[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 
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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 
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    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
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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.
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   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.]

                                
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