Friday, September 16, 2011

A Note on Treasury Debt Management – Opportunistic vs. Regular and Predictable

At the August quarterly refunding, the Treasury asked its advisory committee on debt management, the Treasury Borrowing Advisory Committee (“TBAC”) to discuss the cost and benefits of extending the average maturity of the public debt and to provide a way to quantify those costs and benefits.  In its report to the Secretary, TBAC’s discussion of the maturity question was not particularly helpful:

“The presenters considered the total interest expense over time, the volatility of interest expense through time, as well as roll-over and liquidity risks.  The presentation highlights that longer dated term premiums appear elevated relative to the past.  That said, today there are uncertainties surrounding the long-term fiscal outlook, inflation expectations, and future borrowing needs.  A healthy discussion ensued amongst members as to whether or not the current long end premium was warranted.  While no definitive answer was reached, members felt that the current term structure of yields should not deter normal long-end issuance.  However, the Committee agreed that further analysis would be undertaken.”

More instructive, though, was the attached presentation (which can be found after the Treasury charts here).  The analysis seems to lean in favor of floating rate notes, which do not have rollover risk but are based on short-term rates.  The presentation also suggests that Treasury should issue more long-term debt when it thinks that there is a good chance that interest rates will rise more than the “term premium” embedded in long-term rates.  The presentation concludes that the term premium is relatively high but absolute rates are low.  The first bullet on the concluding slide states:  “The benefits of extension do not come for free.  Historical analysis suggests that shorter term funding has at many times been both cheaper and the volatility costs have not been high.”  They balance this statement with the following: 

“It is possible, however, that ‘this time is different’ because

o Nominal rates are much closer to the zero bound than previous periods

o Deficits are very  high historically and rising interest expense less acceptable

o Concentrated foreign ownership creates less reliable demand

o The benefits of funding attributable to being the reserve currency may be fading”

TBAC seems not to want to take a firm view on the maturity question.  This may be because the committee members have different views or because they do not want to say something with which senior Treasury officials may disagree.  What is interesting, though, is that the analysis focuses on current market conditions as the basis for deciding what maturities to issue.  This is a change from a long-term TBAC and Treasury view that debt management should be regular and predictable, and that Treasury should tap all maturity sectors regardless of current interest rates. The thinking was that the benefits to the Treasury of regularity and predictability outweighed any potential gain from trying to outsmart the market.  Treasury, it was thought, was just too big a borrower to do that successfully and consistently.  As one Assistant Secretary for Domestic Finance in the George H.W. Bush Administration put it: “It’s tough for an elephant to dance” (or something very close to that).

But the leadership of Treasury and the membership of TBAC have changed.  Treasury had been shortening the average maturity in the previous Administration; it is now lengthening it.  Part of the reason for this inconsistency is no doubt due to a weakening of the influence of the career staff on these types of issues.  During the late 1970s and until the mid 1980s, the key person making debt management decisions was a long-term career Treasury official, Francis X. Cavanaugh, who was adamant on regularity and predictability and a staunch believer in issuing 30-year bonds on a quarterly basis.  After he left Treasury, those views gradually became less accepted by a succession of political appointees.  Also, political appointees, who have a shorter-time horizon than most career staff, want to leave their mark on Treasury in the relatively short time they have to do it.  (I have, perhaps somewhat unfairly, in this regard remarked that political appointees just want to have fun.)  For those in charge of debt management, making changes is something they can do within the constraints of what the market will accept.

I am in the regular and predictable camp, but I do give the current Treasury credit for not surprising the market.  There is no clearly correct answer to the maturity question, and I am inclined to think that, within some reasonable and fairly broad parameters, it is not that important as long as the Treasury does not do something clearly stupid or rapid.  I do think the Treasury’s reputation took a hit in both the decision and the botched announcement of discontinuing the sale of 30-year bonds in the George W. Bush Administration.  However, while some people faced legal trouble because of their actions when they was a selective leak of the embargoed announcement [see clarification below], the decision was relatively quietly reversed after Peter Fisher left the Treasury, and  the memories of that episode have faded. 

Another interesting aspect of the maturity issue is the potential for Treasury and the Federal Reserve to be at odds.  The Federal Reserve apparently is considering a strategy of getting long-term rates down by reducing the supply of longer-term Treasuries in the market.  Rather than another quantitative easing program, the Fed is thinking of doing this by selling short-term Treasuries in its portfolio and using the proceeds to purchase long-term Treasuries.  Obviously, the Treasury could accomplish the same thing by selling more short-term Treasury securities and less long-term securities.  The Treasury, though, does not view debt management as a way to try to manipulate the term structure of interest rates but is focused on keeping its interest costs as low as possible “over time.” 

(There is an interesting recent blog post by someone using the name “Bond Girl” about this:  “Leave Operation Twist in the past.”  The author is not favor of the Fed trying to change the shape of the yield curve.)

Clarification:  With regard to the announcement of the cessation of 30-year bond issuance, the Treasury did not leak the news.  A consultant present at the press conference told a senior economist at a major investment banking firm about the announcement while the news was still embargoed.  The Treasury also broke its own embargo by posting the announcement on its website prior to the lifting of the embargo but after the consultant had told his client the news.  This was not one of Treasury's better days. 

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