Monday, August 6, 2012

Treasury Floating Rate Notes, Treasury Debt Management, and TBAC

As a former Treasury official, who at times worked on debt management issues including the introduction of new products, I am disappointed with the decision Treasury announced last Wednesday (August 1) to sell floating rate notes ("FRNs"). The new notes will not make their appearance for some time though, since the Treasury said it would take at least a year to get ready. Also, no matter what happens in the Presidential election, there will be a new Treasury Secretary next year, since Tim Geithner has indicated that he will be leaving. Thus, it will be up to the next Secretary to decide whether to proceed with FRNs, though by the time he or she is confirmed, there would likely be both bureaucratic momentum for and market interest in the product.

As I have noted previously, the case for floating rate notes is not convincing. The Treasury argues that this is another way to extend the maturity of the public debt while at the same time providing short-term collateral to investors, such as money market mutual funds, without a continual need to rollover the securities. This is obviously in the interest of investors, who would likely receive a higher yield than available on Treasury bills without the operational hassles of rolling over securities. But why is it in Treasury's interest? The Treasury would be paying more than it does on bills and would not have locked in an interest rate. Moreover, Treasury has no trouble rolling over bills; it does this every week of the year. If the FRNs could be sold at a yield less than Treasury bills as compensation by investors for removing the need to rollover securities, then a case could be made for Treasury issuing them. No one, though, thinks this is likely.

The Treasury has not specified the terms and conditions of the FRNs, including to what short-term rate it would be linked. The Treasury Borrowing Advisory Committee ("TBAC"), a group of individuals with high-level positions at prominent firms active in the Treasury market on both the sell- and buy-side, recommends the GCF (General Collateral Financing) Repo Index, a new index published by the Depository Trust and Clearing Corporation ("DTCC") since November 2010. This index is based on the rates of repo transactions cleared by the Fixed Income Clearing Corporation ("FICC"), a subsidiary of DTCC. The major dealers in Treasury securities are members of FICC. A futures contract on the DTCC GCF Repo Index began trading last month on NYSE Liffe U.S., a fact which TBAC cited in their July 31 report to the Secretary of the Treasury.

In fact, the DTCC GCF Repo Index has been suggested as a substitute for Libor, though there is skepticism about that. The problem that some have pointed out with using the GCF Repo Index is that the rate could reflect significant counterparty risk in the event of a financial crisis. In a financial crisis, Treasury yields usually go down reflecting a "flight to quality," but FRNs might pay more if the GCF repo rate were to increase.

Why is TBAC unanimously advising that Treasury issue FRNs and providing a questionable recommendation as to the rate on which the FRNs should be based? This advisory committee is supposed to give advice to Treasury that is in the public interest, not in the interest of the firms that employ its members. There is a question whether they have done this with respect to FRNs.

One of the justifications for the existence of TBAC is that having individuals from different firms provides a check, since if one individual seemed to be providing self-serving advice, the other members would call that person on it. This may not work though if all the firms have the same interest.

A problem with TBAC is that the members for the most part enjoy being on the committee. Unfortunately, this can create the impression that TBAC's advice may at times be skewed. In order to ensure that the committee, whose existence has been questioned in the past by members of Congress, continues to survive and that the individuals on the committee remain members, there is an incentive to provide the advice that members believe Treasury officials want to hear.

It is of course helpful, indeed necessary, for Treasury to speak to major investors and market makers in its securities. However, given the advice that it has proffered on FRNs, there is a question about the usefulness of having a TBAC. While TBAC members may provide useful insights, either formally or informally, on technical issues, it has not done its reputation any good on the FRN issue. If the TBAC members genuinely believe that FRNs are a good idea and that they should be linked to the GCF repo rate, they should have made a better case. 


  1. Just as the Treasury brought back long-since retired maturities as the need to issue more debt grew, it would be issuing FRNs in order to increase the size of the market for its debt. I agree that one of the biggest challenges will be selecting an appropriate index on which to peg the interest payments.

    1. I find this a somewhat surprising justification for issuing a new type of security that effectively is a short-term security with a higher yield than T-bills. Treasury has no problem rolling over and raising money with bills. In fact in the same policy statement that Treasury announced its plans to issue FRNs, it also announced that it is building the operational ability to accept negative rate bids in Treasury bill auctions.

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