[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
U.S. DEPARTMENT OF THE TREASURY'S DEBT BUYBACK PROPOSAL
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 29, 1999
__________
Serial 106-74
__________
Printed for the use of the Committee on Ways and Means
_______________________________________________________________________
For sale by the U.S. Government Printing Office,
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
__________
U.S. GOVERNMENT PRINTING OFFICE
66-896 WASHINGTON : 2000
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of September 22, 1999, announcing the hearing........... 2
WITNESSES
U.S. Department of the Treasury, Hon. Lee Sachs, Assistant
Secretary, Financial Markets................................... 6
U.S. General Accounting Office, Paul L. Posner, Director, Budget
Issues, Accounting and Information Management Division,
accompanied by Tom McCool, Director, Financial Institutions and
Market Issues, and Carolyn Litsinger, Head of Work on Federal
Debt........................................................... 24
______
American Enterprise Institute, John H. Makin, Ph.D............... 38
Bond Market Association, and Salomon Smith Barney, Charles M.
Parkhurst...................................................... 42
U.S. DEPARTMENT OF THE TREASURY'S DEBT BUYBACK PROPOSAL
----------
WEDNESDAY, SEPTEMBER 29, 1999
House of Representatives,
Committee on Ways and Means,
Washington, D.C.
The committee met, pursuant to call, at 10 a.m., in room
1100, Longworth House Office Building, Hon. Bill Archer
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
September 22, 1999
No. FC-13
Archer Announces Hearing on
Treasury's Debt Buyback Proposal
Congressman Bill Archer (R-TX), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
U.S. Department of the Treasury's debt buyback proposal. The hearing
will take place on Wednesday, September 29, 1999, in the main Committee
hearing room, 1100 Longworth House Office Building, beginning at 10:00
a.m.
Oral testimony at this hearing will be from invited witnesses only.
Witnesses will include representatives of the U.S. Department of the
Treasury, the U.S. General Accounting Office, and other experts in debt
management. However, any individual or organization not scheduled for
an oral appearance may submit a written statement for consideration by
the Committee and for inclusion in the printed record of the hearing.
BACKGROUND:
Article I, Section 8 of the Constitution gives Congress the power
``to borrow money on the credit of the United States.'' Congress has,
therefore, historically been concerned about the level of public debt
and the cost to the taxpayer. Originally, Congress approved each
Government debt issue. In more recent times, through the statutory
limit on the public debt (31 U.S.C. 3101) specified levels of overall
debt were authorized, and adjusted when necessary. Congressional
oversight of Treasury's debt management policies is essential to ensure
the lowest cost of borrowing to the taxpayer given the large scope of
public borrowings.
The Congressional Budget Office and the Office of Management and
Budget have both forecast sizeable budget surpluses over the next 15
years. Fiscal year 1998 surpluses already have reduced the Government's
borrowing needs, causing Treasury to adjust its debt management
policies. Last year, Treasury suspended auctions of 3-year notes and
reduced the frequency of 5-year note sales.
As large surpluses continue to reduce the Government's borrowing
needs, Treasury must consider how its policies will affect taxpayer
costs and capital market efficiency. Consequently, Treasury is
exploring new debt management polices. On August 4, 1999, Treasury
announced regulations (31 CFR Part 375) to allow Treasury to buy back
outstanding debt before it matures. In essence, Treasury would buy back
old debt and re-issue new debt in its place. Such a policy would not
reduce the level of debt, but it may help Treasury achieve other goals,
such as improving liquidity and achieving targeted cash balances. A
debt buyback program would increase short-term costs, but should
generate long-term budgetary savings.
In announcing the hearing, Chairman Archer stated: ``With large and
growing budget surpluses projected over the next 15 years, we have an
historic opportunity to reduce our national debt. As the Administration
explores adjustments to its debt management policies, including a new
proposal to buy back outstanding debt, the Congress needs to remain
engaged in decisions regarding the level of debt and its costs to the
taxpayer, as well as the growing debate concerning the efficiency of
global and domestic capital markets. Our goal should be to reduce
significantly the national debt at the least cost to the taxpayer.''
FOCUS OF THE HEARING:
The hearing explores the potential costs and benefits of Treasury's
debt buyback proposal and the effect such a proposal would have on the
budget. In addition, the hearing will examine Treasury's debt
management goals and the policy issues posed by growing surpluses.
Finally, the hearing will review the economic and budgetary effects of
Treasury's debt management policies.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch
diskette in WordPerfect 5.1 format, with their name, address, and
hearing date noted on a label, by the close of business, Wednesday,
October 13, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways
and Means, U.S. House of Representatives, Room 1102 Longworth House
Office Building, Washington, D.C. 20515. If those filing written
statements wish to have their statements distributed to the press and
interested public at the hearing, they may deliver 200 additional
copies for this purpose to the Committee office, Room 1102 Longworth
House Office Building, by close of business the day before the hearing.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. All statements and any accompanying exhibits for printing must
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1
format, typed in single space and may not exceed a total of 10 pages
including attachments. Witnesses are advised that the Committee will
rely on electronic submissions for printing the official hearing
record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the
name, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. This supplemental sheet
will not be included in the printed record.
The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press
and the public during the course of a public hearing may be submitted
in other forms.
Note: All Committee advisories and news releases are available on
the World Wide Web at `HTTP://WWW.HOUSE.GOV/WAYS__MEANS/'.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
Chairman Archer. The Committee will come to order.
For the first time in over 40 years, the Federal budget
will record back-to-back surpluses. These surpluses have
allowed us to pay down the debt by $51 billion last year, and
it is now projected that we will pay down the debt by over $100
billion this year. This is truly a historic achievement that
many of us, even as recently as 2 or 3 or 4 years ago, would
not have believed to be possible.
The prospect of large and growing budget surpluses in the
future has created a new challenge for the Treasury Department
in how the national debt is managed. In August Treasury
proposed a new direction for debt management practices. This
option would allow Treasury to buy back debt from the public
before it matures. That also would have been unthinkable even a
few years ago.
As I understand the proposal, Treasury would, in essence,
buy back old debt and re-issue new debt in its place. Such a
policy would not reduce the level of debt, but it may help
Treasury achieve other goals, such as improving liquidity and
achieving targeted cash balances. Clearly any change in
Treasury's debt management policy could have far-reaching
implications for consumers, financial markets, and the economy,
and that is why we are conducting this hearing today.
How much will this plan cost in the short and the long
term? What will be the impact on the taxpayer? How will the
budget surplus be affected? What impact will this have on the
markets? And what lessons have other countries learned when
faced with a similar challenge? I hope to hear from our
witnesses on these and other questions.
In closing, let me say I am proud that we find ourselves in
this situation. The Treasury proposal to change debt policy is
further proof that there is indeed a budget surplus in
Washington, and that we have already paid down billions of
dollars in debt. That is, in itself, a tremendous
accomplishment that few people ever thought possible only a few
years ago.
I now will recognize Mr. Rangel for any comments he would
like to make on behalf of the minority, and without objection,
each member will be able to insert their written statements in
the record at this point.
Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman. I want to join with
you in welcoming the new Treasury Assistant Secretary Lee
Sachs. We congratulate you collectively for your confirmation.
It is good news, as the chairman said, that we come to
discuss a new challenge in debt management that arises out of
fundamental good news, the fact that the Federal Government has
started to run unified budget surpluses, and as a result, we
can begin to start to retire Federal debt held by the public.
As recently as 1992, the unified deficit was $290 billion. This
year the unified budget is likely to have a surplus of about
$115 billion. This has been great for the economy, and it also
means that we are starting to put resources into the bank for
future generations rather than running up balances on the
national credit card. It means that we have a historic
opportunity to fix the Social Security and fix Medicare and to
do it while the sun is shining.
A great deal of this progress has been due to the
leadership of President Clinton and Vice President Gore and the
very tough votes provided in 1993 by Democrats alone, without
the assistance of anyone from the other side. We voted for this
historic deficit reduction package and today we are seeing the
benefit of such courage.
The Treasury now proposes to buy back outstanding debt.
This may be a new technique because I understand that the
Treasury needs this tool to carry out the kind of debt
management that Treasury has done in the past. When there were
deficits, Treasury could manage this mix between long- and
short-term Treasury securities by choosing the kind of
securities to sell. However, now that there are surpluses, the
debt makes this change by the arbitrary nature by which
outstanding securities happen to mature; by buying back the
actual activity, Treasury can manage their debt mix again.
This is an opportunity for Members of Congress to hear from
witnesses who I hope will keep us focused on the fundamentals
and steer us away from the misunderstandings that might arise
from the complex technicalities of budget accounting and debt
management. We hope that Congress will continue to protect
these newly found surpluses so that you will be able to use the
new techniques in managing debt.
Thank you for being here.
And thank you, Mr. Chairman.
Chairman Archer. Thank you, Mr. Rangel.
[The opening statement of Mr. Ramstad follows:]
Statement of Hon. Jim Ramstad, a Representative in Congress from the
State of Minnesota
Mr. Chairman, thank you for convening this important
hearing to examine the Department of the Treasury's proposal to
redeem outstanding, unmatured Treasury securities.
Let me begin by noting what a pleasure it is to be
discussing this issue. It wasn't that long ago when growing
deficits and exploding debt were the norm. Due to a concerted
effort at fiscal responsibility, we are moving in a new
direction in which growing surpluses are now expected.
Just last year the budget surplus was $69 billion. This
week, the President estimated the surplus will be $115 billion
in fiscal year 1999. Over the next 10 years, the news gets even
better. In fact, the Congressional Budget Office projects that
over the next decade, there will be a decline in publicly-held
debt to $865 billion, from the current $3.3 trillion.
I'm under no illusion that this will be easily
accomplished. It will take a strong effort to maintain this
fiscal course. But I think we all agree that the era of
deficits is over.
This new path does present some difficult economic issues
and today we will explore one of them: redeeming federal debt.
In response to the growing surpluses, the Treasury has already
stopped issuing three-year notes and the monthly auctions of
five-year notes have been reduced to quarterly auctions.
In August, Treasury issued a proposed regulation to begin
redeeming unmatured Treasury securities. In theory, this
proposal will improve the flexibility and liquidity of the
federal government and promises to keep borrowing costs down.
But these benefits will come at a direct cost to the Treasury.
In other words, this proposal presents a short-term cost to
the bottom line of the federal government with the promise of a
long-term benefit.
I am anxious to hear from the witnesses today just how much
this will cost in the short term and if there are any
quantifiable long-term benefits.
Again, Mr. Chairman, thank you for providing us this forum
to explore the Administration's proposals in detail.
Secretary Sachs, we are pleased to have you here on what is
in effect your maiden voyage before this Committee. We welcome
you, and we will be pleased to hear your testimony. We hope
that you can keep your verbal testimony to 5 minutes, and your
entire printed statement would then, without objection, be
printed in the record.
Welcome and you may proceed
STATEMENT OF LEE SACHS, ASSISTANT SECRETARY FOR FINANCIAL
MARKETS, U.S. DEPARTMENT OF THE TREASURY
Mr. Sachs. Thank you, Mr. Chairman, Mr. Rangel,
distinguished Members of the Committee. It is an honor to be
here today to discuss Treasury debt management and our proposal
to create a mechanism to repurchase outstanding Treasury
securities prior to maturity.
Mr. Chairman, I would like to thank you personally and
other Members of this Committee for the leadership you have
shown on debt management issues. Your role in this area has
been extremely helpful to the Department in exercising its debt
management responsibilities in a fiscally prudent and
nonpartisan manner.
The fiscal discipline of recent years has helped to foster
a strong U.S. economy and has led to our first back-to-back
budget surpluses since 1956 and 1957. We expect this quarter to
pay down $16 billion in privately-held marketable debt,
bringing the total reduction to an estimated $100 billion by
the end of this fiscal year, and $210 billion for the past 2
years.
Reducing the supply of Treasury debt held by the public has
enormous benefits for our economy. It means that less of the
savings of Americans will flow into government bonds and more
will flow into investment in American businesses. It means less
reliance on borrowings from abroad to finance American
investment. It means less pressure on interest rates and, thus,
lower relative borrowing costs for businesses and American
families.
While reducing the debt held by the public greatly benefits
the economy, it brings with it significant challenges. As a
result of the reductions in publicly-held debt, the ongoing
task of debt management for the Federal Government will be very
different in the years ahead than it has been in the past when
debt was rapidly increasing.
Treasury debt management has three main goals: First, to
provide sound cash management in order to ensure that adequate
cash balances are available at all times; second, to achieve
the lowest cost financing to the American taxpayer; and third,
to promote efficient capital markets.
In our efforts to achieve these goals, we seek to maintain,
No. 1, the risk-free status of Treasury securities; No. 2,
consistency and predictability in our financing programs; No.
3, deep and liquid markets; and No. 4, a balanced maturity
structure.
The financing tools that Treasury has had at its disposal
in the past to achieve the goals and promote the principles I
just described have included primarily the ability to determine
the issue sizes, offering schedules, and types of securities
offered.
Using these tools, Treasury has paid down debt by refunding
our regularly maturing debt with smaller amounts of new debt.
Repurchase of outstanding debt prior to maturity would
represent another tool that would provide us with greater
flexibility in meeting our debt management goals and would be
consistent with the principles we have followed in meeting
those goals. While we have made no decisions as to whether we
will, in fact, conduct debt buybacks, publication of the
proposed rule for public comment is the first step to making
debt buybacks an actual debt management tool for the Treasury.
These buybacks would have a number of potential benefits.
First, buybacks can enhance market liquidity by allowing us to
maintain regular issuance of new benchmark securities across
the maturity spectrum. This enhanced liquidity should reduce
the Government's interest expense and promote efficient capital
markets. Second, by paying off debt that has substantial
remaining maturity, we would be able to prevent what could
otherwise be a potentially costly and unjustified increase in
the average maturity of our debt. Third, buybacks 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.
Among the issues which must be given careful consideration
in the coming months is the budgetary treatment of proposed
buybacks. As most older Treasury securities were issued in
higher interest rate environments, repurchasing such debt in
the near term would most likely require payment of a premium.
Current budget practice would require that any premium paid by
the Treasury to buy back debt would be treated as interest
expense at the time of the buyback while future savings would
be accounted for in future fiscal years. The future savings, in
reality, would offset the up front expense paid in the form of
the premium. In other words, the up front budget impact would
merely reflect a difference in the timing of immediate outlays
and future savings.
Although we cannot ignore this issue, we must do our utmost
to ensure that budgetary treatment issues do not affect the
efficient management of our Nation's debt. It is important to
maintain both the integrity of our budget practices and our
debt management. We must ensure that everyone understands that
both our budget treatment and debt management principles will
be upheld and their integrity maintained.
Having a mechanism in place through which Treasury can
conduct debt buybacks is simply good policy. Debt buybacks can
help fulfill our core debt management goals by improving our
cash management capabilities, offering potential taxpayer
savings, and promoting efficiency in capital markets through
enhanced liquidity.
Mr. Chairman, as you stated in your announcement of these
hearings, our goal should be to reduce significantly the
national debt at the least cost to the taxpayer. This proposal
is an effort to ensure that this Treasury Department and future
Treasury Departments have another important tool in place with
which to achieve that objective.
We look forward to continuing to work with this Committee
and others to continue to advance these goals.
That concludes my opening remarks. I would be happy to take
any questions.
[The prepared statement follows:]
Statement of Hon. Lee Sachs, Assistant Secretary for Financial Markets,
U.S. Department of the Treasury
Mr. Chairman, Ranking Member Rangel, and distinguished
members of the committee, it is an honor to be here today to
discuss Treasury debt management and our proposal to create a
mechanism to repurchase outstanding Treasury securities prior
to maturity.
Mr. Chairman, I want to thank you personally and other
members for the leadership this committee has shown on debt
management issues. Your role in this area has been extremely
helpful to the Department in exercising its debt management
responsibilities in a fiscally prudent and non-partisan manner.
The fiscal discipline of recent years has helped to foster
a strong U.S. economy and has led to our first back-to-back
budget surpluses since 1956 and 1957. We expect this quarter to
pay down $16 billion in privately-held marketable debt,
bringing the total reduction to an estimated $100 billion by
the end of FY 1999.
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 publicly-held debt
outstanding now stands at $3.6 trillion, more than $1.7
trillion lower than it otherwise would have been. As a result,
Treasury debt is taking up an ever smaller share of the capital
markets. In 1992, Treasury marketable securities represented 32
percent, or just under a third, of the U.S. debt markets. They
now represent only 23 percent of the U.S. debt markets.
Moreover, Treasury's share of the gross new issuance of long-
term debt has been reduced by more than half. While we still
have to issue debt to refund maturing securities, last year
that Treasury debt issuance represented only 18 percent of new
long-term debt issued in the United States, down from 40
percent in 1990.
Reducing the supply of Treasury debt held by the public has
enormous benefits for our economy.
It means that less of the savings of Americans
will flow into government bonds and more will flow into
investment in American businesses.
It means less reliance on borrowings from abroad
to finance American investment.
It means less pressure on interest rates and thus
lower relative borrowing costs for businesses and American
families.
While reducing the debt held by the public greatly benefits
the economy, it brings with it significant challenges. As a
result of the reductions in publicly-held debt, the ongoing
task of debt management for the Federal government will be very
different in the years ahead than it has been in the past when
debt was rapidly increasing.
Debt Management Goals and Principles
Before discussing our debt buy-back proposal in detail, I'd
like to briefly review the goals and principles of Treasury's
debt management program, which provide the background and
context for the debt buy-back proposal. These goals and
principles were outlined in greater detail for this panel last
year when my predecessor, now Under Secretary Gensler spoke to
you about debt management more broadly.
Treasury debt management has three main goals: (1) to
provide sound cash management in order to ensure that adequate
cash balances are available at all times; (2) to achieve the
lowest cost financing for the taxpayers, and (3) to promote
efficient capital markets.
In achieving these goals, we are guided by five
interrelated principles:
First, maintenance of the ``risk-free'' status of Treasury
securities to assure ready-market access and lowest cost
financing.
Second, consistency and predictability in our financing
program. Keeping to a regular schedule of issuance with set
auction procedures reduces uncertainty in the market and helps
minimize our overall cost of borrowing.
Third, maintenance of market liquidity, both to promote
efficient capital markets and lower Treasury borrowing costs.
Fourth, financing across the yield curve. A balanced
maturity structure enables us to appeal to the broadest range
of investors and mitigates refunding risks. Providing a pricing
mechanism for interest rates across the yield curve also
further promotes efficient capital markets.
Fifth, unitary financing. We aggregate the financing needs
for all programs of the Federal Government and borrow as one
nation. This ensures that all programs of the Federal
government benefit from Treasury's low borrowing rate.
The financing tools that Treasury has had at its disposal
in the past to achieve the goals and promote the principles
described have included primarily the ability to determine the
issue sizes, offering schedules and types of securities
offered. Using these tools, Treasury has paid down debt by
refunding our regularly maturing debt with smaller amounts of
new debt. To do this, we have reduced the size of our regular
Treasury bill auctions, reduced the frequency of issuance of 5-
year notes, and discontinued issuance of 3-year notes. At our
last quarterly refunding announcement, we announced a reduction
in the frequency of issuance of our thirty-year bonds. Aside
from allowing us to maintain the size of our benchmark issues,
this reduction also will help to keep the average maturity of
our debt from lengthening further.
Proposed Debt Buy-Back Rules
Repurchase of outstanding debt prior to maturity would
represent another tool that could provide us with greater
flexibility in meeting our debt management goals and would be
consistent with the principles we have followed in meeting
those goals. While we have made no decisions as to whether we
will, in fact, conduct debt buy-backs, publication of the
proposed rule for public comment is the first step to making
debt buy-backs an actual debt management tool for Treasury. We
hope to have final regulations in place during the first
quarter of 2000.
The process proposed for the debt buy-back program is
fairly straightforward. Treasury would issue a press release,
which would include the eligible securities and the total
amount of the buy-back. Treasury would have the right to buy
back less than the amount announced. Offers would be submitted
through primary dealers. This limitation will enable us to make
use of the Federal Reserve Bank of New York's open market
facility. Other holders of eligible securities could
participate through offers submitted to a primary dealer. The
proposed rules call for a ``reverse auction''--a multiple price
process in which successful offerors receive the price at which
they offered securities. Following the completion of the
auction, Treasury would issue a press release providing for
each security the amounts offered and accepted, the highest
price accepted, and the remaining privately-held amounts
outstanding. FRB New York will transmit results messages to
primary dealers informing them of the acceptance of the offers
they submitted.
Benefits of Buybacks
We believe that buybacks would have a number of potential
benefits as a debt management tool:
First, buy-backs could enhance market liquidity by
allowing us to maintain regular issuance of new ``benchmark''
securities across the maturity spectrum, in greater volume than
would otherwise be possible. This enhanced liquidity should
reduce the government's interest expense and promote more
efficient capital markets.
Second, by paying off debt that has substantial
remaining maturity, we would be able to prevent what could
otherwise be a potentially costly and unjustified increase in
the average maturity of our debt: from just over five years to
more than seven years on the current trajectory.
Third, 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.
In addition, although it is not a primary reason for
conducting buy-backs, we may occasionally be able to reduce the
government's interest expense by purchasing older, ``off-the-
run'' debt and replacing it with lower-yield ``on-the-run''
debt. A Treasury security is referred to as being ``on-the-
run'' when it is the newest security issue of its maturity. An
on-the-run security normally is the most liquid issue for that
maturity and therefore generally trades at lower yields than
off-the-run debt. Because an off-the-run security generally
does not have the same liquidity as an on-the-run issue, it may
trade at higher yields, and thus lower prices, than on-the-run
securities. Treasury may be able to capture part of the yield
differential and thus reduce the government's interest costs by
purchasing and retiring older debt and replacing it with lower
yielding on-the-run debt.
Before I came to the Treasury Department, I spent thirteen
years at a major investment bank. I frequently advised major
corporations on their debt management policies. Debt buybacks
and exchanges are common debt management tools used by some of
the most sophisticated corporations in the private sector.
Similarly, other countries experiencing budget surpluses have
explored and/or implemented buyback programs to attempt to
maximize the budgetary benefits of such surpluses. Even in the
United States, the repurchase of outstanding securities that
have not matured is not without precedent. Treasury conducted
several debt exchanges or advance refundings between 1960 and
1966, and again in 1972 under which new issues were exchanged
for outstanding, unmatured debt. In addition, the Treasury's
Borrowing Advisory Committee has unanimously recommended the
use of debt buy-backs as a debt management tool in the future.
Budgetary Impact
Let me now turn to the budgetary treatment of proposed
buybacks. As most older Treasury securities were issued in a
higher interest rate environment, repurchasing such debt in the
near term would most likely require payment of a premium, which
means that we would have to pay more than the face value of the
bonds. Current budget treatment would require that any premium
paid by the Treasury to buy back debt would be treated as
interest expense at the time of the buyback. It would account
for a future savings in interest expense in future fiscal
years. The future savings, in reality, would offset the up-
front expense paid in the form of the premium. In other words,
the up-front budget impact would merely reflect a difference in
the timing of immediate outlays and future savings. We also
must recognize that not all securities trade at a premium.
There are also securities, albeit a minority in today's
environment, that trade at a discount to their face value. If
buybacks were to involve such securities, the discount would
lower interest outlays in the period during which the buyback
occurred. Again, this would reflect a difference in the timing
of cash flows.
Although we cannot ignore this issue, we must do our utmost
to ensure that budgetary treatment issues do not affect the
efficient management of our nation's debt. It is important to
maintain both the integrity of our budget practices and the
integrity of our debt management. We must ensure that everyone
understands that both our budget treatment and debt management
principles will be upheld, and their integrity maintained.
Efficient debt management is consistent with the best long-run
budget outcomes.
Having a mechanism in place through which Treasury can
conduct debt buybacks is simply good policy. Debt buybacks can
help fulfill our core debt management goals--by improving our
cash management capabilities, offering potential taxpayer
savings, and promoting efficiency in capital markets through
enhanced liquidity.
Mr. Chairman, as you stated in your announcement of these
hearings, ``our goal should be to reduce significantly the
national debt at the least cost to the taxpayer.'' This
proposal is an effort to ensure that this Treasury Department
and future Treasury Departments have another important tool in
place with which to achieve that goal. We look forward to
continuing to work with this committee and others to continue
to advance these goals. I will be happy to answer any questions
you may have.
Thank you.
Chairman Archer. Thank you, Secretary Sachs.
It might be helpful to the Members of the Committee if you
could explain to us specifically what happens with the surplus
in the event that there are no maturing bonds that will absorb
those extra dollars. And I am talking now on a week-to-week,
month-to-month basis. What happens, in practice, to the dollars
that are received by the Treasury in excess of the bonds that
are maturing and in excess of the bills you have to pay? What
happens to that extra cash money when you have no maturing
bonds to pay off?
Mr. Sachs. Mr. Chairman, we do have bonds that mature every
week just by the nature of our maturity schedule. We issue new
Treasury bills weekly and therefore they mature weekly so we
will always have that. When dollars--when receipts come in,
some of the money does go to pay those maturities. The excess
cash that doesn't go to do that or is not spent can go into one
of two places. Some of it will go into Treasury's account at
the Federal Reserve, and the balance of it will go into the
TT&L accounts which are essentially accounts at various
commercial banks throughout the country.
Chairman Archer. Are there any limitations as to how much
of that excess cash can be put in either one of those
depositories?
Mr. Sachs. Practically yes. The capacity of TT&L accounts
tends to be--although it is not an absolute ceiling--around $60
billion. There is not necessarily a cap on what we could put
with the Federal Reserve, but the more we put there, the more
it affects their open market operations.
Chairman Archer. And what interest does the Treasury
receive on the funds that are put with the Federal Reserve?
Mr. Sachs. I am sorry?
Chairman Archer. What interest rate does the Treasury
receive on the funds that are placed with the Federal Reserve?
Mr. Sachs. I believe it is the overnight repo rate; it is a
market-determined interest rate.
Chairman Archer. What interest does the Treasury receive
from the depository banks?
Mr. Sachs. It is the Federal funds rate less 25 basis
points.
Chairman Archer. And how are those banks chosen?
Mr. Sachs. I believe there is a list of banks that has been
in place for some time. It includes the top-tier quality banks
in this system. That is a list that has been around for quite
some time. I don't think we have changed that in a while.
Chairman Archer. How is that list determined?
Mr. Sachs. Mr. Chairman, I am not sure of the history of
how that list got put together. I know that on the list are
some of the largest, most credit worthy banks in the system.
Chairman Archer. Within that list, how is the decision made
as to which of the banks get what amount of money?
Mr. Sachs. We try and spread it as evenly as we can.
Chairman Archer. The amounts would clearly be in excess of
the FDIC guarantees, insurance guarantees. Is that a wise thing
to do to have the taxpayers' money in large chunks in bank
deposits, private banks across the country?
Mr. Sachs. These deposits are collateralized.
Chairman Archer. In what way are they collateralized?
Mr. Sachs. The banks in which we would deposit these funds
put up securities as collateral to support the credit
worthiness of those deposits.
Chairman Archer. I appreciate your taking us through that
just so we have a basic understanding.
Clearly, it would be better if we could find a way that
that money can be used to pay down the debt rather than to
simply sit in a bank account; and I think that is probably one
of the aspects of your suggestion relative to buying debt that
has not yet matured.
Do you need a change in law to be able to do that?
Mr. Sachs. To buy back debt?
Chairman Archer. Buy debt that has not matured?
Mr. Sachs. No, sir. The Treasury currently has authority to
enter into debt buybacks.
Chairman Archer. And when do you propose to initiate this
process after you have had public response to your suggestions?
Mr. Sachs. Mr. Chairman, as you know, we are coming up
toward the end of the comment period. We released the proposed
rule at the beginning of August. The 60-day comment period ends
next week on October 4. We will take the next several months to
go through any comments that come in, formulate the final rule,
and we hope to have it in place sometime in January.
As to when we might enter into actual debt buybacks, we
haven't made any decisions on that yet. I would expect it would
be--might be earliest, in the first quarter of next year.
Chairman Archer. Do you have a time period in advance that
you would want to issue public notice of your intention to do
that prior to the starting date?
Mr. Sachs. We have been talking about that. We don't have a
specific time period in mind yet. It is something on which we
have invited public comment. We will be interested to see what
the public has to say about that.
Chairman Archer. Do you have a projection of how much added
interest charges would occur in the first year after you began
this operation? You commented that the premium that you would
have to pay, and you would have to pay a premium for the higher
interest bonds which would be the ones you would want to
retire, would that premium be charged as an interest expense in
the year of the purchase?
Mr. Sachs. Correct.
Chairman Archer. How much extra interest expense would
occur in the first year?
Mr. Sachs. Again, Mr. Chairman, it is hard----
Chairman Archer. I know it would depend on how much you
bought, and et cetera, but what are your projections as to what
the increased interest expense might be in the first year?
Mr. Sachs. Honestly, we don't have projections at this
time. The amounts that we might purchase will, in part, depend
on what the surplus looks like at that time and what the
markets look like at that time. It would be very difficult to--
unfortunately, it is very difficult to answer that question
this far in advance.
Chairman Archer. For how many years would there be added
interest expense before you began to witness savings that would
offset the interest expense?
Mr. Sachs. The savings would begin to occur really as soon
as you----
Chairman Archer. I understand, but certainly in the first
year the added interest expense would exceed whatever savings
you would have.
How long would it take before the aggregate savings would
equal the added expense?
Mr. Sachs. That would depend on what bonds we purchased and
how big the premiums would be. If we were to buy some shorter
term bonds with lower coupons, the premium would be lower, but
it would also take longer for the savings to accrue.
Chairman Archer. Have you attempted to run this through
your computer model to get some sort of feeling about what
might be an average projection?
Mr. Sachs. No, sir. I can tell you this. We have looked at
what the average dollar prices are of our bonds, but without
knowing how much we would purchase or specifically which ones
we would purchase, it is really hard to answer this question.
Chairman Archer. Thank you very much.
Mr. Rangel.
Mr. Rangel. Thank you, Mr. Chairman.
I gather from your response to the chairman that you don't
need any congressional authority to do the things that you are
suggesting you want to do.
Mr. Sachs. That is correct.
Mr. Rangel. And you are like an investment banker for the
Federal Government that you look at the interest rates that we
are paying and purchase back before maturity certain bonds with
the idea that you are going to get a better deal in buying
debt. Therefore, the ultimate goal is to reduce the debt, and
ultimately we will be reducing interest payments overall that
our government has; is that correct?
Mr. Sachs. Yes, sir.
Mr. Rangel. Right now, you just don't know the mix because
you don't know the market and just what bonds you will be
buying and where will you be reinvesting?
Mr. Sachs. Correct.
Mr. Rangel. But what the chairman was trying to say is that
we, of course, who look for short-term answers would want to
know that as a result of you doing the best that you can for
our government and the marketplace, just how well are we doing?
Just how much debt actually is being reduced? Just how much
interest is it that we don't have to pay? Just how much surplus
will be increased as a result of the good work which you are
trained in doing that you will be doing for the Federal
Government?
Now, we recognize you can't speculate and give us a figure
now, but to reframe the chairman's question, is there a period
of time that you can review what you have done and determine
what you have saved?
Mr. Sachs. Yes. We should be able to do that. The savings
that we would generate are derived in a number of different
ways. Clearly, by repaying higher coupon debt and refinancing
with lower coupon debt, there are savings there. The savings
that will be harder to identify, but which will be equally
meaningful, are the savings that we would generate by creating
additional liquidity in the Treasury securities market.
It will be hard to look back and say that by virtue of
having done this, we have increased liquidity by a certain
amount and that that will have reduced our interest rates by -X
number of basis points. It is not that easily measurable, but
we do know that by increasing liquidity, investors will demand
a lower interest rate for the securities they buy from us than
they would if we had less liquidity.
Mr. Rangel. The banks that the chairman was referring to
that you use for these Treasury bonds, do they compete in terms
of trying to solicit their selection? And the follow-up
question would be, are minority banks involved just because
they are minority banks in terms of being partners in these
transactions?
Mr. Sachs. It is the same interest rate for all banks, so
it is not a competition on price. They take our deposits and
pay us the Federal funds rate minus 25 basis points, or less a
quarter of 1 percent.
As to your follow-up question, if I could ask to get back
to you with an answer on that. I am not that familiar, as I
said, with the list of institutions.
Mr. Rangel. Last, this seems like it has got to be
generating a lot of transactions and including a lot of
brokers. Do we expect that commissions, brokers' commissions,
and transactions costs for buying back debt and purchasing new
shorter interest, lower interest, debt is going to increase the
cost of these transactions?
Mr. Sachs. I would not expect so. We do not pay those
costs. The way we have outlined how the program would work is
that the offers to the Treasury Department are competitive. In
other words, we get to choose the most attractive offers that
are out there, the cheapest securities for us. So I do not
believe that that would be a factor.
Mr. Rangel. Thank you, Mr. Chairman.
Chairman Archer. Mr. Crane.
Mr. Crane. Thank you, Mr. Chairman. I have just one
question and that is, are your projections anticipating a fall
in long-term interest rates?
Mr. Sachs. Our projection--which projections are----
Mr. Crane. If you are buying long-term debt with short-term
debt, isn't that predicated on the assumption that long-term
debt interest is going to fall?
Mr. Sachs. This proposal is not specifically saying we
would buy long-term debt and issue short-term debt in its
place. What this proposal would allow us to do is to streamline
our inventory of debt, in other words, to buy some of the
higher coupon, less liquid securities that are out in the
market and essentially consolidate those into larger, more
liquid issues that may have a longer or a shorter maturity than
the securities we purchased. It is not necessarily buying long-
term debt and replacing it with short-term debt.
Mr. Crane. I yield back the balance of my time, Mr.
Chairman.
Chairman Archer. Mr. Shaw.
Mr. Shaw. Thank you, Mr. Chairman.
During this period of buying back higher-interest-paying
bonds at a premium, are we still issuing new bonds during this
period?
Mr. Sachs. In some cases, yes; in some cases, we're not. To
the extent that we are reducing debt outstanding, we will not
necessarily be issuing as much new debt in its place.
Mr. Shaw. If we were to just simply put a moratorium on
issuing new debt, would this be sufficient to take care of the
surplus?
Mr. Sachs. What would happen in that case is, we would have
greatly reduced liquidity in the Treasury market. We still do
have to roll over our maturing debt, and the reduced liquidity
would increase the cost of refinancing the debt that was
maturing. The lower the liquidity in the market, the higher the
interest rates we would have to pay on the new bonds we would
issue.
Mr. Shaw. I am missing something. It seems to me that if
you reduce the number of bonds that we issue, that you would
get a better price for them because the supply would be down
and, therefore, the interest rate would drop on what we have to
pay on the debt that we are refinancing if we cut down on the
supply of new bonds being issued. Am I correct on that?
Mr. Sachs. Yes, sir.
Mr. Shaw. Is that inconsistent with what you just said?
Mr. Sachs. No, it is not inconsistent. There is the total
amount of debt outstanding to which you are referring, and we
are reducing that. The composition of what remains outstanding
is what I am referring to. If the total amount of debt we have
in the market were concentrated in larger, more liquid issues,
that should lead to lower interest rates because there would be
greater liquidity in those bonds. If the total amount were
spread over many more issues, they would be less liquid, and
that would most likely result in higher interest costs.
Mr. Shaw. When you are buying back some of the higher-
interest-paying loans, what type of term are you looking at on
these bonds?
Mr. Sachs. Those decisions would be made at the time of the
buyback operations.
Mr. Shaw. Have you done some analysis to try to figure out
what is best for us in the long run? Is it best we buy long-
term bonds that are high interest rate or is it best that we
buy 1-year bonds?
Mr. Sachs. Again, it will depend on what the market looks
like at the time of the buybacks.
Mr. Shaw. Do you just go into the market and buy these
bonds as anyone would, as a bank would? How do we pick and
choose which bonds are being purchased?
Mr. Sachs. We are trying to set up a mechanism, and again
we are in the comment period of soliciting input from the
private sector in terms of exactly how we would execute these
buybacks, but the way it is currently contemplated is that we
would announce our intentions with some advance notice. We
haven't determined how far in advance--how many bonds, maximum,
we would like to buy, and approximately where in our maturity
spectrum we would like to purchase them.
I don't know if that answers your question, but that is the
mechanism we would use and offers offerers--would offer
competitively those securities.
Mr. Shaw. Do we have any experience to draw on? Have we
ever done this before?
Mr. Sachs. It is not exactly the same thing, but back in
the 1960s and early 1970s, the United States engaged in what is
called an exchange offer where new securities were
simultaneously issued in exchange for securities that investors
could turn in.
Mr. Shaw. I have one more question. What do you contemplate
will be the impact on our budget of this added interest
expense? Is it going to be negligible, or is going to be
something we in the Congress are going to have to deal with?
Mr. Sachs. Again, it is hard to say how much the interest--
the up front interest expense would be in engaging in these
operations because we don't know how much of it we would do.
Again, the interest premiums that would be paid would result in
a reduction in the current year's surplus. It does not have an
effect for the following year's----
Mr. Shaw. That is what I am concerned with because all of
us are working with that surplus and trying to figure out how
we are going to stay within caps that we have set for
ourselves. My question simply is, is this something that we
have to be concerned about? Are these premiums going to break
the caps, are they that significant? What kind of dollars--are
we talking about--millions or billions or multiple billions?
Mr. Sachs. Again, I wish I had an answer for you today on
the size.
Mr. Shaw. If you could make some projections, I think the
leadership in the House would really like to take a look at it.
Not that we need another problem, but I think it is something
we should anticipate.
Mr. Sachs. I should also just reiterate, if I could make
two points. I see the light is on. The premiums that we would
pay by buying back these securities would not have an effect on
the cap issue. Treasury currently has the authority to engage
in this. It does not require a change in law; it does not
require offsets. So I don't think----
Mr. Shaw. But we have to consider where those monies are
going to be coming from. And I see my time has expired.
Chairman Archer. A little while back.
Mr. Shaw. Yes, sir.
Chairman Archer. Mr. Cardin.
Mr. Cardin. Thank you, Mr. Chairman.
Mr. Sachs, welcome. I am going to be getting back to the
point Mr. Shaw made. As I understand it, when you make a
decision to repurchase, that will have no impact on the total
amount of debt that is outstanding, but just the mix of your
inventory as to the length of maturities and what inventory of
publicly-held debt you think is in our best interest from
liquidity, from cost, and from market conditions.
Is that a fair assessment of why you want this tool?
Mr. Sachs. That is one reason, sure. This tool would, as I
tried to indicate earlier, this tool would allow us to
hopefully reduce expense over time.
Mr. Cardin. But the repurchase itself will not reduce the
amount of publicly-held debt because it will be less new debt
that you are going to be incurring, or be more new debt that
you will be incurring, but different maturities, to get the
type of liquidity and the type of cost and the type of impact
on the market that you think is in the best interest of our
Nation.
Mr. Sachs. That is correct. In and of itself, this purchase
does not reduce the debt.
Mr. Cardin. Let me get to Mr. Shaw's point, because I think
it is a very important point.
I understand you can't predict what the cost will be. You
don't know if you will use this tool in the first quarter of
next year; and if you use it, you don't know to what extent,
you don't know what the market conditions will be, you don't
know what you will be repurchasing and what you are going to be
issuing. It is impossible to tell the impact now.
But the point Mr. Shaw raises is a very valid point. If you
use this in the first calendar quarter of 2000, it will affect
the amount of surplus in fiscal year 2000. It may not have a
major impact, but it will have some impact because we will be
spending more on interest in 2000, admittedly saving interest
costs over a period of time--just the opposite of what Congress
normally does. We usually try to figure out some way to spend
money now, but not count it now.
Now, what you are doing is saving us money, but we have to
pay for it now. Just one of these reverse things that Congress
is not used to, this type of fiscal responsibility.
But I think it is important for us to try to calculate
whether this is going to have a negligible impact or a
significant impact as we look at projected surpluses and how we
in Congress wish to manage the projected surpluses of the
future.
Mr. Sachs. Congressman, thank you. I know a lot of you have
asked this question. No one wishes I had an answer today more
than I do.
If I could use a private sector analogy for a moment,
before coming to Treasury I spent 13 years in the private
sector in an investment bank where one of my primary
responsibilities was advising corporations on how to manage
their debt structures and what they should do in this area, and
many of the largest, most sophisticated corporations are using
this tool right now and have been for some time.
The way this is treated when they do it--and they are
focused on their earnings every quarter and every year--is that
when they purchase some of their debt in the market at a
premium, that premium, it is not scored, but it is accrued in
the year in which they buy that debt back. It is reflected in
their earnings for that quarter. And the way they show that is,
they obviously have to show the number. Their earnings will be
reduced by that premium in that quarter.
They also show the number as it would have appeared had
they not entered into that operation. And that is the number
that the analysts look at. The analysts--all the analysts and
investors view this as a very positive thing for them to do.
They understand they are reducing their interest costs going
forward.
Mr. Cardin. Mr. Sachs, let me interrupt you for a moment
because I agree with you. I am for you having this ability to
use this tool.
You are absolutely right; our accounting system should
accurately reflect the current cost, and you should be able to
accrue and therefore not be penalized for saving us money. And
Mr. Nussle and I have worked on some budget reform proposals
here to try to move us toward more accrual accounting in the
budget system.
I would be somewhat concerned, though, that if we only do
this type of an accrual to make the budget look rosier, we
should be doing some of the accruals that are doing the
reverse--that is, that we are incurring obligations today, but
we don't pay for them until tomorrow--but it seems like
Congress never wants to take responsibility for what we really
spend today.
You are doing--I am complimenting Treasury because you are
doing just the reverse. You are willing to pay somebody today
to save us some money in the future. We normally do it just the
reverse. These are some things we should have been doing for a
long time and our accounting system should reflect that.
Mr. Sachs. Thank you, Congressman.
Chairman Archer. The gentleman from Maryland has put his
finger on something that should be a priority for all of us in
the Congress and that is to make sense out of the way the
Federal budget is determined. You highlighted only one part of
it: that is not the way the private sector would do it, but
there are many, many other parts that need to be changed also.
Let me just piggyback for a moment on what you said, Mr.
Cardin, by asking one question first. When we talk about our
debt, do we talk about net debt or gross debt? The gross debt
would be what we owe in bonds, but then that should be offset
to the degree that we have money owed to us by banks and by the
Federal Reserve. That money is sitting in a bank depository,
and it is owed to the United States of America, so do we
reflect net debt or gross debt?
Mr. Sachs. It depends. Again, it depends which number you
are looking at.
Chairman Archer. That is what I am asking you. What numbers
do we look at when we talk about debt?
Mr. Sachs. For the purposes of this discussion, the debt we
are focused on is the privately-held, marketable debt held by
the public.
Chairman Archer. Again, from an accurate bookkeeping
standpoint, that should be reduced by the amount of debt that
is owed to us on these cash balances; should it not? There
would be no private corporation that would exclude the money
that was owed to them from the amount of their net debt? That
is OK. It is just another anomaly in our budgeting concept.
The point I would make relative to what Mr. Cardin said is
that obviously the amount of surplus that we have reduces the
amount of debt.
Mr. Sachs. Yes.
Chairman Archer. If we reduce the surplus, we are going to
have more debt.
Mr. Sachs. Yes.
Chairman Archer. OK. If your immediate funding mechanism
reduces the surplus by having a higher interest charge in the
first year, then we are going to have more debt in that first
year. That has to follow.
Mr. Sachs. Yes.
Chairman Archer. That is net in the first year. So it
actually does --although it may be a relatively small amount of
money--increase the debt in the first year.
Mr. Sachs. That is correct.
Chairman Archer. Thank you for letting me piggyback on your
comments, Mr. Cardin.
Mr. Houghton? Is Mr. Houghton here?
Is Mr. Foley here?
Mr. English.
Mr. English. Thank you, Mr. Chairman. I simply want to
compliment Secretary Sachs for his testimony. I have no direct
questions, but we are looking forward to seeing your plan go
forward. Thank you.
Mr. Sachs. Thank you, Congressman.
Chairman Archer. Is Mr. Lewis here?
Mr. McNulty is not here.
Mr. Tanner.
Mr. Tanner. Thank you, Mr. Chairman.
I find this--I guess it speaks to my idea of Federal
Government, but I find this entire exercise fascinating, and I
am glad you are here and I am glad we are talking about how we
manage the Nation's debt and how we reduce it by buybacks or
otherwise.
I want to call your attention to this GAO pamphlet that was
published in May, and on page 28 of that, the following
appears: CBO figures show that if all projected surpluses are
retained and are used to reduce debt held by the public, net
interest primarily, the interest paid on debt held by the
public, will decline from about 15 percent of the net outlays
in fiscal year 1998 to about 4 percent in 2009. CBO numbers
also show that about 23 percent of the growing budget surpluses
over the next 10 years come from interest savings if the
surplus is maintained and is fully used to reduce debt held by
the public.
Using CBO estimates, if the budget were to be in balance
rather than in surplus from 2000 to 2009, net interest costs in
fiscal year 2009 would be $123 billion greater, or about $568
billion cumulatively between now and then. Now, that, to me, is
the reverse of the power of compound interest as some people
like to come here and talk about so much, and--first of all,
let me--do you agree with the GAO analysis that I have just
described here generally, or would you want to comment on that?
Mr. Sachs. It sounds right. This was just put in front of
me, but it sounds correct, yes.
Mr. Tanner. Would you agree that the efficacy of paying
this surplus on the debt, as opposed to virtually any other use
of this ``extra money'' in my view, given these kinds of
observations, far outweighs almost any other single use we
could make of this ``extra money.''
Mr. Sachs. There are certainly tremendous benefits to the
economy in reducing the debt that you are referring to.
Mr. Tanner. If it seems this is true, we have as a
percentage of GDP now a historically high debt vis-a-vis peace
versus war. Over 40 percent of the GDP is held by the public
and then another 20 or so is, so-called, held by the
Government.
Mr. Sachs. Yes.
Mr. Tanner. So over 60 percent of our GDP we have
outstanding--well, said another way--you characterize it for
me, please.
Mr. Sachs. The debt held by--I don't have in front of me
what you have in front of you, but the debt held in government
accounts is obviously very different than debt held by the
public.
Mr. Tanner. 1.8 versus 3.6 thereabout.
Mr. Sachs. Interest on that debt is interest we are paying
to ourselves as opposed to paying to third parties.
Mr. Tanner. On page 3 at the top of the page of your
testimony, you have informed us of some of the tools that you
have used. When debt matures, you issue a smaller amount of
debt. You have ceased issuing 3-year notes here, it says.
Mr. Sachs. Correct.
Mr. Tanner. Using these tools, you have been able to
achieve what in terms of debt reduction?
Mr. Sachs. Over the course of the last 2 years, during
which we have had the back-to-back budget surpluses, we have
been able to reduce the amount of the privately-held marketable
debt, which is what this proposal is dealing with, or would be
dealing with, by roughly $210 billion, which is, by the way, a
reduction of almost 7 percent of the outstanding privately-held
marketable debt.
Mr. Tanner. On an average interest rate of 5 percent, $200
billion would be an interest savings of $10 billion a year,
roughly. Would that be--.
Mr. Sachs. When I was in the private sector, I was faster
at doing math in my head.
Mr. Tanner. Five percent of $200 billion, if that is what
you owed and what you paid, and it was for--our average rate, I
think, is 6, around 6; is that correct?
Mr. Sachs. I don't know what the average interest rate was
on the debt that matured over the last 2 years.
Mr. Tanner. But if it were 5, you have got a $10 billion
savings every year forever.
Mr. Sachs. That would be a good thing.
Chairman Archer. The gentleman's time has expired.
Mrs. Johnson.
Mrs. Johnson of Connecticut. Thank you, Mr. Chairman.
Thank you for being with us today on what is a very
important subject. I wanted to just take you back in history
and have the Treasury give us some historical data. In 1993,
the administration changed its debt management policies by
issuing more short-term and less long-term debt.
What was the actual savings by that policy in the ensuing
years?
Mr. Sachs. Congresswoman, if I could get back to you on
that answer----
[The following was subsequently received:]
In May 1993, the Treasury announced that it would be
instituting a shift in the maturity of its borrowing toward
shorter term issues. The actions taken were to pare back the
issuance of 30-year bonds, from four to two times per year, and
to discontinue issuing 7-year notes. The funding would be
shifted to a mixture of securities with maturities of three
years or less.
In May 1993, OMB estimated the savings of reducing the
average maturity in the FY 94-98 period to be $10.8 billion,
while CBO's estimate of savings for the same period was $7.3
billion. Although OMB did not update its estimate, in May 1994,
CBO reported that it had no reason to change its original
forecast. Subsequently, it was generally recognized that, given
the cumulative effects of deviations of the actual deficits and
interest rates from the original baseline forecast,
calculations of the actual savings resulting from any one
particular change would be unreliable. It is, however,
generally recognized that the savings to the government of the
May 1993 decision were significant and may have exceeded
original estimates.
Mrs. Johnson of Connecticut. I would appreciate your
getting back to me, and I will tell you why I want you to get
back to us, year by year. The projected savings from that
policy change were substantial, and I think it is very
important, as we look at the management changes you wish to
make now, to know what the savings were from issuing more
short-term debt and less long-term debt in 1993.
I also wanted to--that, I think, will help us to evaluate
what our options are at this type.
Then a number of countries like Britain and Canada have
begun reducing debt and they have run into some pretty serious
problems. In Great Britain there is a shortage of long-term
government bonds for pension funds to invest in. That is a very
serious problem. Are we anticipating those kinds of problems?
Are you factoring the experience of other countries into your
planning?
Mr. Sachs. Congresswoman, we are certainly looking at the
experience of other countries as we go through this. I should
reiterate that the proposal that we are discussing today is an
effort to enhance the liquidity of our long-term securities.
This proposal would not necessarily accelerate the pace at
which we would reduce the amount of outstanding securities.
Mrs. Johnson of Connecticut. I think we need to be able to
see what you are proposing at this time in the context of what
you began actually doing in 1993 and see what the impact was
there, whether it reduced the cost of our debt to us or
actually increased those costs, how the real costs compared to
the estimated either savings or costs--at that time they were
estimated as savings--and how your current proposals relate to
your earlier actions in 1993.
Mrs. Johnson of Connecticut. In addition, I would like to
just get a brief answer because I would like to make a comment
after that. What is going to be--what impact will your new
policies have on the time at which we hit the debt ceiling
limit of $5.995 billion?
Mr. Sachs. This buyback proposal?
Mrs. Johnson of Connecticut. Yes. Will it defer the day at
which we come up against the debt ceiling?
Mr. Sachs. It should not have a meaningful impact on that.
Mrs. Johnson of Connecticut. If we are in an era of debt
surplus, it seems that we ought to be able to figure out how to
move that date.
I would like you to look at Mr. Shaw and Chairman Archer's
Social Security reform proposal. Rather than putting those
surplus dollars into new debt, which is what we do when new
Social Security dollars come in, we buy new debt with them and
then we are obliged to that debt, and ultimately taxes will
have to go up unless we have made other provisions to repay
that debt, it actually spends those Social Security dollars,
but in a way that does secure them in investment savings
accounts so we don't buildup new debt and we do, as a fact,
eliminate Social Security from that balance sheet. I think when
you talk about debt management, you really ought to be thinking
about the Archer-Shaw proposal as an extraordinarily powerful
debt management tool.
Mr. Sachs. Congresswoman, I appreciate your comments.
The proposal that we have in front of us today is this
buyback proposal. It does not have an impact on Social Security
one way or another except by virtue of putting downward
pressure on interest rates. That--and reducing our borrowing
costs.
Mrs. Johnson of Connecticut. If it ends up costing us, then
that money will come out of basically Social Security revenues
as many costs have in the past. We hope to get through this
budget year and not spend--our intent is not spend any Social
Security revenues, and we are pretty committed to that. There
is more than us at the bargaining table, however. I just urge
you to look at that.
Mr. Sachs. Sure. We believe that this proposal will save
the taxpayer money.
Mrs. Johnson of Connecticut. Thank you.
Mr. Crane. Ms. Dunn.
Ms. Dunn. No questions.
Mr. Crane. Mr. Portman.
Mr. Portman. Thank you, Mr. Chairman. Just following up on
Mrs. Johnson's question, there has been a statement made by the
administration, that a line has been drawn in the sand, which
says that the President has pledged to save Social Security
first before spending any amount of the surplus. My question to
you would be does this debt buyback program increase short term
costs?
Mr. Sachs. This debt buyback program, if we were to engage
in transactions and buy securities in the open market that have
dollar price premiums, would be reflected in a lower budget
surplus number for the year in which the buyback occurred.
Mr. Portman. And that would mean that there are short term
costs in that buyback year; and, therefore, the surplus would
be affected, and have you already saved Social Security?
Mr. Sachs. The savings----
Mr. Portman. That is a rhetorical question.
Mr. Sachs. The savings that would be generated by virtue of
engaging in this exercise would----
Mr. Portman. Would there be long term savings?
Mr. Sachs. Yes, which would put us in a better position to
be able to meet our future obligations, including Social
Security.
Mr. Portman. Without Social Security reform, how are the
debt buybacks paid for?
Mr. Sachs. The debt buybacks, again because there is no--I
hope this is answering your question--because there is no
change in law required for us to engage in these buybacks, they
do not require offsets as might otherwise be required.
Mr. Portman. But it affects the surplus?
Mr. Sachs. It does affect the surplus, yes, in the current
year.
Mr. Portman. Which means in a case of no on budget surplus
but Social Security surplus, which seems likely for next year,
there would be a cost to the Social Security surplus without
having first saved Social Security?
Mr. Sachs. It would not. When Social Security, when Social
Security has surpluses, they invest in Treasury nonmarketable
securities, as they would whether we engaged in debt buybacks
or not.
Mr. Portman. But for that year there would be less surplus
to invest in those?
Mr. Sachs. There would be a lower surplus reflected at the
end of that fiscal year.
Mr. Portman. I guess the line in the sand like other lines
in the sand in this political world, may not really be a line
in the sand. Over time you think it would have an impact which
would be positive for taxpayers, but in the meantime we would
not be reforming Social Security while moving ahead with using
some of that surplus for immediate buybacks which would have a
cost to the surplus. Therefore, the pledge to save Social
Security first before touching the surplus would be difficult
to fulfill.
Mr. Sachs. But again, Congressman, the purpose behind this
proposal is to reduce the cost to the Federal Government.
Mr. Portman. Long term?
Mr. Sachs. Yes, absolutely. And again that puts us, the
Government, in a better position to meet all of those long term
obligations, including Social Security.
Mr. Portman. Following on Mrs. Johnson's comments, I think
it does cross the line in the sand and once again indicates the
need for us to get serious about Social Security reform and
investing that surplus as proposed in the Archer-Shaw bill, or
in assets that have a higher return on investment where we
actually have the money work for the Social Security recipients
rather than investing in the treasuries. I thank you for your
time today.
Mr. Sachs. Thank you, Congressman Portman.
Mr. Crane. Mr. Watkins.
Mr. Watkins. Thank you, Mr. Chairman.
Let me say that this is an intriguing time in our
discussions of budgets and what we do with surpluses. Some have
said with debt buybacks we don't generate from this following
interest rates, we are not accomplishing the situation, and I
think also the gentlelady from Connecticut's point is valid. I
am concerned whether you are going to buy back long term or
short term debt. You didn't give a specific answer on that. I
know in 1993 the administration moved to try to shorten
everything to short term debt. To me you don't have to be a
rocket scientist to realize if we are going to deal with it,
you need to look at long term debt. What is our obligation on
long term and what is our obligations on short term? Do we have
those?
Mr. Sachs. I have those figures for you. Again it depends
on your definition of long term. Longer than 1 year, we have
notes and bonds with original maturities longer than 1 year of
about $2.5 trillion, just doing the addition in my head.
And bills with maturities 1 year or less are about $650
billion.
Mr. Watkins. I look at anything less than 5 years as short
term.
Let me say if we are looking at it, we should be looking at
long term. There is no question--I agree with the policy in
1993. I think we should look at the short term and I think
Rubin and others had some good points on that. I think down the
road we need to be saying how do we reduce the long term and I
think we should look at the overall obligations. I want to add
this tidbit, we need to be looking at what our trade imbalances
are doing and those imbalances that are bringing in a lot of
money from a lot of other countries. I think that would be
very, very important.
I would go through some of the same questioning as some of
the others, but because of time I won't.
I will make this point. When I served in the State Senate
in Oklahoma, probably one of the most proud votes I cast was
where we had one on buying down debt and paying off bonds, and
I was a lone no vote. I had to explain where I went. People
didn't understand.
I went down to the treasurer's office in the vault and I
read the bonds. We paid off bonds at 1 percent. If I cannot
take the public's money and make more money than that, then I
shouldn't be in public service.
I think we need to look at what we are doing. Archer-Shaw
may allow us to put that money into savings that make twice as
much than what we are paying off. We need to be making that--
that is what a businessman would do. You came out of Wall
Street and I came off Main Street as a small business man, but
I wouldn't be a good steward of the people's money if I didn't
get the kind of return from it that we should, and that is
nearly Biblical in some respects. But I think just as I cast
that vote years ago, I want to make sure that I cast one that
will help secure that future for the future generations. If
something does happen right now and we end up going to the
buyback, I think we need to take some long term debt out of
circulation instead of short term.
Mr. Sachs. Just to go back to the first point that you were
making, as I indicated in my opening remarks, one of the
reasons that we would like to have this tool in place is to
efficiently manage the average maturity of our debt. People can
have different opinions about whether our average maturity
should be 5 years, 6 years, 7 years. But we don't want to have
our average maturity extend beyond where we would otherwise
want it to. Without our ability to buy back debt, it would
extend as it did last year.
Mr. Watkins. I submit to you if we actively manage our
surpluses, we can control the maturity of those debts, but we
have to actively manage them, not just dump everything in at
one time.
Mr. Crane. The time of the gentleman has expired. We want
to thank you, Mr. Sachs, for your appearance here today. The
Committee will stand in recess subject to call of the Chair for
the two votes that we have on the floor right now.
[recess.]
Mr. Nussle [presiding]. At this time the Committee will
resume its hearing, and we would request that Mr. Posner, who
is the Director for Budget Issues, Accounting and Information
Management Division of the U.S. General Accounting Office, take
the witness stand. We appreciate you coming today and we would
recognize you at this time for 5 minutes.
Without objection your testimony will be placed in the
record and you can feel free to summarize it at this point.
Thank you.
STATEMENT OF PAUL L. POSNER, DIRECTOR, BUDGET ISSUES,
ACCOUNTING AND INFORMATION MANAGEMENT DIVISION, U.S. GENERAL
ACCOUNTING OFFICE; ACCOMPANIED BY TOM McCOOL, DIRECTOR,
FINANCIAL INSTITUTIONS AND MARKET ISSUES, AND CAROLYN
LITSINGER, HEAD OF WORK ON FEDERAL DEBT
Mr. Posner. Thank you, Mr. Chairman. I want to recognize
Tom McCool on my right, who is the director of GAO's financial
institutions and market issue area, and Carolyn Litsinger on my
left, who is head of work on Federal debt.
We provided two GAO reports for your packets, one we issued
several months ago, a primer on the Federal debt. In our view
we think that it helps to have some basic tools to understand
this issue better. Interest costs in the budget are the third
largest program in the Federal Government, and we think that
understanding more the dimensions and the dynamics and the
importance of debt can be helped by this kind of tool. We just
issued today for yourselves and for Senator Domenici a study
following on this primer on the management of Federal debt in a
time of surplus and the new challenges, and that is what I am
going to talk about today.
As you know, the debt held by the public has gone down
thanks to 2 consecutive years of surpluses. The publicly-held
debt now stands at $3.6 trillion. The CBO projections show if
we continue to save all of the surpluses, on and off budget,
debt held by the public would be falling to less than a
trillion dollars in 2009 or about 6 percent of the economy,
which would be quite a low figure for our history.
Basically the Assistant Secretary did a good job of stating
Treasury's goals for debt management. Those goals remain valid
in times of surplus or deficit. However, in surplus there are
some unique challenges that come to the fore. In a surplus
period, the profile of the maturities of your debt essentially
is a large function of the kind of debt that is already
maturing and due to mature.
The resulting profile can shift somewhat automatically,
unless you take active intervention to change the mix. Just for
your information, the chart shows that notes are the
predominant form of Treasury security. Bills are 10 percent of
the total, and this is as of July. Long term bonds are 20
percent, and a small portion are inflation adjusted.
The story of debt management in the 1998 and 1999 period
illustrates the challenges in 1997 and 1998 we had what is
known as an April surprise. We had a large amount of revenues
that came in the door, larger than anyone projected, either OMB
or CBO, and as a result the cash balances grew. In order to
address that problem, Treasury reduced the issuance of new
bills. In other words the short term bills were the ones that
came due frequently, and because they were the ones that came
due most frequently, they were the ones that took the hit on
the surplus, if you will.
And as a result, we emerged with a disproportionately lower
stock of bills at the end those 2 years. While total debt was
reduced by 3 percent, the total stock of bills was reduced by 9
percent. The short term market began to experience liquidity
problems because the supply of bills was shorter than the
demand. Arguably Treasury borrowing costs were somewhat higher
because the profile of debt had lengthened as a result.
If we just let debt go on automatic pilot, these would be a
continuing lengthening of the profile of the debt and a
possible liquidity problem in the bill market at that time.
To respond to that, Treasury did several things which
illustrate how active management is important in this area to
address these problems. First, they used more actively issued
cash management bills early in 1999 that enabled them to reduce
the size of the cash balances on hand.
The second thing they did is to concentrate borrowings in
fewer issues. We know that they eliminated the 3-year note, for
example.
The third thing they did, was to reduce the notes that they
issued disproportionately which enabled them to increase the
issuance of bills. What that meant is that since the notes had
longer maturity, they were able to rebalance their profile to
some extent. So as a result of those actions, in other words,
even in months when the cash was in a deficit position, they
did not re-issue notes that were coming due to fund the
Government's needs. Instead they issued bills in their place.
And the aggregate effect of that was that for modified and
mitigated the slide towards longer-term debt.
We know and Treasury has testified that we have a
continuing problem here in the sense that as debt continues to
come down, the choices will get harder. Again, it requires a
more active strategy to achieve Treasury's various goals.
Treasury in August announced further measures to further
concentrate on securities and, as we know from the hearing
today, buybacks to actually reduce off-the-run issues and
thereby gain the ability to prop up the more liquid benchmark
issues.
Let me address three tools that we see available to
Treasury. One is the buyback which I will talk about here in a
minute.
We also know that Treasury traditionally uses reopenings
where active issues are enriched to prop up the liquidity of
benchmark issues.
Treasury can also buy back bonds without a premium that are
callable. At this point there are no callable bonds. There will
be one coming due--reaching its callable period in year 2000,
and over the next 9 years there will be $87 billion of callable
bonds. But as it stands, in order to buy back the outstanding
higher cost debt, Treasury has to pay a premium. Based on what
we have seen in some other countries and corporations, we know
that buying back debt is a legitimate strategy to actively
manage your debt portfolio and to try to promote liquidity.
Canada, for instance, is in the process of doing this. The
problem is that premiums must be paid to get investors to sell
the bonds valued above par, which are most of the outstanding
bonds. This is not a scoreable event in congressional budget
terms. There is no pay-go hit. There are no offsetting savings
that must be found. The issue is that it would be recorded as a
reduction in the surplus and counted on a cash basis as a cash
outlay. However, it also should be noted that over time, the
baseline would be lower under current interest rates because
your interest costs would be reduced. So it is really a timing
shift, recognizing the higher cost debt that you have already
accumulated in 1 year rather than spreading it out over time.
There are challenges here in terms of how we can consider
this technique of debt management under our current process.
There are also future challenges as we continue to reduce debt.
Let me recognize here that there are substantial economic and
fiscal benefits from reducing debt and maintaining surpluses
that we have to always keep in mind. As the back drop for the
challenges Treasury faces.
As debt held by the public continues to be reduced,
Treasury will continue to need to concentrate the remaining
debt in fewer issues to promote liquidity of benchmarks in the
market.
The markets will most likely continue to adjust as debt
continues to decline, possibly find other benchmark instruments
to use in lieu of Treasuries, but the process will not be
seamless, nor will it be costless. For example, under CBO's
projections in 2009, the estimated $865 billion of stock of
debt that is projected to be remaining will be less than the
Federal Reserve and State and local governments currently owe
combined. In other words, as debt shrinks more and more, all of
the claimants in the market that find Treasuries useful for a
variety of purposes are going to have to make a substantial
adjustment and how Treasury responds to that will be very much
worth watching.
Thank you.
[The prepared statement follows:]
Statement of Paul L. Posner, Director, Budget Issues, Accounting and
Information Management Division, U.S. General Accounting Office
Mr. Chairman and Members of the Committee.
I appreciate the opportunity to appear before you to
discuss managing debt in a time of surplus. As you requested,
my testimony today will be drawn from a report we are issuing
today to Senate Budget Committee Chairman Pete V. Domenici and
you regarding actions taken by the Treasury to manage the
marketable debt held by the public in this new fiscal
environment.\1\
---------------------------------------------------------------------------
\1\ Federal Debt: Debt Management in a Period of Budget Surplus
(GAO/AIMD-99-270, September 29, 1999). This report is a follow on to a
``primer'' on federal debt issued in May entitled Federal Debt: Answers
to Frequently Asked Questions--An Update (GAO/OCG-99-27, May 28, 1999).
---------------------------------------------------------------------------
The federal budget is about to record the first back-to-
back budget surpluses in more than 40 years. As a result,
federal debt held by the public has declined and, if projected
surpluses materialize, it will continue to fall throughout the
next 10 years. The Treasury faces the challenge of managing the
surplus rather than financing a deficit. To support its
management goals, the Treasury has concentrated its borrowing
into fewer but larger debt offerings, and targeted its
reductions to offset the trend toward generally more costly
long-term debt.
In August the Treasury published proposed rules for
advanced repurchase of outstanding debt held by the public--a
debt ``buy-back.'' These repurchases could require the Treasury
to pay a premium since most of the older securities have
interest rates higher than those issued today. Since the
Treasury has the authority for these repurchases, any premiums
would not require an offset under the Budget Enforcement Act,
but the payment of a premium would affect the size of the
surplus.
As debt declines, the Treasury will face more difficult
trade-offs in achieving broad and deep markets for its
securities and lowest cost financing for the government. There
will be greater pressure on the Treasury to further concentrate
debt in fewer issues to maintain deep and liquid markets in
benchmark securities. Although markets tend to adjust over
time, these changes may not be seamless or without cost.
Federal Debt Held by the Public is Declining
As all of you know, fiscal year 1998 brought the first
unified budget surplus since 1969. The fiscal year that ends
tomorrow also will show a surplus--although we don't know its
exact size yet. The Congressional Budget Office (CBO)'s July
update showed surpluses continuing throughout the next 10
years.
In fiscal year 1998 debt held by the public fell by about
$51 billion, and the Treasury has already reduced the amount of
debt held by the public by $68.2 billion in the first 9 months
of fiscal year 1999. As figure 1 shows, the debt held by the
public reached a peak of $3.83 trillion in March 1998 and
dropped by $180 billion, to $3.65 trillion, by July 31,
1999.\2\
---------------------------------------------------------------------------
\2\ This total is net of unamortized premiums and discounts on
public debt securities.
[GRAPHIC] [TIFF OMITTED] T6896.001
CBO's July projections show debt held by the public falling
further from $3.65 trillion in fiscal year 1999 to $0.9
trillion in 2009, assuming current policies.\3\
---------------------------------------------------------------------------
\3\ These budget projections assume compliance with discretionary
spending caps on such spending through 2002, that discretionary
spending will grow at the rate of inflation thereafter, and that all
surpluses are used to reduce debt.
---------------------------------------------------------------------------
The Treasury's Debt Management Goals and Challenges
The Treasury's stated goals for debt management have
remained the same to date regardless of whether the unified
budget is in surplus or deficit: to have sufficient operating
cash to meet the government's obligations, to achieve lowest
financing cost, and to promote broad and deep capital markets.
Although the goals may be the same, the management challenges
are not.
Just as deficits lead to increased borrowing, surpluses
generally result in the Treasury retiring debt. These two
actions are not symmetrical, however. When the debt is
increasing, the Treasury is issuing more securities than are
maturing and is adding to the amount of debt outstanding. By
selecting the instruments with which to borrow, the Treasury
can have a greater effect on the maturity profile of the
outstanding debt. In contrast, during periods of surplus, the
Treasury is retiring more debt than it is issuing. Because the
Treasury is not adding to the amount of debt outstanding, the
maturity profile is more determined by the maturities of the
remaining outstanding debt. As a result, the profile of
outstanding marketable debt--both the type of security and when
the debt matures--is a significant determinant of how and when
the Treasury can reduce debt.
The profile of the Treasury's marketable securities
consists of bills that mature in a year or less, notes with
original maturities of at least 1 year to not over 10 years,
and bonds with original maturities of more than 10 years out to
30 years. As figure 2 illustrates, as of July 1999, 57 percent
of the outstanding marketable public debt is nominal (not
adjusted for inflation) notes, 20 percent is bills, 20 percent
is nominal bonds, and the remaining 3 percent is inflation-
indexed notes and bonds.
[GRAPHIC] [TIFF OMITTED] T6896.002
The Debt Management Story To Date
The ``April surprise'' that occurred in fiscal years 1997
and 1998 created a situation in which the Treasury suddenly and
quickly absorbed unexpectedly high tax revenue, which initially
resulted in reductions in short-term debt. Since some bills
mature each week, the unexpected cash inflows were used to
redeem bills. However, according to a Treasury official, bills
were redeemed at such high levels that the liquidity of the
bill market was adversely affected and the average life of
marketable debt increased modestly--as shown later in Figure 4.
Although in fiscal year 1998 total marketable debt declined 3.2
percent, the amount of outstanding bills fell 9.2 percent. If
left unaddressed, the shortage of bills and the lengthening of
the average maturity of outstanding debt could have increased
the Treasury''s cost of borrowing. According to Treasury and
Federal Reserve officials, the amount of bills reduced was
sufficiently large to cause the market for bills to become less
liquid.
After this experience, the Treasury took steps to offset
these trends and to better position itself to reduce debt
without endangering its management goals. Instead of reducing
the size of all issues equally, the Treasury concentrated its
borrowing in fewer but larger debt offerings, eliminating the
3-year note and reducing the frequency of the 5-year note from
monthly to quarterly in May 1998. In anticipation of a large
influx of April tax receipts in 1999, the Treasury operated
with a lower cash balance, using cash management bills to
ensure adequate cash balances.
[GRAPHIC] [TIFF OMITTED] T6896.003
Figure 3 compares the allocation of the surpluses for the
first 9 months of fiscal years 1999 and 1998.\4\ The higher
level of operating cash shown for this period of fiscal year
1998 reflects the fact that this was the first year of budget
surplus. As the year continued, the Treasury both reduced
outstanding debt and moved to change the profile by
significantly reducing bills, reducing some notes, and
continuing to issue bonds and inflation-indexed securities. In
fiscal year 1999, however, the Treasury used more of the cash
from the surplus to reduce outstanding debt held by the public
by operating with lower cash balances. Seventy-two percent ($68
billion) of the fiscal year 1999 unified budget surplus through
June 1999 has been used to reduce debt. In contrast, in a
comparable period in fiscal year 1998 only 33 percent ($22
billion) of the surplus was used to reduce debt.
---------------------------------------------------------------------------
\4\ A budget surplus does not translate dollar-for-dollar into debt
reduction because the cash obtained from surpluses can be used to
increase cash balances, to finance Federal direct loan and loan
guarantee programs, and for other transactions (largely changes to
accrued interest and checks outstanding). See Federal Debt: Debt
Management in a Period of Budget Surpluses, GAO/AIMD-99-270 for more
detail.
---------------------------------------------------------------------------
The average maturity of outstanding debt has lengthened
from 5 years and 3 months in 1996 to 5 years and 9 months in
February 1999. The Treasury's actions in fiscal year 1999--
reducing relatively more notes than bills--have been aimed at
partially offsetting this trend, and in March 1999 the average
maturity of outstanding debt stood at 5 years and 6 months.
Nevertheless, if the Treasury continued to sell new securities
on the May 1999 auction schedule, the average maturity of the
outstanding debt would continue to grow. This would happen
because the Treasury would redeem short-term securities as they
mature and longer-term securities would remain outstanding.
Figure 4 shows the trend in average maturity of outstanding
debt from 1990 to 1998.
[GRAPHIC] [TIFF OMITTED] T6896.004
The Treasury announced in August 1999 that it will reduce
the frequency of issuance of 30-year bonds from 3 times a year
to twice a year. This will allow the Treasury to continue to
concentrate on fewer but larger benchmark issues \5\ and to
partially counter the current lengthening of the average
maturity of outstanding debt. Treasury officials also announced
that they are considering reducing the frequency of issuance of
1-year bills and 2-year notes. This move would allow the
Treasury to increase the liquidity of the remaining benchmark
issues. Continuing to issue new debt across the maturity
spectrum and especially in certain benchmark securities is key
to supporting the Treasury's current goals of obtaining the
lowest financing cost and maintaining a broad, deep market for
U.S. securities.
---------------------------------------------------------------------------
\5\ The most recently issued Treasury securities, known as
``benchmark'' issues, are used by other financial services to price
their products.
---------------------------------------------------------------------------
Tools To Increase the Treasury's Flexibility in Managing the Debt
As total debt held by the public continues to fall, the
Treasury may take other actions to enhance a broad, deep market
for Treasury securities and lowest cost financing while still
ensuring adequate cash balances. These actions include re-
opening the most recent securities issues (selling more of the
most recent issue rather than opening a new issue),
repurchasing outstanding debt before it matures, and redeeming
callable securities as they become callable.
Re-open current issues
The Treasury can increase the liquidity of outstanding
issues by continuing to sell debt from the most recent issue
(re-opening) rather than opening new issues. This strategy is
useful when the Treasury wants to issue a small amount of a
given type of security and it determines that the overall cost
of re-opening is lower than it would be for new issues. The
Treasury uses re-openings regularly for bills and has used this
tool in the past for notes and bonds. Re-opening allows the
Treasury to concentrate its new debt into larger, more liquid
issues.
Two other tools--advance repurchase of securities and
redeeming callable bonds--would target one segment of
outstanding debt by either inviting or requiring investors,
respectively, to redeem securities they currently hold.
Reducing the amount of outstanding debt through advance
repurchase of noncallable and callable securities allows the
Treasury to reduce specific, less liquid debt issues and to
issue new, more liquid (and generally lower cost) benchmark
securities across the maturity spectrum and in greater volume
than would otherwise be possible.
Advance repurchase of debt
Repurchasing debt in advance of its maturity is one way for
the Treasury to use the cash obtained from budget surpluses to
retire outstanding debt. This would allow the Treasury to
maintain a higher volume of new, more liquid benchmark
securities. Repurchasing high-interest outstanding debt could
also reduce the government's interest costs.
On August 4, 1999, the Treasury published proposed rules
that would establish a reverse auction--where primary dealers
submit offers to sell (rather than buy) a security. Comments on
these proposed rules are due on or before October 4, 1999.
Repurchasing debt could necessitate the payment of a
premium since most of the Treasury's older securities were
issued with interest rates higher than those of securities
issued today. Any premium paid to buy back debt might be
treated as an interest outlay in the budget year when the
securities are repurchased.
Since the Treasury would repurchase using existing legal
authority and no legislation would be required, the Treasury's
actions would not constitute a ``scorable event'' under the
Budget Enforcement Act. Therefore, even if the premium were
shown as an outlay in the budget year when the repurchase
occurred, no offsetting cuts would be required although the
amount of the surplus would be affected.
Callable bonds
In some years, the Treasury has the option to redeem
certain securities before their maturity dates without paying a
premium. Before December 1984, the Treasury issued bonds that
can be redeemed at face value at the Treasury''s option 5 years
in advance of the maturity dates (or on any interest payment
date thereafter, after providing 4 months notice). A number of
outstanding callable bonds with relatively high interest rates
could be redeemed beginning in 2000. There are $87.6 billion in
high-interest rate bonds that can be called between May 2000
and November 2009. Redeeming bonds would reduce the amount of
debt held by the public and may reduce interest costs.
Future Debt Challenges
Budget surpluses offer the prospects of significant
benefits for both the budget and the economy in the near and
longer term. However, surpluses pose challenges to the
Treasury's debt management. Declining levels of debt prompt the
need to make choices nver how to allocate debt reduction across
the full maturity range of securities used.
The stakes associated with debt reduction strategies are
considerable. As debt declines, the Treasury faces more
difficult trade-offs in achieving broad and deep markets for
its securities and the lowest cost financing for the
government. Moreover, a wide variety of government and private
sector participants both here and abroad have come to rely on
Treasury securities to meet their investment needs. Both
declining amounts of Treasury securities as well as shifts in
their composition affect the interests of these participants.
These changes, for instance, may very well affect the use of
Treasury securities as benchmarks to price other financial
transactions. Although markets tend to adjust to these shifts
over time, changes may not be seamless or without cost.
Projections of continuing and increased unified budget
surpluses suggest that the challenges to debt management
experienced in 1998 and 1999 are a harbinger of more difficult
decisions yet to come. The CBO July 1999 baseline projected
that debt held by the public would decrease from $3,618 billion
in fiscal year 1999 to $865 billion in fiscal year 2009,
assuming compliance with discretionary spending caps through
2002, growth at the rate of inflation thereafter, and that all
projected surpluses are used to reduce debt. To gain an
appreciation of the size of the projected reduction, consider
that the level of debt held by the public projected by CBO for
2009 is less than the dollar amount of federal securities owned
by the Federal Reserve and state and local governments combined
at the end of fiscal year 1998. The particular allocation of
securities will be determined by a number of factors but the
comparison above gives a sense of the size of the continuing
and more extensive adjustments by both the Treasury and market
participants.
As debt held by the public continues to shrink, there will
be greater pressure on the Treasury to further concentrate debt
in fewer issues to maintain deep and liquid markets. Moreover,
the Treasury will need to reassess its issuance of
nonmarketable securities such as state and local government
securities series and savings bonds. In a similar situation,
Canada has begun a pilot program to consolidate its portfolio
by buying back outstanding smaller, less liquid issues,
allowing a simultaneous auction of new, larger replacement
benchmark issues. The U.S. Treasury has taken a number of
actions to concentrate its portfolio already and is considering
other strategies to enable it to issue new and more liquid
issues as overall debt declines, such as buying back
outstanding, less liquid debt.
Mr. Chairman, this concludes my prepared statement. I will
be glad to respond to any questions you or other Members of the
Committee may have.
[Attachments are being retained in the Committee files.]
Mr. Nussle. Thank you, Mr. Posner. You just in a very brief
amount of time tried to--it is like drinking out of a faucet,
drinking more out of a fire hydrant is what you tried to do,
and that is to describe a very complicated situation involving
not only our current debt situation and some proposals.
There are many representatives who I have heard describe
this, and I probably have been--I could be accused of having
done the same thing, describing our debt as similar to a credit
card. We say to our constituents, this is the time that we
ought to pay back the debt on our credit card, and that is how
we describe it.
Could you describe where we are at in a way that I could
use to my constituents? I know what you just went through is a
very highly technical explanation, but when we are talking
about paying back the debt, assuming that there are resources
to do so in a cash flow situation, could you describe why debt
repayment is not an easy task or can be difficult?
You just described if I am not mistaken a situation saying
paying back the debt is not as easy as it may seem. Could you
describe that again in maybe a little more layman's terminology
so I could redescribe that to my constituents.
Mr. Posner. Every year there are a certain number of
securities that in debt parlance roll over, in other words have
to be refinanced. In fiscal year 2000, $1.2 trillion of the
over $3 trillion debt will roll over.
Mr. Nussle. And these are the T bills that people purchase?
Mr. Posner. Right.
Mr. Nussle. And savings bonds?
Mr. Posner. That's right. As those roll over, if we just
balance the budget, we could simply roll over the issues that
are expiring every year and continue with that stock of debt.
Possibly in the same type and maturity, possibly not.
Mr. Nussle. And the only issue would be how much interest
we are paying and that would be assumed in the budget?
Mr. Posner. Right. And Treasury manages that to some extent
as well. What we have now is the supply of publicly-held debt
that we are rolling over is less because we have a surplus. In
other words, when someone hands you a Treasury bill to pay off,
we pay them off and typically we issue more debt to do that. We
don't have to do that any more because we have a surplus to pay
them off.
We don't have to reach back in the bond market to finance
the debt refunding. That is essentially the mechanics of how a
surplus works in our system. So we are not issuing as much new
debt to finance the debt rolling over. That is mechanically how
that works.
Because bills are the most frequently issued bond, when you
suddenly find yourself with a large supply of cash and you have
all of these bills coming due, you pay them off and you
extinguish these bills from the debt inventory, so to speak. So
you find yourself with a shrinking supply of bills in the
active market. Because bills are useful to the market in a
variety of ways, you have a liquidity problem because you are
not supplying the demand as much as you used to be doing.
And that is what Treasury found itself presented with in
1998 when it had this April surprise. It had this big influx of
cash. Where is it going to park the cash. As you heard this
morning, it can park it in TT&L accounts and some other things,
but it has to reduce the debt at some point. And when it
reduces the debt that happens to be maturing first, you find
yourself with a profile that doesn't match your goals. So how
do you essentially try to rebalance that debt or retarget that
debt so you can shift it more into the direction that the
market needs and in ways that help Treasury reduce its costs.
One of the techniques Treasury used is, when some of the
longer-term issues have come due this past year, they have not
refunded those issues. In lieu of that, they have issued more
short term bills to try to enrich that market. They have been
trying to more actively manage that profile so they can better
arrive at the profile that meets their goals.
Another way to do it is you take all of these outstanding
issues that you have issued many years ago that are called off-
the-run issues because they have long since stopped being
actively traded on the initial market, and you try to find a
way to buy them back with the cash from the surplus. You can go
out to the market and issue new debt that is more liquid and
that gives you a small interest premium as a result, interest
bonus, if you will, because they are more liquid.
So it is very much like a balloon in figuring out which
part of the balloon you are going to crimp. It is a very
complicated kind of a set of tools and approaches that they
have to use. Debt buybacks, as you know, are something that
corporations use extensively. It is something as we have said
some other nations are using. It is the kind of technique
that--we see some potential promise from the standpoint of
being able to enrich the issues that you want to target for
policy purposes. I am not sure how far that goes to addressing
your concern.
Mr. Nussle. The first half was right on the mark. The
second half I think it may be a little more difficult.
Let me ask you this because this question does come up
quite often. Is there a level of debt that we should strive to
achieve in your opinion and is that zero? Most of my folks back
home would say ``yes'', pay off your debt. Is that the level
that we should be achieving, assuming that you can maneuver the
balloon as you say, and whether it is a buyback plan or some
form of reopenings or whatever, you can achieve the cash flow
that you need, is zero what we are trying to achieve?
Mr. Posner. I think that is a real fundamental policy
question as to how far. Our debt is about 40 percent of our
economy. It is higher than it has been in peacetime. For the
most part we--we have a chart in our primer here--where we show
the debt-GDP ratio since the beginning of our Nation,
basically. And debt has only exceeded 30 percent of GDP in wars
and depressions, and by and large debt as a share of GDP has
hovered at 30 percent or below.
We are clearly above that. We know that we are facing
longer-term obligations. As the Comptroller General has
testified, we feel that there is a strong case to be made to
continue to reduce debt. It has two benefits. No. 1 is,
reducing interest cost as a share of the budget. No. 2 is,
promoting long-term economic capacity and economic growth which
we are going to need to pay off these obligations that we are
facing with the baby boom retirement.
So the question is what level is sufficient, and zero
doesn't necessarily have to be the right answer. We have
noted--and I am often tempted to say maybe we can have this
debate when we are around 25 percent of GDP, but I think the
direction clearly should be downward.
There are substantial questions about whether we should in
fact maintain a market for Treasuries. It is clearly useful for
a number of actors in our country.
We are familiar with one nation, Norway, for example, that
achieved substantial surpluses with petroleum discoveries, to
the point where they could have eliminated their debt market
and then some, and they chose to retain a debt market of
somewhere around 30 percent of GDP. What do you do with the
money? They invested the money in overseas corporations and
they have created a petroleum fund with these assets that they
are going to be able to call in to finance their baby boom
pensions and retirements in the next 30 years. They clearly
faced the fork in the road. They decided to maintain a domestic
market partly for currency reasons and partly for the reasons
that having a domestic debt market is useful.
Mr. Nussle. The distinguished gentleman from New York is
recognized.
Mr. Rangel. I was following the Chair's questions and your
answers, and I can tell you that Republicans and Democrats in
America are just so excited about paying down the Federal debt
and reducing our interest payments, and we are just fighting
each other taking credit for it.
But after your testimony, it just seems like yes, it is
good policy and in the long run it will pay off, but we face
serious challenges in buying back debt in times of surplus.
What could be the downside in terms of the challenges that
Treasury will face where it goes unchallenged that the less we
owe, the less interest, the more moneys we have to invest in
other things.
I gathered from your response to Mr. Nussle that you are
concerned about the marketplace of debt?
Mr. Posner. Well, it is partly that. It is partly that we
have to pay attention to liquidity not only from the market
standpoint, but also from the Federal standpoint because we
gain some cost savings from having more liquid issues.
I don't want to give the impression that we are always
looking for the cloud in the silver lining here because clearly
surpluses are a very salutary thing. Reducing debt--it just
takes active management to achieve these goals that we are
trying to achieve, one of which is lowest cost to the Treasury.
And the question that we have to face is what should that
profile of debt be and should we proactively manage that in a
way that achieves our goals, one of which is lowest cost to the
Treasury. Another of which is----
Mr. Rangel. When you say cost, are you talking about the
increased cost in buying our debt before it matures, is that
the major cost?
Mr. Posner. In general it is the whole profile of your
outstanding debt. Is your profile reaching a cost level that
you think that you can reduce by perhaps shortening the debt.
Although there are tradeoffs there because when you shorten
your profile, that means that you are rolling it over more
frequently, which subjects you to refinancing risks, so there
are tradeoffs here.
With regard to this proposal, you could clearly buy back
high cost debt and that is good. However, if you pay a premium,
which you would, then you really haven't achieved in cost
savings. Except when you re-issue more liquid debt, then
Treasury does get a marginal cost savings through that.
I think the primary goal of the Treasury buyback program
should be evaluated based on its contribution to liquidity and
efficient functioning of the markets, which is one of the goals
that Treasury sets for itself in this whole set of operations.
Mr. Rangel. Thank you.
Mr. Nussle. The gentleman from Pennsylvania.
Mr. English. Thank you. I wanted to follow through on
something else you had said to the chairman, Mr. Nussle.
When asked about zero debt, you talked about the GDP to
debt ratio. Is it not also true--and stipulating that I believe
that we should be buying down the national debt, is it not also
true that simply keeping the debt stable over time in absolute
terms and growing the economy also has the effect of changing
the debt to GDP ratio in a constructive way?
In fact, if you have policies that encourage higher growth
rates, you achieve much the same thing, albeit in the short
term with a higher interest cost, but you end up from the
standpoint of the capital markets still lowering interest rates
and stimulating further economic growth?
Mr. Posner. I think that is probably right. I can ask the
other panelists if they want to chime in on that. I think the
one thing you have to recognize, debt reduction has two
significant benefits. One is to the economy. You are right if
you kept the nominal debt the same and grew GDP, then the
relative burden would be cut, but there are also fiscal
benefits by reducing the share of the budget going for
interest. So if you kept debt the same size, you would not
necessarily make progress on that front.
Mr. English. But you would also expand the tax base and
hence the capacity over time. This is a very dynamic situation,
is it not?
Mr. Posner. That is correct.
Mr. English. As Alexander Hamilton, still I think our
greatest Treasury Secretary, pointed out, there are benefits to
having a national debt of a manageable size.
Mr. Posner. Yes, sir.
Mr. English. Is it not fair to say from a cash management
standpoint what happened in 1997 and 1998 with the Treasury
finding so much cash on hand imposed unexpected costs on the
American taxpayer? In summarizing your testimony, is it not
fair to say that what happened imposed--because of the
liquidity shortage and because of the need to call in so much
debt, did it not in effect have some negative consequences for
the American taxpayer?
Mr. Posner. Well, I think it did affect the liquidity of
the bill market, and probably at the margin perhaps affected
interest costs. But I think again when we evaluate that, we
have to recognize that everybody got this one wrong. In other
words, nobody anticipated the amount of revenues we were
getting in the door in either of those years.
Mr. English. I would like to do something unusual in
Washington, and that is try to understand this in the abstract
and not look for a scapegoat so I am not particularly worried
about that. The Treasury has proposed a reverse auction. Is
there any alternative method of repurchasing debt that is not
currently callable?
Mr. Posner. Carolyn is going--I know there are other
approaches Treasury has used in the past.
Ms. Litsinger. There are a number of other ways that debt
can be bought back. One would be a swap of debt where you
exchange one debt security for a new benchmark issue of similar
maturity.
Mr. English. In this context are any of those alternative
methods in your view superior to what the Treasury is
proposing?
Mr. Posner. We really haven't looked at that question at
this point.
Mr. English. May I call on you to do that, and I would
welcome correspondence to myself and to the Committee on that
point.
[The following was subsequently received.]
[The following was subsequently received:]
At the request of Chairman Archer, the U.S. General
Accounting Office is currently conducting a review of debt
management by the the U.S. Treasury and other selected
countries which directly addresses Representative English's
question. GAO has provided te Committee with several briefings
and will issue a final report upon completion of its work.
Mr. English. What consequences are there to the Treasury's
understanding ratioing of debt issues, the fact that there are
fewer debt issues, does that have any impact on capital
markets?
Mr. Posner. It has an impact through this liquidity
problem. As the supply of debt shrinks, we are not issuing as
much as the demand, and so the potential prices are affected
and we are not satisfying that segment of the market.
Markets do adjust but that is a long run phenomenon and we
know that adjustment won't be seamless. If we continue down
this path, you would think that markets would find other
benchmarks, for example, to focus on. But it is principally the
liquidity problem that has affected the markets.
Mr. English. May I ask one more question and I will make it
brief.
Mr. Nussle. Without objection.
Mr. English. Given that the Treasury has, as I understand
it, not budgeted for their proposal on cash management, I would
be curious about how it is likely to affect the efforts
presumably of both parties to sequester those national revenues
that are arising from the payroll tax and use them explicitly
for Social Security purposes.
In other words, does this Treasury proposal mean that the
Treasury is going to be invading--or creating a deficit outside
of Social Security?
Mr. Posner. Well, the way it is currently accounted for and
the way it would affect the actual cash position of the
Government is, in the current year, it would be a reduction in
the surplus.
Now, whether it is a reduction in Social Security surplus
depends if there are enough on-budget surpluses to draw from
for this purpose or not. If there aren't, then it would be a
call on that portion of the surplus. However, over time, if we
do buy back higher-cost securities, we are going to----
Mr. English. And savings----
Mr. Posner [continuing]. And savings on the tail. When you
look at a 10-year perspective, you could probably judge it to
be neutral. Except for the premium, the financing of the
premium, as Chairman Archer pointed out earlier, would be a
slight additional cost that would have to be financed.
Mr. English. Thank you.
And thank you for the opportunity, Mr. Chairman.
Mr. Nussle. Are there other Members who wish to ask
questions of this panel? If not, thank you, panelists, for your
testimony and you are excused. We appreciate your testimony
today.
The final panel for today's hearing on the Treasury's debt
buyback proposal includes Dr. John H. Makin, resident scholar
of the American Enterprise Institute; and Charles H. Parkhurst,
vice chair, Government and Federal Agency Securities Division,
Bond Market Association and managing director of Salomon Smith
Barney of New York.
We appreciate you gentlemen coming here today to give us
testimony on this issue and we will recognize Dr. Makin first,
and your full testimony, without objection, will be inserted in
the record and you can feel free to summarize your testimony at
this time. Dr. Makin.
STATEMENT OF JOHN H. MAKIN, RESIDENT SCHOLAR, AMERICAN
ENTERPRISE INSTITUTE
Mr. Makin. Thank you, Mr. Nussle, and Mr. Chairman and Mr.
Rangel and Members of the Ways and Means Committee. It is a
pleasure to be back before you, after an absence of several
years, to testify on the Treasury's proposal to buy back some
of the U.S. Government's outstanding debt before it matures.
Any attention paid to careful management of the U.S.
Government's debt is, of course, commendable. As one of the
Members has already noted, Alexander Hamilton, the first
Secretary of the Treasury, remarked in his report on the public
credit issued in January of 1790 that America's national debt
could be a blessing to the country. And I think some of the
discussion today about the benefits of having a well-managed
stock of outstanding debt was well anticipated by Alexander
Hamilton.
With Hamilton's principles in mind and with the knowledge
that the current stock of U.S. Government debt held by the
public stands at about $3.6 trillion or a modest 41 percent of
GDP, I see no urgency about the overall size of the debt.
Indeed, CBO projects that over the next decade, debt held by
the public could drop to about 6.4 percent of GDP, based on
some assumptions about the economy and the course of government
finance.
Having said that, of course, we all must remember the great
sense of alarm with which prospective U.S. Government finances
were viewed during most of the eighties. I would argue, and
have argued at more length in the attached American Enterprise
Institute publication about the determinants of interest rates,
that the concerns about America's debt buildup were overdone
while, simultaneously, the optimism about the future course of
debt may also be overdone. Basically, the argument suggests
that there is little relationship between the level of interest
rates and normal oscillations in the fiscal stance of
governments, of advanced industrial countries like the United
States and Japan, and that the proper attention of fiscal
policy should be directed primarily to collecting taxes in the
way least costly to the economy and on a scale that finances
consistently a modest-sized Federal Government.
The Treasury's debt buyback proposal is really about the
management of a given stock of debt rather than about its
absolute level or its level relative to GDP. The Treasury's
proposal aims to improve liquidity in the Treasury market and
amounts to debt management of the type that most corporations
perform on their balance sheets.
And as I listened to the testimony this morning, I was
trying to think of a way to characterize the role of this
proposal in the context of overall fiscal policy. I guess I
would do it something like this.
If I were a child who had been deprived of candy for a year
or several years, paying down the debt is the equivalent of
being able to go out and buy some candy. Very attractive. Lots
of fun. It raises lots of choices.
But the Treasury's debt management proposal is really about
what size packages of candy you should buy. In other words, it
is not about the level of the debt.
We are all happy to be running down debt. The Treasury is
addressing what I would generally call, both as a public policy
expert and as a participant in the financial markets, a
``peripheral issue,'' one that the Treasury can and does manage
pretty much on its own. And there are some technical issues
raised that I just want to briefly touch on.
The Treasury's debt management proposal would involve the
purchase of some illiquid issues, particularly longer
maturities financed, in turn, by the issue of shorter term
government debt. The reason that there are going to be longer
maturities is simple. If you have got a 1-year instrument, why
worry about a liquidity issue? It is going to mature at par, so
it is not an issue to be bought back prior to maturity. The
fact that most of the issues that the Treasury would be buying
back would be higher yield issues of longer maturities is
simply due to the fact that interest rates have been going down
for the past 25 years. So naturally most of the issues that the
Treasury would contemplate repurchasing would be issues with
higher coupons of longer maturity.
The debt isn't generally callable and can't be retired
before maturity at par. It has to be purchased in the
marketplace at prices that fully reflect the unusually high
coupon. For example, U.S. Government bonds that mature in
November 2006 carry a market price of about $1,432 per unit,
well above the par value of $1,000 per unit. This reflects the
fact that investors who purchased 30-year bonds yielding 14
percent at a time when U.S. inflation was high and the finances
of the U.S. Government were less sound than they are today have
reaped a windfall gain from their purchases of U.S. Government
bonds. That is because now U.S. Government bonds of comparable
maturities yield between 5\1/2\ and 6 percent and so the
investor has to be compensated with the higher premium that he
would be giving up.
We should not do away with the callable feature of
Treasuries because such a future makes them more attractive. We
have already covered the fact that above-bar buybacks would
reduce the surplus in a given year. I think it is important to
realize that buybacks don't provide any net benefit in terms of
overall outlays unless the Treasury is issuing short-term debt
to buy back long-term debt and interest rates fall in a way
that is not currently anticipated by the market.
In closing, let me say that the American government
currently enjoys one of the soundest fiscal positions among
industrial
countries, and in the world for that matter. This may be the
time simply to leave well enough alone and concentrate instead
on constraining the growth of spending while simultaneously
restructuring the tax system to reduce the cost of collecting
revenues. Indeed, sound arguments could be made to move to
lower and uniform tax rates and that would probably benefit the
economy more over the next decade than would the reduction of
the national debt to 6 percent of GDP. Certainly the benefits
of such measures would be greater than efforts to rearrange the
debt structure of U.S. Government securities outstanding.
Thank you.
Mr. Nussle. Thank you.
[The prepared statement follows:]
Statement of John H. Makin, Resident Scholar, American
Enterprise Institute
Mr. Chairman, members of the Ways and Means Committee,
thank you for providing me with the opportunity to testify
today on the U.S. Treasury's proposal to buy back some the U.S.
government's outstanding debt before it matures.
Any attention paid to careful management of the United
States government's debt is, of course, commendable. Alexander
Hamilton, the first Secretary of the Treasury, remarked in his
Report on the Public Credit issued in January of 1790, that
America's national debt could be a ``blessing'' to the country.
By this he meant that the United States could be well served by
maintaining even a large outstanding stock of debt which was
well managed and provided lenders with a reliable store of
value providing a fair rate of return. More broadly, Hamilton
reminds us that U.S. Treasury debt management should be aimed
at minimizing the government's borrowing costs for a given
stock of debt and not necessarily at eliminating the debt.
With Hamilton's principles in mind, and with the knowledge
that the current stock of U.S. government debt held by the
public stands at about $3.6 trillion or a modest 41 percent of
GDP, I see no urgency about the overall size of the debt.
Indeed, CBO projects that, over the next decade, debt held by
the public could drop to about 6.4 percent of GDP based on some
reasonable assumptions about the economy and the course of
government finance. Having said that, of course, we all must
remember the great sense of alarm with which prospective U.S.
government finances were viewed during most of the 1980s. I
would argue, and have argued at more length in the attached
American Enterprise Institute publication about the
determinance of interest rates, that the concerns about
America's debt buildup were overdone while, simultaneously, the
optimism about the future course of debt may also be overdone.
Basically, the argument suggests that there is little
relationship between the level of interest rates and normal
oscillations in the fiscal stance of government's of advanced
industrial economies like the United States and Japan and that
the proper attention of fiscal policy should be directed
primarily to collecting taxes in the way least costly to the
economy and on a scale that finances consistently a modestly-
sized federal government.
The Treasury's debt buyback proposal is really about the
management of a given stock of debt rather than about its
absolute level or its level relative to GDP. The Treasury's
proposal aims to improve liquidity in the Treasury market and
amounts to debt management of the type that most corporations
perform on their balance sheets.
The Treasury's debt management proposal would involve the
purchase of some illiquid issues, particularly longer
maturities financed in turn by the issue of shorter-term
government debt. The fundamental constraint on a benefit to the
U.S. government from this debt management is the fact that
virtually all of U.S. government debt is not callable. That is,
the debt cannot be retired before maturity at par. Rather, it
must be purchased in the marketplace at prices that fully
reflect the unusually higher coupon level that such debt may
carry. For example, the U.S. government bonds that mature in
November of 2006 carry a market price of $1432 per unit, well
above the par value of $1,000 per unit. This reflects the fact
that investors who purchased 30-year bonds yielding 14 percent
at a time when U.S. inflation was high and the finances of the
U.S. government were less sound than they are today have reaped
a windfall gain from their purchase of U.S. government bonds.
That is because now U.S. government bonds of comparable
maturities yield between 5.5 and 6.0 percent and so the owner
of a U.S. government bond yielding 14 percent is not going to
yield up his high-yielding bond for anything less than a price
that fully reflects the present discounted value of that higher
yield, in this case an extra $432 per $1000 of face value.
The facts outlined here are not meant to suggest any
modification in the non-callable feature of Treasury
securities. Such a non-callable feature makes the bonds more
valuable to investors who are willing to purchase them when
circumstances such as larger supply or rising inflation make
for a higher yield. The non-callable feature on long-term
government debt rewards those lenders who were willing to
purchase Treasury bonds at a time when they were decidedly out
of favor. Those are the kinds of investors one wants to keep in
the universe of potential customers for U.S. government debt.
The fact that, although U.S. government debt rose rapidly
during the 1980s while interest rates were falling, is
testimony for the benefits of sound debt management,
particularly the benefits of bringing down inflation and to
eventually aligning the growth of revenues and outlays so as to
stabilize and ultimately to reduce the ratio of government debt
to GDP.
The way the U.S. budget is scored, the premium paid to
retire debt with high coupons (interest rates above current
market interest rates) would count as an outlay and therefore
would raise the measured budget deficit during the year in
which such debt management was undertaken. This, however, need
not constitute a major argument against the proposal since the
premium paid is actually a pre-payment of higher coupons in
future years and the impact on the present value of overall
payments to serve the national debt would be close to zero.
In summary, if the purpose of the Treasury's proposed debt
management initiative is to reduce the present value of debt
service outlays on the national debt, it is unlikely that much
will be accomplished. In effect, the Treasury, by issuing
short-term debt to buy back long-term debt, is betting on a
fall in long-term interest rates that is not currently
anticipated by the market. If long-term interest rates were to
drop, say from the current level of 6.0 percent to 3.0 percent,
the Treasury's proposed swap of short-term for long-term debt
could only be done on even less favorable terms than are
available at today's interest rates. Therefore, the Treasury,
by purchasing high-yielding long-term debt at less of a premium
would, after the fact, have saved taxpayers some money. But
since the Treasury would probably be the first to admit that it
is no better at forecasting interest rates than anyone else,
the benefits of the buyback on a forward looking basis,
specifically in terms of debt management costs, would be close
to zero.
The American government currently enjoys one of the
soundest fiscal positions among the industrial countries and in
the world for that matter. This may be the time, simply, to
leave well enough alone and concentrate instead on constraining
the growth of spending while simultaneously restructuring the
tax system to reduce the cost of collecting revenues. Indeed,
sound arguments could be made that a move toward lower uniform
tax rates could benefit the U.S. economy more over the next
decade than would reduction of the national debt to 6.0 percent
of GDP. Certainly the benefits of such measures would be
greater than efforts to rearrange the debt structure of U.S.
government securities outstanding.
[An attachment is being retained in the Committee files.]
Mr. Nussle. Mr. Parkhurst, your testimony in its entirety
is included in the record. You may feel free to summarize.
Welcome.
STATEMENT OF CHARLES H. PARKHURST, VICE CHAIR, GOVERNMENT AND
FEDERAL AGENCY SECURITIES DIVISION, BOND MARKET ASSOCIATION,
AND MANAGING DIRECTOR, SALOMON SMITH BARNEY, NEW YORK, NEW YORK
Mr. Parkhurst. Thank you very much and good morning. I am
pleased to be here to discuss the Bond Market Association's
views on the Treasury Department's buyback proposal. The Bond
Market Association represents securities firms and banks that
underwrite, trade and sell debt securities both domestically
and internationally. Our membership includes all major dealers
in government securities including all 30 primary dealers. For
15 years, my career has been focused on the government
securities market. I have seen the size of the market grow
substantially over the years as persistent deficits cause
Treasury issues to swell.
Now we are at a time of unprecedented surpluses and the
question before us now is to how to most effectively retire the
Government's debt. Under some projections, the Government
securities market will disappear entirely in the next 15 years.
The Association believes that a properly structured buyback
program is the best way to retire the Government's debt and
will--I repeat, will reduce interest expense for the American
taxpayer. Beyond that, it is vital that to the extent possible,
we maintain the premier role of the government securities
market as a global benchmark. After all, it is quite possible
that the Government may again become a net borrower sometime in
the future.
My written statement discusses in detail the benefits to
Federal taxpayers in the economy as a whole of maintaining an
active and liquid on-the-run market for Treasury securities.
Rather than outline my entire written statement, I would like
to discuss what I believe is the biggest obstacle to the
success of a buyback program; that is, the budgetary accounting
of premiums and discounts on outstanding government securities
purchased by the Treasury in the open market.
I was going to go through the details of the budgetary
accounting, but my predecessors have done that ad nauseam, so I
am going to skip over that part and jump to the consequences of
the way the Government accounts for buying securities back at a
premium.
Almost all the securities which are likely candidates for
buyback are traded premiums. That means in the current budget
rules, most buyback transactions would have the effect of
reducing the surplus. This has several implications. First, it
could limit the size and the success of the buyback program.
Treasury may be essentially unable to buy back many securities
because of negative budget consequences.
Second, it could prevent Treasury from buying back those
securities which offer the largest interest cost savings for
the Government over the long haul, in other words, those which
carry the highest coupon rates. Finally, to the extent that
Treasury does buy back premium or discount securities, these
transactions would result in annual budget surpluses larger or
smaller than otherwise would be the case.
The most obvious solution to this problem would be to
change or clarify the budget accounting rules so that any
expense or savings associated with buying back securities could
be spread out over the years that the securities would have
been outstanding. This method is used by other sovereign
nations that have conducted buybacks.
We sincerely believe that this accounting issue, as arcane
as it sounds, could be a serious impediment to the buyback
program. We urge all parties involved in the discussion over
buybacks to work together to address this issue. If the
accounting cannot be changed, it is crucial to the program's
success that Treasury not be driven by the short-term budgetary
impact of their purchase decisions. If Treasury were to skew
their purchases toward low-priced bonds, the impact on the
liquidity of the entire Treasury market would be severely
impaired. I simply can't emphasize that point enough.
Finally, I would like to spend a minute to talk about the
timing of debt buybacks. Treasury plans to issue--to use debt
buybacks as one tool to help them manage their cash balances.
That has been discussed at length as well. While we feel this
is a useful attribute of debt buybacks, we also feel that a
regular buyback schedule is crucial to the ultimate success of
the program. Just as regular, quarterly Treasury issuance
maximizes investor focus on the auctions, we feel a regular
schedule of buybacks would yield the greatest participation and
therefore the most advantageous pricing for the Treasury.
And finally I want to spend a few minutes talking about
something that was a little bit confusing in prior testimony,
and that is, will the Government actually save money from
conducting debt buybacks? And apart from the issue of adjusting
the average maturity, which I think should be put aside as a
separate issue, it is very clear to market participants that
you can quantify the interest rate savings very directly. Let
me give you one simple example of that.
Right now the Treasury can issue 10- and 30-year bonds at
approximate yields of 5.9 and 6 percent, respectively. They
could simultaneously issue those bonds and purchase 20-year
bonds, in other words, bonds that exist right in between a
maturity spectrum, at approximately 635 or 640. So effectively
what the Treasury would be doing is retiring 20-year bonds,
issuing 10- and 30-year bonds, doing nothing to the average
maturity and very easily quantify the interest rate savings.
To put it in perspective historically, the spreads that I
just alluded to are literally at their widest point over the
last 15 years I have been following this market. So not only
can the Treasury save money, but they can save more money by
implementing the program now than they could have in the last
15 years.
Thank you.
[The prepared statement follows:]
Statement of Charles H. Parkhurst, Vice-Chair, Government and Federal
Agency Securities Division, Bond Market Association and Managing
Director, Salomon Smith Barney, New York, New York
The Bond Market Association appreciates the opportunity to
comment on the Treasury Department's debt buyback proposal and
on Treasury debt management in general. The Bond Market
Association represents securities firms and banks that
underwrite, trade and sell debt securities, both domestically
and internationally.
Our membership includes all 30 primary dealers in
government securities as recognized by the Federal Reserve Bank
of New York, as well as hundreds of other securities firms and
banks that participate in the government securities market. We
take a very active interest in issues related to federal
government finance and the Treasury securities market. A liquid
and efficient government securities market is in the interest
of securities dealers and, much more importantly, in the
interest of the federal government and U.S. taxpayers. The Ways
and Means Committee's continued attention to Treasury debt
management issues is welcome and appreciated. We commend you,
Chairman Archer, for calling this hearing, and we are pleased
to present our views.
We find ourselves today in an enviable position. We are
assembled this morning to discuss the most efficient and
desirable way for the Treasury Department to retire the debt of
the United States. Just a few years ago, it was virtually
unthinkable that the fiscal deficit would be eliminated and
that the entire federal debt held by the public--nearly $3.3
trillion--would be expected to be retired entirely in our
lifetimes. The question now for the Treasury Department and for
members of this committee is how to retire the debt in the most
orderly way without threatening the efficiency and liquidity of
the market.
The Government Securities Market
The U.S. government securities market is widely
acknowledged as the most liquid and efficient securities market
in the world. Daily trading volume in Treasury securities
totals in the hundreds of billions of dollars. Trading
spreads--secondary market dealer transaction costs-are razor
thin. Treasury securities are held by a large and diverse group
of investors, including individuals, state and local
governments, corporations, pension funds, insurance companies,
central banks and others. The government securities market is
the model of market efficiency around the world, and the
market's efficiency and liquidity provide several important
economic benefits.
Low-cost government financing--The market's efficiency
allows the federal government to issue approximately $2
trillion per year in bills, notes and bonds at reasonable
terms. Considering that approximately $5.6 trillion of Treasury
debt is outstanding, if the government incurred an overall cost
of borrowing just 1/100th of a percentage point (1 basis point)
higher, taxpayers would face an additional interest expense of
$560 million per year. Clearly, maintaining an efficient new-
issue market for Treasury securities is in the interest of
taxpayers.
A ``reference'' interest rate market--The U.S. Treasury
securities market is the interest rate benchmark for all the
other U.S. debt markets. Corporate, municipal and federal
agency bonds and mortgage--and asset backed securities are all
priced by their ``spread to Treasuries,'' i.e., their yield
above comparable government securities, which allows for much
more efficient pricing. This ``reference yield curve'' allows
borrowers other than the federal government--corporations,
states and localities, government-sponsored enterprises and,
indirectly, homebuyers and consumer borrowers--to access
capital at the lowest possible costs for several reasons.
First, the liquidity of the Treasury market allows market
participants to hedge risk associated with positions in other
types of bonds. Second, because Treasury securities are
considered to be free from credit risk, it is easier to
evaluate debt instruments such as corporate bonds and mortgage-
backed securities against the risk-free rates in the Treasury
market.
A vehicle for implementing monetary policy--When the
Federal Reserve seeks to adjust interest rates or the money
supply, it acts principally through the government securities
market. On an almost daily basis, the Federal Reserve Bank of
New York buys or sells Treasury securities under repurchase
agreement contracts. Less frequently, the Fed buys or sells
Treasury securities outright. The Fed's counterparties are a
network of securities dealers known as ``primary dealers.'' The
Fed uses the government securities market principally as a
monetary policy tool because of the market's efficiency and
liquidity.
The efficiency of the government securities market is best
observed by examining ``on-the-run'' Treasury securities. On-
the-run Treasuries are the most recently issued series of bonds
in each regularly auctioned maturity. The vast majority of
secondary market trading in government securities takes place
in these benchmark issues. The on-the-run market is supported
by a dependable and well-publicized schedule of Treasury
Department auctions. This regular and predictable schedule is
necessary because Treasury often sells tens of billions of
dollars of bills, notes or bonds over short periods of time.
Market participants depend on a regular auction schedule to
plan for the efficient placement of large volumes of
securities. The Treasury Department's financing is motivated by
a single factor: the government's cash position. The Treasury
Department must ensure that the government's cash on hand
remains at levels high enough to ensure that obligations are
met, but not so high that taxpayers incur needless interest
expense. Much of the Treasury Department's new securities
issuance is for the purpose of ``rolling over,'' or
refinancing, outstanding debt that comes due.
In recent years, as the fiscal budget deficit has shrunk
and then disappeared altogether, the government's cash needs
have diminished. Consequently, the Treasury Department has
reduced the sizes of securities auctions and eliminated certain
sales entirely. As the budget surplus continues to grow, the
Treasury Department could simply continue the same strategy of
curtailing auction sizes for new securities. However, we
believe that the sizes of securities auctions would eventually
fall to the point where efficiency suffers, and the government
would pay a higher interest rate on its borrowing than
otherwise. In addition, secondary market trading volume in on-
the-run Treasury securities would fall, and we would begin to
see the loss of economic benefits associated with an active and
liquid secondary market in government securities. If budget
surpluses continue to rise at the rate of current projections,
these negative effects will inevitably occur. Indeed, if the
projections of the Congressional Budget Office and others hold
true, the government securities market will disappear entirely
in about 15 years. However, through the effective use of
buybacks, we anticipate that we can maintain the vibrancy--and
the associated economic benefits--of the on-the-run Treasury
market for much of that time.
The Treasury Department's Buyback Proposal
On August 5, the Treasury Department published a proposed
rule encompassing the terms of a Treasury securities buyback
program. In general, The Bond Market Association supports the
effective use of buybacks as a means of managing the
government's debt position. Buybacks will allow Treasury to
maintain sizable new auctions while retiring outstanding debt
in the most efficient manner possible. We are in the process of
drafting a detailed comment letter on the Treasury proposal
which we will file by the October 4 deadline. We would be happy
to share our comments with the committee members when our
letter is final. For today, we will touch on several key
points.
Premium Versus Discount Coupons
When a debt security carries an interest rate, or
``coupon,'' higher than that currently being demanded by market
investors, that security is said to trade ``at a premium.'' Its
price is higher than its par amount, or face value. Conversely,
when a debt security carries a coupon lower than that currently
being demanded by market investors, that security is said to
trade ``at a discount.'' Its price is lower than its par
amount. Because current market interest rates are low relative
to the past 15 years, most outstanding Treasury notes and bonds
trade at a premium. Moreover, many ``seasoned'' Treasury
securities--securities that have been outstanding for some time
and which are no longer on-the-run--trade ``cheap,'' i.e.,
their prices are lower and their rates of return are higher 4
than one would expect considering the on-the-run market. This
occurs for several reasons.
First, the largest volume of outstanding securities in the
hands of trading market participants is in on-the-run issues.
As on-the-run issues age, a larger volume of these issues finds
its way into the portfolios of buy-and-hold investors and out
of the hands of active traders. As securities become less
actively traded, dealers price them less aggressively. Once an
issue loses its status as on-the-run issue, its rate of return
relative to similar issues rises slightly--it becomes cheaper--
because it becomes less actively traded. Second, certain
securities, those with 15 years or longer to maturity, are
eligible for delivery against the Chicago Board of Trade's
Treasury bond futures contract, a very active hedging and
trading instrument. As long-term bonds age to the point where
they have less than 15 years to maturity and are no longer
deliverable against the T-bond contract, they are priced less
aggressively and carry a higher rate of return, i.e., they are
cheaper. Third, off-the-run bonds with times-to-maturity
shorter than 30 years--the time to maturity for the actively
traded, on-the-run 30-year bond--tend to trade more cheaply
than securities whose times-to-maturity are closer to 30 years.
In implementing a buyback program, the Treasury Department
will likely find it most efficient to purchase securities with
a variety of maturities and coupons. It is our view that a
buyback program where certain issues are bought in their
entirety and other issues are wholly untouched could cause
market disruption. Moreover, it would be to Treasury's
advantage to buy seasoned securities whose prices are cheap,
thereby achieving the maximum interest cost savings.
Unfortunately, federal budget rules may discourage or prevent
the Treasury Department from buying certain premium securities.
This is, we believe, a potentially serious impediment to a
successful buyback program.
Accounting Issues
According to our understanding of federal budget and
accounting rules, if the Treasury Department buys back a
security at a price above par, or face value, the excess amount
above par is accounted for as interest expense in the year the
security is bought. Consider, for example, outstanding bonds
with a total face value of $100 million which, because they
carry an interest rate above the current market, sell at a
price of $125 million. The $25 million difference approximately
represents the difference between interest payments on $100
million of bonds at current rates and the higher interest
payments on the bonds that are actually outstanding. If
Treasury bought these bonds in a buyback transaction, the $25
million excess over face value would be accounted for as
interest expense at the time the purchase takes place. Federal
accounting rules do not allow Treasury to amortize the $25
million expense over the time that the bonds would have been
outstanding. Conversely, for securities bought at a discount,
the price amount below face value would offset other interest
expense incurred during the year. This timing issue is critical
in calculating the government's current-year fiscal position.
If Treasury undertook the buyback in the above example, the
budget surplus in the year the buyback took place would appear
$25 million smaller. If Treasury bought securities at a
discount, the budget surplus could appear larger.
The negative budgetary effects of buying back securities
priced at a premium could seriously hamper the success of the
buyback program. For decades, Treasury staff has been
apolitical in its debt management practices, and we have every
reason to believe that it will continue to be. In addition,
Treasury uses sophisticated financial management tools in
making debt financing decisions, and we expect that the same
level of sophistication would be applied to the buyback
program. However, given the unique nature of the budgetary
effects associated with buybacks, it is conceivable that
Treasury could be influenced to buy back only those securities
which trade at a discount to face value. This would hinder the
program because, first, there are relatively few discount
securities in the secondary market. Second, concentrating
buybacks only on certain securities could cause market
anomalies and could cause the prices of some securities to
suffer.
Finally, Treasury could be effectively discouraged from
buying those securities that would generate the greatest
interest cost savings to taxpayers. Treasury has indicated that
the buyback program will be used to shorten the average
maturity of the government's debt. For various technical
reasons, it is likely that Treasury will concentrate its
buybacks on outstanding issues scheduled to mature after 2014.
Of the outstanding Treasury debt maturing after 2014,
approximately $248 billion would be likely candidates for
buybacks. Virtually all of this $248 billion in outstanding
debt trades at premium prices. In fact, this debt has a current
combined market value of approximately $308 billion. This $60
billion difference--$248 billion of debt at a value of $308
billion represents the ``front-loaded'' interest expense that
the government would incur if these outstanding securities were
bought back over the next ten years. Of course, the interest
savings to taxpayers over the remaining 15 years of
indebtedness would be even higher. It is clearly in the federal
government's interest to buy back these outstanding securities.
However, current accounting rules could make that prospect
practically difficult.
In addition, as a result of this accounting issue, the true
size of the budget surplus could be exaggerated. In order to
achieve a larger surplus, Treasury could simply buy back
discounted securities and inflate the size of the surplus. This
practice could have serious implications if, for example,
Congress were to enact tax cuts that were contingent on meeting
certain budget surplus targets. Conversely, Treasury could
concentrate its buybacks on premium securities in order to make
the surplus appear smaller. The most obvious solution to this
problem would be to change federal budget and accounting rules
so that when Treasury bought back securities priced at a
premium, the excess price over face value could be amortized
over the period that the securities were expected to be
outstanding. The same principle in reverse would apply to
securities bought at a discount.
Other Issues
Our comment letter on Treasury's buyback proposal will also
likely address other issues. We expect to recommend, for
example, that reverse auctions take place on a regular,
predictable schedule with announcements made in reasonable
advance. In addition, we may also recommend that Treasury
exercise caution in selecting which securities to buy back so
as not to magnify any technical or liquidity issues that may be
prevailing in the market at the time. We will also likely
comment on the settlement of buy-back transactions and on other
technical issues.
Summary
The Bond Market Association believes that in general, a
program of regular buybacks represents the preferred method for
retiring federal debt. A successful buyback program would help
to preserve the efficient auction program for new Treasury
securities and would help to keep the government's financing
costs as low as possible. It would also help preserve the
liquid ``on-the-run'' secondary market in Treasury securities,
thereby maintaining the important economic benefits that market
provides. Our principal concern regarding buybacks involves the
accounting treatment of premiums and discounts for securities
bought by Treasury in the public market. If left unresolved,
this issue could threaten the success of the program.
We appreciate the opportunity to present our views, and we
look forward to working with the Treasury Department, the
Federal Reserve and, of course, this committee as this issue
progresses.
Mr. Nussle. Thank you very much for your testimony.
First of all, we love discussing budgetary scoring details;
around here, you can never discuss them ad nauseam. We
appreciate the opportunity to continue that discussion. And, in
fact, that is where probably a lot of this will end up in
making any kind of final decision about what is good policy and
bad policy is, how in fact it scores, because as I understand
Dr. Makin's testimony, one of your--please correct me if I
misunderstand this--basically what you are suggesting is that
the debt buyback plan will only generate savings if interest
rates fall, which makes some logical sense. And I may have
heard a conflict between the two of you on that statement, and
I guess I would just like to hear you talk about what was just
discussed.
You are basically saying, unless they fall, the plan really
doesn't work; is that correct? And could you explain that a
little further? Then I would like to hear at least a little bit
of rebuttal from Mr. Parkhurst.
Mr. Makin. I don't think there is a real difference here.
I think that Mr. Parkhurst's testimony was referring to the
shape of the yield curve and some liquidity premia on some off-
the-run issues. I am saying that if you are going to buy
buyback debt, it is going to be longer term debt. It is
probably going to be selling at a premium to the market, and
that is simply because there is not much point in buying back
short-term debt--it will mature and run off at par, why bother;
that is simple debt management--and second, because interest
rates have been going down since 1979, again typically anything
you are going to buy back will have interest rates above market
rates and so will have to be purchased at a price above par.
The point I am making is straightforward. You go to
somebody who owns, let's say, a bond, a government bond that is
bearing 14 percent that is going to mature in 2006 and look up
its price in the Wall Street Journal. That bond is now selling
for $1,432 per $1,000 face value. The person is saying, look, I
am going to pass up a 14 percent interest rate between now and
2006; you have got to pay me now.
So the Treasury would essentially have to pay now the
present value of the forgone interest on that bond; and they
could do it by borrowing short term. And as has been noted, the
budget procedure, I believe, requires that the $432 per bond be
scored as an outlay.
The point that I am making is, look, why go through all
that? The present value of interest costs to the Treasury isn't
going to be better unless there is an unexpected drop in
interest rates. That is, if interest rates dropped to 3 percent
and you retired 6 percent debt, you retire debt when market
rates are 6 percent, the Treasury has made a gain.
I don't think the Treasury is proposing that they can
forecast interest rates. I think the Treasury is strictly
talking about cash management here. I don't really think the
Treasury is talking much about interest savings other than very
small interest savings from cleaning up their balance sheet and
getting rid of some off-the-run issues. Again, these issues
become less intense with the passage of time. With an illiquid
issue--for example, for my daughter, I bought some off-the-run
Treasuries and got a slightly higher rate of return because I
know that if I needed to sell them before they matured,
somebody on a bond desk would give me a real haircut. The
Treasury is trying to alleviate that problem, saying, let's
neaten up our balance sheet.
The reason I bought it is because I am going to hold it
till it matures and matures at par. There is no issue of
transactions cost selling it beforehand.
Again, that is why I go back and use the candy bar analogy.
The surplus is having candy to buy. This is a very technical
issue which the Treasury can manage, and it is akin to, should
I buy a 2-ounce package of candy or a 4-ounce package of candy?
It is not a big issue. It has virtually no budgetary
implications other than those that are driven--and I understand
that this is important--by the way in which you score the
premium that has to be paid for issues with higher interest
rates.
Mr. Nussle. Mr. Parkhurst.
Part of the reason I ask the question, there is just about
no one that I am aware of forecasting a drop in interest rates
any time soon. Your example makes sense when you are talking
about from 6 to 3. Certainly that makes sense. But there is no
one who is suggesting that kind of drop. In fact, an increase
is what appears to continue to be on the horizon at least. So
that is the reason I ask the question.
Mr. Parkhurst. I think it is important, as I said, to
separate out two different issues. To the extent that the
Treasury wants to push the average maturity of their debt down,
they are in effect making a better interest rate relative to
doing nothing with the average maturity.
Now, it has crept higher over the past year or so, so maybe
they are justified in using debt buybacks as a mechanism for
pushing it down back toward what they perceive to be
neutrality. Maybe they think it is too long right now and this
is one way to get back toward neutrality. That is one issue. I
would separate that issue out from the other issue.
He talked about the 14s of 11, callable 06, and he is
right, that issue will mature at par, so why bother to call to
buy it back. The reality of it, the Treasury, if they issue an
on-the-run security maturing in 06--in other words, the same
maturity date when this one comes due--they can do so at a
substantially lower yield than the securities exchange in the
marketplace. That is the liquidity premium that he referred to
earlier.
While it is true that this issue will over the next 7 years
naturally roll off, the Treasury can actually say, ``Well, I
perceived there to be significant interest savings over that 7-
year period by repurchasing it today and doing nothing to the
average maturity mix.'' That issue probably has a present value
savings in the neighborhood of 2\1/2\ to 3 percent if you look
at present value terms. So for every 100 million that the
Treasury bought back, they would save $2.5 to $3 million in
present value terms; and that is easy to quantify, and I have
my research department behind me if you want to go through the
numbers.
If you look at it in the longer part of the curve, in 2015
and longer, if you look at the Treasury maturity structure, it
is kind of interesting. They, Treasury, stopped issuing
callable bonds in 1985, and prior to that, all 30-year issues
were callable after 25 years. There is a gap in the maturity
structure between, effectively, 2010 and 2015. Since
projections are that the Treasury debt will go down close to
zero in 15 years, it seems to make most sense for Treasury to
start repurchasing securities that mature after 2015.
If you look at the present value savings I just referred to
in the 14s of 11, that was referred to earlier, those present
value savings are on the order of 5 percent. So for every 100
million repurchased, $5 million is saved on a present value
basis. Once again, that is a very quantifiable savings. We have
numbers going back 10 or 15 years in the Government securities
market.
This number used to be on the order of 2\1/2\ to 3 percent,
historically. So the present value savings available to the
Treasury has doubled. And the reason it has doubled primarily
is an overhang from the liquidity problems that existed in the
fixed income markets last fall. I am sure you all remember the
long-term capital rescue that was orchestrated by the Fed. We
are still seeing the overhang from that episode, and one of the
results of it is the significant cheapness in the bond sector
that enables Treasury to save significant money by buying them
back.
Mr. Nussle. Thank you.
Mr. Rangel.
If there aren't any other members who wish to ask
questions, thank you very much for your testimony and your
attendance today; and with that, this hearing on the debt
buyback proposal is adjourned.
[Whereupon, at 12:37 p.m., the hearing was adjourned.]