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Presentation to the Treasury Borrowing Advisory Committee
U.S. Department of the TreasuryOffice of Debt Management
January 30, 2007
2Office of Debt Management
Fiscal Perspectives
3Office of Debt Management
Recent US economic performance has been strong
4Office of Debt Management
Corporate and individual tax receipts remain strong
Corporation Taxes
0
10
20
30
40
50
60
70
80
90
100
Jan-
03
Apr-
03
Jul-0
3
Oct
-03
Jan-
04
Apr-
04
Jul-0
4
Oct
-04
Jan-
05
Apr-
05
Jul-0
5
Oct
-05
Jan-
06
Apr-
06
Jul-0
6
Oct
-06
$ Billions
0
10
20
30
40
50
60
70
80
90
100$ Billions
Major Corporate Tax Dates
Record $88.3 billion
Fiscal 2006 Y-O-Y growth = 24.8%
Individual Taxes
0
50
100
150
200
250
Jan-
03
Apr-
03
Jul-0
3
Oct
-03
Jan-
04
Apr-
04
Jul-0
4
Oct
-04
Jan-
05
Apr-
05
Jul-0
5
Oct
-05
Jan-
06
Apr-
06
Jul-0
6
Oct
-06
$ Billions
0
50
100
150
200
250$ Billions
Fiscal 2006 Y-O-Y growth = 11.4%
Major Individual Tax Dates
5Office of Debt Management
Corporate profits and equity markets continue to rise
S&P 500 Index
650
750
850
950
1050
1150
1250
1350
1450
Jan-
03
Apr-
03
Jul-0
3
Oct
-03
Jan-
04
Apr-
04
Jul-0
4
Nov
-04
Feb-
05
May
-05
Aug-
05
Nov
-05
Feb-
06
May
-06
Sep-
06
Dec
-06
650
750
850
950
1050
1150
1250
1350
1450
13.6% rise in 2006
Source: Haver Analytics
After-tax Corporate Profits
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
Q1-
03
Q1-
04
Q1-
05
Q1-
06
$ Trillions
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6$ Trillions
Source: Haver Analytics
6Office of Debt Management
Nonfarm payrolls continue to post gains while the unemployment rate remains low
Change in Nonfarm Payrolls (SA, Thousands) and the Civilian Unemployment Rate
-300
-200
-100
0
100
200
300
400
Jan-
03
Jul-0
3
Jan-
04
Jul-0
4
Jan-
05
Jul-0
5
Jan-
06
Jul-0
6
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
M-O-M Change in Nonfarm Payrolls Civilian Unemployment Rate
7Office of Debt Management
Treasury continues to monitor other trends
8Office of Debt Management
Housing market trends appear uneven, and energy prices, while moderating, remain volatile
Median Sales Price of Existing Single-Family Homes and Year-Over-Year Change
-10%
-5%
0%
5%
10%
15%
20%
Jan-
03
Jan-
04
Jan-
05
Jan-
06
-25
25
75
125
175
225
275$ Thousands
Y-O-Y Change Median Sales Price
Source: Haver Analytics West Texas Intermediate Crude Oil
0
10
20
30
40
50
60
70
80
90
Jan-
03
Apr-
03
Jul-0
3
Oct
-03
Jan-
04
Apr-
04
Aug-
04
Nov
-04
Feb-
05
May
-05
Aug-
05
Nov
-05
Mar
-06
Jun-
06
Sep-
06
Dec
-06
$/barrel
0
10
20
30
40
50
60
70
80
90$/barrel
Source: Haver Analytics
9Office of Debt Management
And while deficits have been declining, government expenditures continue to outpace receipts
Federal Deficit/Surplus as a Percentage of GDP
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
95 96 97 98 99 00 01 02 03 04 05 06
Fiscal Year
Percent
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0Percent
Federal Receipts and Outlays as a Percentage of GDP
14.0
15.0
16.0
17.0
18.0
19.0
20.0
21.0
22.0
95 96 97 98 99 00 01 02 03 04 05 06
Fiscal Year
Percent
14.0
15.0
16.0
17.0
18.0
19.0
20.0
21.0
22.0Percent
Receipts Outlays
10Office of Debt Management
Given recent trends, we would like the Committee’s views on the following:What is the Committee's view on the fiscal outlook in 2007 and beyond?Is Treasury’s issuance calendar adequately placed to address its future funding needs?
11Office of Debt Management
Competitiveness of the US Treasury Market
12Office of Debt Management
The US Treasury market is the most liquid government debt market in the world
13Office of Debt Management
Among major sovereign debt markets, average daily trading volume is highest in the US Treasury market
Average Daily Debt Trading Volume
0
100
200
300
400
500
60020
00
2001
2002
2003
2004
2005
2006
blns $ US Japan UK
Source: FR2004 Primary Dealer, Japanese Securities Association, UK DM O
14Office of Debt Management
Treasury market liquidity remains healthy
Primary auction demand is deep and continues to evolveAverage daily trading volume in the on-the-run US Treasuries continues to growBid-ask spreads remain narrowAverage trade sizes in the secondary market are growingGrowth of the US inflation-linked market has surpassed that of all other major inflation-linked debt issuers
15Office of Debt Management
Features of the US Treasury market: TransparencyRegular and predictable issuanceMinimal regulatory burden
16Office of Debt Management
Secretary Paulson’s Principles on Competitiveness in US Capital Markets
Treasury remains committed to strengthening not only the Treasury market but also US capital markets as a whole.
Global viewEvolving and responsive regulatory structureRules based on sound principlesRisk-based approach to regulationEnforcement to deter bad behavior, not hinder innovation or responsible risk taking
17Office of Debt Management
We welcome the Committee’s views on the following:How does the competitiveness of the US Treasury market compare to that of foreign bond markets?Are there steps that we should undertake to ensure that the Treasury market remains the preeminent debt market?
PAGE 1
Treasury Borrowing Advisory Committee Presentation to the Treasury
January 30, 2007
A Review of Short-Term Debt Issuance as it Relates to Short-Term Borrowing Needs
PAGE 2
Outlays and Receipts Rising
Outlays and Receipts, Fiscal Year Totals
0
0.5
1
1.5
2
2.5
3
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
$Tril
lions
Receipts Outlays
`
Source: US Department of Treasury
PAGE 3
The question before this committee, and the investment community at large, is whether the steps taken by the Treasury and others have been sufficient to withstand a future wide scale disruption, or whether additional measures should be considered and implemented at thistime.
This report will touch upon the following:Current borrowing need volatilityThe factors that will contribute to further volatility in borrowing needs
The effectiveness of short-term debt securities in the current environment
Treasury’s effectiveness of managing high cash balances (TT&L--Treasury Tax and Loan and the TIO--Term Investment Option, a pilot program offered to TT&L participants)
If the market were to face a large scale disruption at a time when Treasury cash balances were low, is the Treasury well placed to handle such a contingency event? Is Wall Street Prepared?
Review the suggestions presented to Congress by the GAO; both positive and negative
Additional tools or issues the Treasury should consider at this time
PAGE 4
Volatility of Borrowing Needs in Dollar Terms
Source: US Department of Treasury
80 85 90 95 00 05
billio
ns
-300
-200
-100
0
100
200
300Receipts Q/Q $B (+/- 1SD)
80 85 90 95 00 05
billio
ns
-300
-200
-100
0
100
200
300Outlays Q/Q $b (+/- 1 SD)
Source: US Department of Treasury
PAGE 6
Borrowing Have Been Trending Lower, Despite Volatility in Outlays & Receipts
Fiscal Year Budget Budget % GDP2003 -$375 3.4%2004 -$411 3.5%2005 -$321 2.5%2006 -$248 1.9%2007 Estimates Budget Budget % GDPOMB -$339 -2.4%CBO -$172 -1.3%Primary Dealers -$275 -2.0%$Billions
Source: US Department of Treasury
PAGE 7
Contributing Factors to Forecast Errors: Reviewing the Obvious
Cyclical Influences
Price of Oil
Supplemental Appropriations
Aging Population
Tax Provisions
PAGE 10
Contributing Factors: Supplemental Appropriations
Year $Millions Informal Title2000 $16,952 Military Construction
Defense2001 $27,479 Emergency Supplemental and Resc.
Recovery Response to Terrorist Acts2002 $45,317 Defense
Emergency Supplemental and Resc. 2003 $81,107 Emergency Wartime Supplemental Appropriations
Emergency Supplemental Appropriations for Disaster Relief ActLegislative Branch
2004 $117,703 Supp for Defense/Iraq/AfghanistanDefense 20052004 Emergency Disaster Relief Supp.
2005 $160,410 Emergency Supplemental for Hurrican Disasters Assistance Act, 2005Emerg. Supp. Approp. Act for Defense, Global War on Terror and Tsunami Relief, 2005Emerg. Supp. Approp. Act to Meet Immediate Needs Arising from Consequences of Hurrican Katrina, 2005Second Emergency Supp. Appropriations Act for Katrina, 2005
2006 $94,430 Defense Approp. Actm, includes Katrina, Avian Flu, and a-t-bSBA disaster loans program accountAct for Defense, the Global War on Terror, and Hurrican Recovery
Source: CBO
Supplemental Appropriations: 2000-2006
Source: Congressional Budget Office (CBO)
PAGE 11
Contributing Factors: Aging Population
Source: The Board of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds
0123456789
1011121314
1970 1990 1998 2002 2006 2010 2014 2030 2050 2070
% o
f GD
PMedicare Spending as a % of GDP
Forecast
PAGE 12
Contributing Factors: Tax Provisions
Long term borrowing needs rose substantially in the wake of the first round of Bush Tax cuts earlier this decade.
OMB estimates borrowing needs will decline sharply once those tax provisions expire in 2010.
Legislated tax changes since February decrease receipts 2006-2009, then increase receipts in both 2010 and 2011.
PAGE 15
A Review of the Effectiveness of Short-Term Debt Instruments
PAGE 16
Effectiveness of Short-Term Debt Instruments
Over the past several years the Treasury implemented the following innovations in short term financing:
July 2001: Introduced 4-week bill program, reducing reliance on cash management (CM) bills
2001: 52 week bill issuance suspended
October 2003: Launched the Term Investment Option Program (TIO)
2004: Eliminated compensating balances
In line with Treasury’s mandate to maintain low cash balances they now operate with a direct pay for services model
March 2006: Launched repurchase agreement pilot program
PAGE 17
Effectiveness of Short-Term Debt Instruments: 4-Week Bills
$275
$164 $176
$235 $227
$346
$124
$175
$247$268 $252
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
$Bill
ions
Amount of CM Bill Issuance (Fiscal Years)
Source: US Department of Treasury
PAGE 18
Effectiveness of Short-Term Debt Instruments: CM Bills
0
20000
40000
60000
80000
100000
120000
140000
10/03 12/03 2/04 4/04 7/04 9/04 11/04 2/05 4/05 6/05 8/05 11/05 1/06 3/06 6/06 8/06 10/06 1/07
$Mill
ions
Cash Balance CM Bill Issued
Source: US Department of Treasury
PAGE 19
Short-term debt instruments: Flexibility in Issuance
2528
3329
33
20
108
12 11 11
0
5
10
15
20
25
30
35
40
45
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Num
ber o
f Day
sWeighted Average Term to Maturity of CM Bills (Fiscal
Source: US Department of Treasury
Fiscal Year
$92
$863 $880 $908
$742 $791
$0
$200
$400
$600
$800
$1,000
$1,200
2001 2002 2003 2004 2005 2006
$Billion
s
4-week Bill Issuance
PAGE 20
The Opposite End of the Spectrum: Managing High Cash Balances
PAGE 21
Managing High Cash Balances: TT&L Accounts
Treasury Tax and Loan (TT&L) Accounts
The TT&L accounts earn Fed Funds less 25 basis points, a rate set by the Treasury in 1978, not in line with current market rates.
The interest earned on TT&L accounts creates a negative funding spread for the Treasury. It is insufficient to cover the cost of funding short-term debt instruments.
In the late 1990s as financing rates became more transparent, the Treasury proposed to bring the interest rate in line with current market rates, which would have increased the return on Treasury balances by more than 20 basis points.
TT&L participants met the Treasury’s suggestion with significantresistance citing that the wider spread was appropriate compensation for the transaction.
In response to the resistance from TT&L participants, and in an effort to reduce the negative funding spread, the Treasury introduced the Term Investment Option pilot program in 2002.
PAGE 22
Managing High Cash Balances: TIO Accounts
Term Investment Option (TIO)
The TIO pilot program proved successful and transitioned into a permanent program in October 2003.
Over the first forty-two auctions, the difference between auction rates and what he Treasury would have earned had it left the balances in Main TT&L Accounts (FF less 25bp) was uniformly positive and averaged17.3 basis points.1
The Treasury has continued to successfully pursue new and innovative ways to increase the interest earned on high cash balances: mostrecently launching a pilot repo program.
70% of high cash balances that flow through TT&L accounts are now redirected into the TIO and Repo programs.
1Federal Reserve, Recent Innovations in Cash Management, Volume 10, Number 11
PAGE 23
Managing High Cash Balances: Pilot Repurchase Agreement Program
Repurchase Agreement Pilot Program (Repo)
Repurchase Agreement Pilot Program started in March 2006.
It operates on a DVP basis only with TT&L depositories.
The pilot program currently earns a better funding rate than both the TT&L and TIO accounts.1
Since the Treasury launched the pilot Repurchase Agreement Program, over $206 billion TT&L funds have been invested.2
1GAO-06-02692216th Annual Government Financial Management Conference, Department of the Treasury
PAGE 24
Low Treasury Cash Balances and Wide Scale Market Disruptions
The Implications
PAGE 26
GAO’s Recommendations to Congress, September 2006
Recommendation: examine the requirements for Treasury to establish a line of credit.
Financial institutions, specifically large commercial banks, would have to be willing and capable of lending money to Treasury in the appropriate amount and time required by Treasury. Under Basel II, banks would incur 100% capital charges for unsecured loans. Negotiations would have to consider how a collective capital charge in a high stress environment would impact the banking system and define the circumstances under which Base II could be waived. Because the nature and impact of potential future wide-scale disruptions are unknown, uncertainty exists regarding the ability of participating institutions to meet their obligations.
Recommendation: examine the ability of the Treasury to issue a cash management bill for private placement.
Institutions have ability and authority to purchase a CM bill that meets Treasury’s funding needs. Federal Reserve plays large role, by providing liquidity to depository institutions. Clearing and settlement systems must function to complete transactions.
PAGE 27
GAO’s Recommendations to Congress, September 2006
Recommendation: Congress should consider allowing the Federal Reserve to lend directly to the Treasury during a “wide-scale” disruption using a carefully crafted last resort funding option.
Severs the long standing independence of the Federal Reserve.
What defines a “wide-scale” disruption? War? National disaster? The most carefully crafted bills are subject to revision.
In the event the Federal Reserve lost independence, the cost of future funding would likely increase to compensate for political uncertainty. The amount of risk premium the market could demand is as ambiguous as predicting the future disruption.
Congress has provided the Federal Reserve with considerable scope for independently exercising its best judgment as to what monetary policy should be. At the end of the day, it is public confidence that is a central bank's most precious commodity in a democracy.1
1 McDonough: The Importance of Central Bank Independence in Achieving Price Stability, July 2, 2002
PAGE 28
Tri-party Repurchase Agreements: A Consideration for Contingency
Planning
PAGE 29
Tri-Party Repurchase Agreements: A Contingency Planning Consideration
Execution
Treasury raises cash by issuing securities, e.g. T-Bills, appropriately staggering maturities.
Treasury invests in open tri-party repurchase agreements at prevailing market rates with banks and primary dealers.
In the event of a significant market disruption, the Treasury, at its option, may elect to close open tri-party trades and receive proceeds. Banks may return funds directly, primary dealers may make funds available at the clearing banks, BoNY and Chase.
In the event market participants require additional liquidity, the Federal Reserve, at its option, may perform open market operations and discount window transactions to maintain market stability.
PAGE 30
Tri-Party Repurchase Agreements: A Contingency Planning Consideration
Treasury issues additionalsecurities for emergencies(say, $25b in 4-week bills.)
Market Event
Treasury executes$25b of tri-party repowith counterparties
on open
Treasury closes$25b of tri-party
repos
Street and Banks needadditional liquidity in response
to market conditions.
FRBNY adds liquidity throughopen market operations and
the discount window.
PAGE 31
Tri-Party Repurchase Agreements: A Contingency Planning Consideration
Advantages
Disintermediation of Fed and Treasury. Maintains credibility of Federal Reserve.
If in the event the “auction/security grid” failed, the Treasury would still have cash on hand to fund liabilities.
Flexibility to scale up auction size over time as social security outlays expand.
Reduces interest expense by eliminating the negative funding spread.
Funding Costs
Financially, the proposed structure may prove attractive based on T-Bill versus overnight tri-party financing rates.
Using current market rates, a 4 week bill with a bond equivalent yield of 4.98% compares favorably to the equivalent GC repo yielding 5.18%. In this example Treasury would earn 18 basis points in positive carry.
PAGE 32
Tri-Party Repurchase Agreements: A Contingency Planning Consideration
Considerations
Transaction cost may outweigh potential spread advantage.
Volatility of daily financing rates may be of concern.
Repurchase agreements may not be adequate to cover emergency funding needs. Explore private placement CM bills as a second tier alternative or supplement to tri-party participation.
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