18 United States of America1
- International Monetary Fund
- Published Date:
- August 2003
The U.S. Treasury enjoys several advantages over other countries in managing debt. Federal debt issuance is a relatively small percentage of total domestic debt issuance, so financial markets easily absorb changes in the government’s borrowing needs. The depth of private markets also allows the government to borrow solely in domestic currency. The sophistication of domestic financial markets allows the government to rely on the private sector for a range of activities that increase the liquidity of treasury securities. The wide breadth of participation in treasury auctions makes uniform-price auctions feasible. Underlying these advantages is the additional advantage of a large, diverse economy that assures investors that debt will be repaid. Many of these advantages have become self-reinforcing: As market depth and breadth have increased, more market participants have been willing to rely more on treasury securities.
The advantages enjoyed by the United States have influenced the development of the treasury market and U.S. debt management techniques. The result is a system that has unique characteristics and constraints. Consequently, the following outline of U.S. governance, strategy, and market development may have limited applicability to other countries.
The power of the U.S. government to borrow is authorized by the U.S. Constitution. Congress has delegated the secretary of the treasury the power to issue
- certificates of indebtedness and bills: debt obligations maturing not more than 1 year from the date of issue,
- notes: debt obligations maturing at least 1 year and not more than 10 years from the date of issue,
- bonds: debt obligations of more than 10 years,
- savings bonds: retail debt obligations maturing not more than 20 years from the date of issue, and
- savings certificates: retail debt obligations maturing not more than 10 years from the date of issue.
The secretary of the treasury is authorized to prescribe the terms and conditions of the debt obligations issued by the treasury and the conditions under which the debt obligations will be issued. For this and other duties, the secretary may delegate duties and powers to another officer or employee of the U.S. Department of the Treasury. In practice, this means that a political appointee under the secretary generally makes debt management decisions with the advice of career staff.
The Secretary of the treasury can invest in the treasury’s own securities or in commercial bank deposits secured by a broad range of pledged collateral acceptable to the treasury, including obligations of the U.S. government and private issuers. As part of its cash management, the treasury maintains relationships with a large number of commercial banks that help to absorb its large seasonal swings in cash balances.
Congress sets a limit on the total face amount of debt obligations issued by the secretary of the treasury. This limit is changed periodically as provided by law, either through the congressional budget process or otherwise. Until late 1917, congressional approval was required every time the treasury needed to borrow. During World War I, this approach to debt issuance became unduly cumbersome, and congress gave the treasury the authority to borrow, while maintaining authority over the total amount of debt outstanding. This practice has allowed the treasury to issue debt for a period, often one or two years, without having to seek congressional approval.
The secretary of the treasury is required to submit to congress an annual report that includes certain statistics about the treasury’s past and projected public debt activities. These reports are based on the administration’s annual budget projections and increase the accountability of government debt managers. In addition, the government auditing agency may investigate the treasury department’s debt management activities.
The department of the treasury is organized into two major components: the departmental offices and the operating bureaus. The departmental offices are primarily responsible for the formulation of policy and management of the treasury department as a whole, and the operating bureaus carry out the specific operations assigned to the department.
Within the departmental offices, the secretary of the treasury has primary responsibility for debt management activities of the federal government, is the principal economic adviser to the president, and plays a critical role in policymaking by bringing an economic and government financial policy perspective to issues facing the federal government. Departmental staff formulate and recommend domestic and international financial, economic, and tax policy. Debt management responsibilities include
- determining the treasury’s financing needs, planning schedules of security issues and amounts needed, and analyzing alternative types of securities and sales techniques;
- soliciting private sector advice in carrying out treasury financing and debt management policy, and preparing reports containing such recommendations;
- analyzing current economic and securities market conditions and their potential effects on treasury financing on a regular basis;
- coordinating with the Federal Reserve Bank of New York, part of the central banking system, regarding its fiscal agent responsibilities;
- participating in an interagency market surveillance group; and
- coordinating and approving market borrowing of federal agencies and government-sponsored enterprises.
Debt administration is conducted by the bureau of the public debt (BPD), which reports to the treasury. Specific functions of the BPD include
- borrowing the money necessary to operate the federal government and accounting for the resulting public debt;
- issuing, keeping records of, and redeeming government securities; servicing registered accounts; and paying interest when due;
- maintaining accounting and audit control over public debt transactions and publishing statements;
- processing claims for physical securities that are lost, stolen, or destroyed; and
- promoting the sale and retention of retail instruments, U.S. savings bonds.
Cash is managed by the financial management service (FMS), which also reports to the treasury. The FMS receives and disburses all public monies, maintains government accounts, and prepares daily and monthly reports on the status of government finances. The FMS is the government’s primary disbursing agent, collections agent, accountant and reporter of financial information, and collector of delinquent federal debt.
The FMS manages the collection of federal revenues, such as individual and corporate income tax deposits, customs duties, loan repayments, fines, and proceeds from leases, and maintains a network of about 18,000 financial institutions to collect these revenues. The FMS also oversees the federal government’s central accounting and reporting system, keeping track of its monetary assets and liabilities. The FMS works with federal agencies to help them adopt uniform accounting and reporting standards and systems.
In addition to the operating bureaus, the Federal Reserve Bank of New York acts as the treasury’ fiscal agent in carrying out debt management activities. Fiscal agency services performed include
- maintaining the treasury’s funds account,
- clearing treasury checks drawn on that account,
- conducting auctions of treasury securities,
- maintaining treasury’s securities electronic bookkeeping system, and
- issuing, servicing, and redeeming treasury securities.
The Federal Reserve System (the Fed) is an independent government entity. Debt policy and monetary policy are conducted independently. Although the treasury and the Fed have independent policies, the Fed acts as the treasury’s fiscal agent, carrying out various operational activities for the treasury, and senior staff meet weekly to discuss policy issues.
The relevant web sites for current information are
Debt Management Strategy and Risk Management Framework
The treasury’s debt management objective is to obtain the lowest possible cost of financing over time. In achieving this goal, the treasury’s debt management strategy is guided by five interrelated principles.
The first principle is maintaining the “risk-free” status of treasury securities. This is accomplished through prudent fiscal discipline and timely increases in the debt limit. Ready market access at the lowest cost to the government over time is an essential component of debt management.
The second principle is maintaining consistency and predictability in the financing program. The treasury issues securities on a regular schedule with set auction procedures. This reduces uncertainty in the market and helps minimize overall cost of borrowing. In keeping with this principle, the treasury does not seek to time markets, that is, it does not act opportunistically to issue debt when market conditions appear favorable.
The idea of regular and predictable auction schedules began in the 1970s. Starting in 1970, the federal government began financing generally increasing deficits, and most of the treasury’s debt management tools were well-suited for the task. New auction cycles were added, frequencies of issuance increased, and auction sizes rose over time. By the late 1970s, the magnitude of the treasury’s financing needs led to the introduction of a “regular and consistent” debt issuance schedule.
The third principle of debt management is the treasury’s commitment to ensuring market liquidity. Liquidity promotes efficient capital markets by providing an underlying security for a wide range of financial transactions and lowers borrowing costs for the treasury by increasing demand for its securities.
Fourth, the treasury finances across the yield curve. A balanced maturity structure mitigates refunding risks and appeals to the broadest range of investors. In addition, providing a pricing mechanism for interest rates across the yield curve further promotes efficient capital markets.
Fifth, the treasury employs unitary financing. The government’s financing needs are aggregated so that borrowing across agencies is conducted through the treasury. Thus, all programs of the federal government can benefit from the treasury’s low borrowing rate. Otherwise, separate programs with smaller, less liquid issues would compete with one another in the market. There are some exceptions to unitary financing, amounting to less than 1 percent of all public debt securities outstanding.
These principles frequently act as constraints on the treasury as it works to meet its objective. Regular issuance across the yield curve may occasionally lead to relatively high short-term borrowing costs—costs that we believe are more than offset by the premium investors are willing to pay for a predictable supply of treasury securities. The most significant constraint, however, is that the future can be seen only imperfectly and, therefore, the treasury constantly works to forecast our likely borrowing needs, anticipate how we should alter our borrowing pattern when the future does not fit our forecast, and anticipate what will prove to be the lowest-cost means of financing in the future.
The treasury’s long-term financing decisions are made quarterly after advice is solicited from the private sector through interviews with market participants and advice from a private sector advisory group. The group is composed of about 20 individuals who come from broker/dealer firms and investment firms and who are active participants in the government securities market. They meet at the time of each treasury midquarter refunding to advise the treasury on their recommendations for the current refunding operation and debt management policy matters. The group’s formal recommendations and the minutes of the group’s meetings are available on the Internet at http://www.treas.gov/domfin. The treasury also solicits advice from individuals through an e-mail address: firstname.lastname@example.org.
Financial liabilities are denominated only in local currency. Domestic currency liabilities are viewed as appropriate for the treasury’s balance sheet, given the very high proportion of its domestic currency assets. Aside from appropriate, a portfolio solely of domestic currency liabilities is feasible because of the large size of domestic financial markets that can readily absorb fluctuations in the treasury’s borrowing needs.
The treasury issues benchmark securities across a wide range of maturities to reduce refinancing risk. Expected borrowing needs are announced quarterly. Changes in schedules or amounts are announced with sufficient lead-time for price discovery and distribution to investors. Underlying this approach is the treasury’s large presence in the market, which means that policy changes are likely to lead to price changes.
Management of liability risk is concentrated on maintaining a stable average maturity through balanced issuance of short-, medium-, and long-term securities and ensuring high liquidity through a regular and predictable issuance of benchmark securities. The average length of privately held, marketable treasury debt at the end of 2001 was 5 years and 6 months, excluding inflation-indexed securities, and 5 years and 10 months, including inflation-indexed securities.
Borrowing programs are based on the fiscal and economic projections contained in the annual budget established by congress. The treasury uses the administration’s most recent projections of the federal government’s budget position as inputs in these models. New budget projections are made annually and published early in the calendar year. Projections are then revised five or six months later.
Based on the administration’s projections, the treasury creates long-term debt projections using internally developed models. These models are used to monitor rollover risk and ensure a relatively smooth maturity profile. Short-term debt issuance patterns are based on cash management projections that incorporate both the administration’s long-term forecasts and the most recent estimates of short-term expenditures and revenues.
The treasury ensures a high level of liquidity through a large, regular, and predictable issuance pattern. The Fed’s primary dealer system for debt issuance, which helps to ensure the success of treasury auctions, further reduces liquidity risk. The frequency and large scale of treasury operations helps to provide assurances that allow for frequent testing of settlement systems.
The treasury is responsible for the operation and management of the commercial book entry program, which includes the announcement, auction, issuance, and buyback of marketable treasury securities as well as regulating, servicing, and accounting for these securities. The Federal Reserve Bank of New York, working as the treasury’s fiscal agent, has the day-today responsibility for identifying, monitoring, and mitigating operational risk associated with the national book entry system, a safekeeping and transfer system for the treasury’s marketable securities. The identification and monitoring of risks associated with the announcement, auction, issuance, and buy-back of marketable treasury securities rests with the BPD. These risks are mitigated by contingency plans and associated with various points of failure throughout the automated systems required to perform these functions.
Operational risk is minimized through the delivery-versus-payment feature of the commercial book entry program and by separate agencies handling auctions and settlements. As an additional assurance, annual audits are conducted by the accounting agency of the legislative branch of government.
Recent policy changes
Because of recent budget surpluses, the treasury had been paying down its outstanding debt by issuing less debt than the amount of maturing debt, decreasing both its short- and long-term debt issuance. Paying down debt is inherently asymmetrical, with the pay-down occurring at the short end of the maturity spectrum, leading to an increase in average length.
The treasury instituted policies to help mitigate growth in the average length, including regular, smaller reopenings of longer-term debt and buybacks of outstanding long-term debt. Also, it recently suspended issuance of 30-year bonds. This decision was based, in part, on a need to reduce longer-term debt issuance. It also reflected market experience, which indicates that financing with 30-year bonds is expensive relative to 10-year financing.
Continuing economic sluggishness, reduced tax revenue, and the fiscal response to the tragic events of September 11 have led to an increase in the treasury’s near-term financing needs. These needs are expected to be temporary and largely met through increased treasury bill and shorter-term note issuance, which in turn has helped to decrease the average length of the privately held marketable debt.
The U.S. government’s holdings of financial assets (including foreign reserves) are small compared with its financial liabilities. Cash is largely held in commercial banks that are required to post substantial collateral. The Fed, as fiscal agent for and at the direction of the treasury, has primary operational responsibility for investment of cash in participating commercial banks. These responsibilities include accepting, valuing, safekeeping, monitoring for collateral deficiencies, and releasing collateral. The Fed is also the primary point of contact for the depositary financial institutions that participate in the program.
Cash management operations are reviewed and audited both internally and externally. Operations, including both the Fed and commercial banks participating in cash management, employ coordinated and comprehensive risk management procedures to ensure that processes and operations are available. Such management ensures that the objectives of the program are achieved and safeguarded.
The Government Securities Market
Debt management has evolved as the U.S. financial markets have become more sophisticated. As recently as World War II, retail instruments provided an important role in debt issuance. In the 1950s and 1960s, the dominant bond issuers were corporate rather than government. Regular issuance of all debt instruments did not occur until the 1970s. Rules on participation continue to evolve in response to changes in the number of treasury market participants and changes in technology.
The major increase in government debt issuance in the United States took place in financial markets that were already well developed. However, given that ready market access is essential to the government’s debt management program, the treasury does focus on how to broaden the market for its securities. Broad distribution of treasury securities enhances liquidity and efficiency of the market for government debt, while minimizing the impacts of government debt management activities on the economy and money markets and increasing the distribution of the benefits of government borrowing.
Because of the treasury market’s size, security, and demand by other investors, treasury securities represent the most liquid capital investment in the world. For investors looking for safety, predictability, and easy liquidity, treasury securities offer a range of benefits suited to those objectives.
The treasury issues fixed-rate nominal and inflation-indexed securities. They are direct obligations of the U.S. government and are known commonly as marketable securities because they can be bought and sold in the secondary market at prevailing market prices through financial institutions, brokers, and dealers in government securities. Except for a few specific issues of treasury bonds that were issued before 1985 that are callable, marketable treasury securities are not redeemable before maturity. All marketable treasury securities are issued only in book-entry form, with a minimum purchase amount of $1,000 and in multiples of $1,000. Since September 1998, customers who have established accounts with the treasury have been able to purchase securities via the Internet at the BPD’s web site (www.publicdebt.treas.gov).
The treasury currently offers fixed-rate nominal securities with maturities ranging from 4 weeks to 10 years on a regular basis. Bills with maturities of 4, 13, and 26 weeks are auctioned weekly, with Thursday settlement dates; 2-year notes are offered monthly for settlement at month-end; and 5- and 10-year notes are auctioned quarterly with midmonth settlement dates. This wide range of maturity dates allows an investor to structure a portfolio to specific time horizons.
In an effort to expand the types of securities it offers and broaden the base of direct investors in its securities auctions, the treasury began auctioning inflation-indexed securities in January 1997. These securities help to protect investors from inflation, and their auctions have had broader direct participation relative to treasury fixed-rate nominal security auctions by appealing to investors that have not previously invested in treasury securities and encouraging other portfolios to invest more. This increased participation should help to lower overall financing costs. The treasury also issues a retail inflation-indexed savings bond.
The treasury initially offered 5- and 10-year inflation-indexed notes and 30-year inflation-indexed bonds, but market interest has largely focused on the 10-year note, so 5-year inflation-indexed notes were last issued in October 1997 and 30-year inflation-indexed bonds were suspended in October 2001. The principal of the security is adjusted daily for inflation. The inflation adjustment is subject to federal income tax in the year it is earned, and the inflation-adjusted principal is paid at maturity. Semiannual interest payments are a fixed percentage of the inflation-adjusted principal. The security uses the nonseasonally adjusted consumer price index for all urban consumers as the inflation index. The treasury currently offers the 10-year inflation-indexed note on a regular, semiannual schedule.
Before the early 1970s, the traditional methods for selling notes and bonds were subscription offerings, exchange offerings, and advance refundings. Subscriptions involved the treasury setting an interest rate on the securities to be sold and then selling (or taking subscriptions for) them at a fixed price. In exchange offerings, the treasury allowed holders of outstanding maturing securities to exchange them for new issues at an announced price and coupon rate. In some cases, new securities were issued only to holders of the specific maturing securities; in others, additional amounts of the new security were issued. Advance refundings differed from exchange offerings in that the outstanding securities could be exchanged before their maturity date.
A fundamental difficulty with fixed-price subscription and exchange offerings was that market yields could change between the announcement of the offering and the deadline for subscriptions. Increased market volatility in the 1970s made fixed-price offerings very risky for the treasury.
A modified auction technique was introduced in 1970, in which the treasury preset the interest rate (coupon rate) and bids were made on the basis of price. The treasury started to auction coupon issues on a yield basis in 1974. Bids were accepted on the basis of an annual percentage yield, with the coupon rate based on the weighted-average yield of accepted competitive tenders received in the auction. Yield auctions free the treasury from having to set the coupon rate before the auction and ensure that the interest costs of new note and bond issues accurately reflect actual market demand and supply conditions at the time of the auction.
Today, all marketable treasury securities are sold in uniform-price auctions, and all treasury auctions are conducted on a yield basis. The terms and conditions for offerings of treasury securities are governed by the terms and conditions set forth in the “Uniform Offering Circular for the Sale and Issue of Marketable Book-Entry Treasury Bills, Notes, and Bonds” (in the United States Code of Federal Regulations, available at www.publicdebt.treas.gov/gsr/gsruocam.htm). A separate announcement is made for each auction, providing the dates of the auction and settlement, the amount offered for sale, the maturity of the security, and other details. The treasury sells the entire announced amount of each security offered at the yield determined in the auction.
The treasury permits trading during the period between announcement and settlement on a when-issued basis that provides for price discovery and reduces uncertainties surrounding auction pricing. Potential competitive bidders look to when-issued trading levels as a market gauge of demand to determine how to bid at an auction. Noncompetitive bidders, to whom securities are awarded at the auction-determined yield, can use the quotes in the when-issued market to assess the likely auction yield.
Until late 1998, the method for selling marketable treasury securities generally had been multiple-price auctions. In a multiple-price auction, competitive bids were accepted from the lowest yield (discount rates in the case of treasury bills) to the highest yield required to sell the amount offered to the public. Competitive bidders whose tenders were accepted paid the price equivalent to the yield (or discount rate) that they bid. Noncompetitive bidders paid the weighted-average price of accepted competitive bids.
The treasury adopted the use of single-price auctions for all marketable treasury securities in November 1998. All auctions of inflation-indexed notes and bonds have been on a single-price basis since the Treasury began selling inflation-indexed securities. As with multiple-price auctions, single-price auctions are conducted in terms of yield (bank discount rate in the case of treasury bills). Bids are accepted from the lowest yield (or discount rate) to the highest required to sell the amount offered. In contrast to multiple-price auctions, all awards are at the highest yield (or discount rate) of accepted bids.
The treasury has found that single-price auctions have some advantages over multiple-price auctions. First, they tend to distribute auction awards to a greater number of bidders than multiple-price auctions. Second, auction participants may bid more aggressively in single-price auctions. Successful bidders are able to reduce the so-called winner’s curse, the risk that a successful bidder will pay more than the common market value of the security and, therefore, will be less likely to realize a profit from selling it. There is evidence that more aggressive bidding has lowered treasury borrowing costs somewhat.
Any entity may submit a bid in a treasury auction directly to a federal reserve bank, which acts as the treasury’s fiscal agent, indirectly through a dealer, or directly to the treasury department. The treasury permits all dealers registered with the Securities and Exchange Commission and all federally regulated financial institutions to submit bids in treasury auctions for their own accounts and for the account of customers. All bidders in treasury auctions—not just primary dealers and financial institutions—may bid in treasury auctions without a deposit, provided the bidder has a payment mechanism in place (an “autocharge agreement”) with its federal reserve bank.
Primary dealers are firms through which the Federal Reserve Bank of New York conducts its open market operations. They include large diversified securities firms, money center banks, and specialized securities firms, and they are foreign owned and U.S. owned. Over the last decade, the number of primary dealers has declined from 46 to 22. Among their responsibilities, primary dealers are expected to participate meaningfully in treasury auctions, make reasonably good markets in their trading relationships with the Federal Reserve Bank of New York’s trading desk, and supply market information to the Fed. Formerly, primary dealers were also required to transact a certain level of trading volume with customers and thereby maintain a liquid secondary market for treasury securities. Customers include nonprimary dealers, other financial institutions (such as banks, insurance companies, pension funds, and mutual funds), nonfinancial institutions, and individuals. Although trading with customers is no longer a requirement, primary dealers remain the predominant market makers in U.S. Treasury securities.
The treasury has facilitated purchases of treasury securities by small investors by awarding securities on a noncompetitive basis for up to $5 million through a book-entry system. Through this system, the investor holds treasury securities directly on the books of the treasury, without using the services of a financial institution or a dealer.
The case study was prepared by the Office of Market Finance of the U.S. Treasury.