Federal Debt: Debt Management in a Period of Budget Surplus (Testimony,
09/29/1999, GAO/T-AIMD-99-300).
Pursuant to a congressional request, GAO discussed managing debt in a
time of budget surpluses.
GAO noted that: (1) the federal budget is about to record the first
back-to back budget surpluses in more than 40 years; (2) 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; (3)
the Department of the Treasury faces the challenge of managing the
surplus rather than financing a deficit; (4) 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; (5) in August the Treasury
published proposed rules for advanced repurchase of outstanding debt
held by the public--a debt buy back; (6) these repurchases could require
the Treasury to pay a premium since most of the older securities have
interest rates higher than those issued today; (7) 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; (8) 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; (9)
there will be greater pressure on the Treasury to further concentrate
debt in fewer issues to maintain deep and liquid markets in benchmark
securities; and (10) although markets tend to adjust over time, these
changes may not be seamless or without cost.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: T-AIMD-99-300
TITLE: Federal Debt: Debt Management in a Period of Budget
Surplus
DATE: 09/29/1999
SUBJECT: Budget surplus
Economic analysis
Debt held by public
Deficit reduction
Public debt
Unified budgets
US Treasury securities
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Before the Committee on Ways and Means, House of Representatives
For Release on Delivery
Expected at
10 a.m.
Wednesday,
September 29, 1999
FEDERAL DEBT
Debt Management in a Period of Budget Surplus
Statement of Paul L. Posner
Director, Budget Issues
Accounting and Information Management Division
*****************
*****************
GAO/T-AIMD-99-300
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
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./Footnote1/
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 (r)buy-back.(c) 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's (CBO) 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./Footnote2/
Figure****Helvetica:x11****1: Federal Debt Held by the Public,
September 1996 Through July 1999
*****************
*****************
Source: Monthly Treasury Statement, Department of the Treasury.
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./Footnote3/
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.
Figure****Helvetica:x11****2: Treasury Bills, Notes, and Bonds as
Percentages of Marketable Public Debt
Outstanding, July 31, 1999
*****************
*****************
Source: Monthly Statement of the Public Debt of the United States,
Department of the Treasury.
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.
Figure 3 compares the allocation of the surpluses for the first 9 months
of fiscal years 1999 and 1998./Footnote4/ 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.
Figure****Helvetica:x11****3: Allocation of Unified Budget Surpluses,
October to June, Fiscal Years 1999 and 1998
*****************
*****************
Source: Monthly Treasury Statement, Department of the Treasury.
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.
Figure****Helvetica:x11****4: Average Length of Marketable Debt, 1990-
1998
*****************
*****************
Source: Treasury Bulletin, Department of the Treasury.
The Treasury announced in August 1999 that it will reduce the frequency of
issuance of 30-year bonds from three times a year to twice a year. This
will allow the Treasury to continue to concentrate on fewer but larger
benchmark issues/Footnote5/ 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.
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 from May 2000 through 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 over 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.
Contacts and Acknowledgments
For information about this testimony, please contact Paul. L. Posner at
(202) 512-9573 or by e-mail at [email protected]. Individuals making
key contributions to this testimony included Thomas James, Jose Oyola, and
Carolyn Litsinger.
(935336)
--------------------------------------
/Footnote1/-^(GAO/OCG-99-27, May 28, 1999).
/Footnote2/-^This total is net of unamortized premiums and discounts on
public debt securities.
/Footnote3/-^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.
/Footnote4/-^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.
/Footnote5/-^The most recently issued Treasury securities, known as
"benchmark" issues, are used by other financial services to price their
products.
*** End of document. ***