far in the first nine months of fiscal 1999, the surplus is running at $94.3 billion. The United States last posted back-to-back annual surpluses in 1956 and 1957.
If debt buybacks proceed, they will be conducted through ''reverse auctions'' in which primary dealers would turn in existing U.S. Treasury securities in response to a Treasury announcement. Dealers would propose a price at which they were willing to sell and Treasury could accept it or reject it. Effectively, it would speed up a process that Treasury already has engaged now that its borrowing needs are shrinking. In the past two years, Treasury whittled down the size of its debt offerings and even dropped some maturities like the three-year note. Wednesday, Treasury Under Secretary Gary Gensler said the traditional sale of 30-year bonds in November was being scrapped though bonds will still be auctioned in February and August. As well, Treasury is considering cutting the frequency of sales of 1-year bills and 2-year notes. Bond markets responded enthusiastically, with the 30-year U.S. Treasury bond shooting up 27/32 of a point, or $8.4375 per $1,000 of face value, and its yield dropping to 6.10 percent from 6.17 percent in late trading Tuesday. A smaller supply of 30-year bonds makes them more attractive for buyers. The announcement of debt buyback plans came as Treasury unveiled plans for selling $15 billion of five-year notes, $12 billion of 10-year notes and $10 billion of 30-year bonds next week. The sales will refund $28.89 billion of publicly held securities that mature Aug. 15 and raise $8.11 billion of new cash for Treasury. An additional benefit from buying back existing debt is that Treasury can maintain larger auction sizes when it issues new debt. U.S. bond dealers said that was important since it adds ''liquidity'' to key maturities that often serve as benchmarks for other lending rates by keeping an ample supply of them on the market so prices cannot be manipulated.
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