GAO 

United States Government Accountability Office

Report to the Secretary of the Treasury

DEBT MANAGEMENT

Treasury Inflation 

Protected Securities 

Should Play a 

Heightened Role in 

Addressing Debt 

Management 

Challenges 

September 2009 

GAO-09-932 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

September 2009

DEBT MANAGEMENT

Treasury Inflation Protected Securities Should Play a 

Heightened Role in Addressing Debt Management 

Highlights of GAO-09-932, a report to the Challenges

Secretary of the Treasury 

The 2008 financial market crisis 

and the economic recession led to 

a rapid and substantial increase in 

federal debt. This report, part of a 

line of work on debt management, 

was conducted under the 

Comptroller General’s authority. It 

describes current debt 

management challenges and 

examines the role of a program that 

could benefit Treasury—Treasury 

Inflation Protected Securities 

(TIPS). GAO analyzed market data 

and interviewed experts as well as 

the two largest holders of Treasury 

securities in each of six sectors. 

What GAO Recommends

GAO recommends that, in the 

context of projected sustained 

increases in federal debt, the 

Secretary of the Treasury take 

steps to increase TIPS liquidity and 

reduce their cost to Treasury: 

increase issuance, issue longerdated maturities, and conduct more 

frequent auctions. Also, the 

Secretary should continually 

review the appropriate 

composition of the TIPS program 

and consider: the impact of 

Treasury’s public statements and 

TIPS issuance on TIPS liquidity, 

how different analytical 

perspectives are valuable for 

evaluating cost, how TIPS can 

diversify Treasury’s investor base, 

and how TIPS impact the cost of 

nominal securities. 

Treasury took note of our findings, 

conclusions, and recommendations 

and said they were consistent with 

their commitment to increasing 

TIPS issuance. 

In January 1997, Treasury introduced an inflation-indexed security—TIPS. 

Treasury’s stated objectives were to both raise the national savings rate and to 

reduce the federal government’s cost of borrowing. TIPS offer inflation 

protection to investors who are willing to pay a premium for this protection in 

the form of a lower interest rate. In a functioning TIPS market, the difference 

between the interest rate on nominal Treasury securities and the interest rate 

on TIPS is expected to be approximately equal to the expected inflation rate. 

Federal government actions in response to both the financial market crisis 

and the economic recession have added significantly to Treasury’s borrowing 

needs. Since the onset of the recession in December 2007, Treasury has 

borrowed more than $2.3 trillion, largely by issuing short-term nominal debt, 

which significantly changed the composition of Treasury’s debt portfolio. The 

challenges presented by increasing debt and the change in its composition 

take place in the context of the medium and longer term fiscal outlook and 

will not recede with the return of financial market stability and economic 

growth. The Congressional Budget Office (CBO) projects that, absent changes 

in current policy, debt held by the public will double in 5 years (from 2008 to 

2013) and almost triple in 11 years (from 2008 to 2019)—reaching 82 percent 

of GDP. In order to meet these challenges Treasury needs to diversify its 

funding sources and lengthen the term-to-maturity of its debt portfolio. TIPS 

can contribute to this effort. 

Treasury’s TIPS program has had varying degrees of liquidity (the ease with 

which investors can trade the security) since its inception. The major 

institutional investors that GAO interviewed perceived Treasury’s 

commitment to the TIPS program as having wavered in recent years, 

decreasing the liquidity of TIPS in the market. Investors demand a premium 

for holding less-liquid TIPS, which increases Treasury’s borrowing costs. 

TIPS offer benefits to Treasury and measuring the cost against which to weigh 

these benefits requires both forward-looking and after-the-fact analysis. A 

more robust TIPS program could benefit Treasury by diversifying and 

expanding its funding sources and reducing the cost of nominal securities. 

Governments are well suited to bear inflation risk because periods of inflation 

are often associated with increased revenues. TIPS auctions also help provide 

a measure of market inflation expectations. 

On July 1, 2009, GAO briefed Treasury’s Office of Debt Management on the 

findings from our analysis and interviews with major institutional investors. 

Treasury later posed questions about ways to improve the TIPS program to 

the Primary Dealers and the Treasury Borrowing Advisory Committee 

(TBAC). At the August 2009 TBAC meeting, members discussed TIPS. 

Following the meeting, Treasury’s Deputy Assistant Secretary for Federal 

Finance reaffirmed Treasury’s commitment to TIPS and announced plans to 

gradually increase issuance of TIPS. 

View GAO-09-932 or key components.

For more information, contact Susan J. Irving 

at (202) 512-6806 or irvings@gao.gov. 
Page i GAO-09-932 

Contents 

Letter 1

Background 1 

Scope and Methodology 2 

Size and Composition of Treasury’s Debt Profile Has Changed 

Substantially 4 

Treasury’s TIPS Program Has Had Varying Degrees of Liquidity 

Since Inception and Major Institutional Investors Have 

Expressed Concern about Treasury’s Commitment to the 

Program 12 

TIPS Program Offers Benefits to Treasury, and Measuring Its Cost 

Requires both Forward-Looking and After-the-Fact Analysis 17 

Concluding Observations 22 

Recommendations 23 

Agency Comments 23 

Appendix I Treasury Inflation Protected Securities 25 

Overview 25 

Principal 25 

Interest Payments 25 

Taxation 26 

Auction Schedule 26 

Purchasing TIPS 27 

Appendix II The Cost of Treasury Inflation Protected Securities 

Compared to Nominal Securities 28 

Disentangling the Drivers of Recent Shifts in the Nominal-TIPS 

Yield Differential (Breakeven Inflation Rate) 29 

Appendix III GAO Contact and Staff Acknowledgments 31 

 

Figures 

Figure 1: Changes in Outstanding Marketable Treasury Securities 

from December 31, 2007, to June 30, 2009 (Total 

Outstanding as of June 30, 2009—$6.6 trillion) 5 

Figure 2: Marketable Securities by Year of Maturity, as of June 30, 

2009 (Total Outstanding—$6.6 trillion) 6 

Figure 3: Net Interest Costs and 10-Year Treasury Rates 7 

 Debt Management
Figure 4: Debt Held by the Public and Percentage of GDP, 2001 

through 2019 9 

Figure 5: Debt Held by the Public as a Share of GDP under Two 

Different Fiscal Policy Simulations 10 

Figure 6: Treasury’s Statements of Support for TIPS, Gross TIPS 

Issuance, and the TIPS Program’s Relative Costs 13 

Figure 7: Bid-to-Cover Ratios for Selected Treasury Securities, July 

2003 to July 2009 16 

Figure 8: Inflation-Protected Mutual Funds and Assets under 

Management, December 2002 to May 2009 19 

List of Abbreviations 

CBO Congressional Budget Office 

CPI-U Consumer Price Index for All Urban Consumers 

GDP gross domestic product 

ODM Office of Debt Management 

OMB Office of Management and Budget 

SIFMA Securities Industry and Financial Markets Association 

TARP Troubled Asset Relief Program 

TBAC Treasury Borrowing Advisory Committee 

TIPS Treasury Inflation Protected Securities 

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Page ii GAO-09-932 Debt Management
Page 1 GAO-09-932 

United States Government Accountability Office

Washington, DC 20548 

 

September 29, 2009 

The Honorable Timothy F. Geithner 

Secretary of the Treasury 

Dear Mr. Secretary: 

Between December 2007 and the end of June 2009, the Department of the 

Treasury borrowed more than $2.3 trillion to finance federal government 

actions related to both the financial market crisis and the economic 

recession in addition to regular government financing needs. This rapid 

and substantial increase in federal debt takes place in the context of the 

medium- and long-term fiscal outlook that will present Treasury with 

continued financing challenges long after the return of financial stability 

and economic growth. GAO has begun a line of work related to Treasury’s 

management of its growing debt portfolio. As part of this ongoing work, 

we will continue to provide updates and make recommendations as 

appropriate. 

In this first report, conducted under the Comptroller General’s authority, 

we describe Treasury’s borrowing challenges and analyze one Treasury 

program that has the potential to provide benefits to both Treasury and 

investors—Treasury Inflation Protected Securities (TIPS). We address the 

following questions: 

• What are the debt management challenges associated with planning for 

future borrowing needs given the long-term fiscal outlook and 

Treasury’s increased borrowing due to economic and financial sector 

stress? 

• What role, if any, should TIPS play in Treasury’s borrowing program? 

Congress has assigned to Treasury the responsibility of borrowing the 

funds necessary to finance the gap between cash-in and cash-out, subject 

to a statutory limit. Treasury’s primary debt management goal is to finance 

the government’s borrowing needs at the lowest cost over time. Issuing 

debt predictably through regularly scheduled auctions lowers borrowing 

costs because investors and dealers value liquidity and certainty of supply. 

Treasury responds to increases in borrowing needs in a traditional 

manner, by first increasing the issuance size of existing securities; then, 

increasing the frequency of issuances; and finally, introducing new 

securities to its auction calendar as necessary. 

Background 

 Debt Management
 

Treasury normally auctions nominal marketable securities that range in 

maturity from 4 weeks to 30 years and sells them at auction on a preannounced schedule. Treasury also issues cash management bills that are 

not part of the regular schedule to meet immediate cash needs. Treasury 

securities are widely viewed as the premium risk-free asset and are 

actively used by investors, traders, and foreign central banks for hedging, 

liquidity, and reserve purposes. The outstanding mix of U.S. Treasury 

securities can have a significant influence on the federal government’s 

interest payments. Longer term securities typically carry higher interest 

rates (which translate to increased cost to the government), primarily due 

to concerns about future inflation. However, these longer term securities 

offer the government the certainty of fixing the interest payments over a 

longer period and reduce the amount of debt that Treasury needs to 

refinance in the short term. In contrast, shorter term securities generally 

carry lower interest rates but add volatility to the government’s interest 

costs and require Treasury to conduct more frequent auctions to refinance 

maturing debt. 

During the 1980s and 1990s, a number of countries introduced inflationindexed securities to their debt offerings, including the United Kingdom, 

France, and the United States.1

 In January 1997, Treasury introduced its 

own inflation-indexed securities, TIPS, as part of its debt program. At the 

time, Treasury’s stated objectives for introducing TIPS were both to raise 

the national savings rate and to reduce the federal government’s cost of 

borrowing. TIPS offer inflation protection to investors who are willing to 

pay a premium for this protection in the form of a lower interest rate. In a 

functioning TIPS market, the difference between the interest rate on 

nominal Treasury securities and the interest rate on TIPS should 

approximately equal the expected inflation rate. Treasury currently issues 

5-, 10-, and 20-year TIPS. In the past, Treasury issued 30-year TIPS, but 

discontinued them in 2001. See appendix I for additional details on the 

structure of TIPS. 

To identify the debt management challenges associated with Treasury’s 

increased borrowing, we analyzed the scale, timing, term to maturity, and 

composition of Treasury’s borrowing since the start of the economic 

Scope and 

Methodology 

 

1

As of the end of 2008, inflation-indexed securities made up 24 percent of the United 

Kingdom’s total outstanding debt portfolio, 15 percent of France’s outstanding debt 

portfolio, and 10 percent of the United States’ outstanding debt portfolio. 

Page 2 GAO-09-932 Debt Management
 

recession, using data and information obtained from the Department of 

the Treasury and the Federal Reserve. We also interviewed market 

experts, Treasury, and Federal Reserve staff and officials. 

To examine what role TIPS should play in Treasury’s debt portfolio and 

the potential for the TIPS program to help address Treasury’s debt 

management challenges, we conducted literature reviews on the costs and 

benefits of inflation-indexed securities and examined research by Federal 

Reserve economists, market experts, academic sources, and the 

Department of the Treasury, including an internal review of the TIPS 

program done by the Office of Debt Management (ODM). We also 

conducted 12 structured interviews in June 2009 with the two largest 

holders of Treasury securities in each of the following sectors: mutual 

funds; commercial banks; life insurance companies; property and casualty 

insurance companies; state and local pension funds; and private pension 

funds. The major institutional investors we interviewed held at least $351 

billion in Treasury securities. Of their Treasury holdings, $99.4 billion were 

TIPS, which was 19 percent of total outstanding TIPS as of March 31, 2009. 

These interviews covered the institution’s holdings of Treasury securities, 

demand for TIPS, changes that could be made to the TIPS program, 

perceived risks to investors in Treasury markets, and Treasury’s sources 

for information on demand for Treasury securities. On July 1, 2009, we 

briefed Treasury’s ODM on the findings from the structured interviews, 

which are discussed and expanded upon in this report.2

Where possible and appropriate, we corroborated the results of our data 

analyses and interviews with other sources. On the basis of our 

assessment we believe that the data are reliable for the purposes of our 

review. We conducted our review from June 2009 through August 2009 in 

accordance with generally accepted government auditing standards. Those 

standards require that we plan and perform the audit to obtain sufficient, 

appropriate evidence to provide a reasonable basis for our findings and 

conclusions based on our audit objectives. We believe that the evidence 

obtained provides a reasonable basis for our findings and conclusions 

based on our audit objectives. 

 

2

ODM is responsible for providing the Assistant Secretary for Financial Markets with 

advice and analysis on matters related to the Treasury’s debt management policy, the 

issuance of Treasury and federally related securities, and financial markets. 

Page 3 GAO-09-932 Debt Management
 

Treasury faces two near-term challenges in managing the growing 

government debt: the rise in total outstanding debt and the shortening of 

the average maturity of the debt profile.3

 Treasury’s total outstanding debt 

increased by $2.3 trillion (25 percent increase in federal debt) since the 

onset of the economic recession in December 2007.4

 In actions Treasury 

described as in accordance with normal operating procedures, Treasury 

increased short-term borrowing to address its massive and immediate 

borrowing needs. As a result, the average maturity of Treasury’s debt 

decreased as the percentage of marketable debt maturing within 1 year 

increased from 35.6 percent to 41.1 percent between September 2007 and 

June 2009. At the end of June 2009, Treasury’s outstanding marketable 

securities stood at $6.6 trillion, an increase of almost $2.1 trillion from 

December 2007.5

 The largest increase in outstanding marketable Treasury 

securities was in short-term debt. Treasury bill and cash management bill 

issuance increased by a combined $1 trillion between December 2007 and 

June 2009.6

 The amount of Treasury notes issued also increased 

significantly over this period, adding $929.3 billion to the amount of notes 

outstanding. Almost half of the increase was comprised of shorter-term 

notes (with 2-year and 5-year maturities). The monthly issuance of 2-year 

notes alone has almost doubled in the last 2 years. Figure 1 shows the 

relative size of the increases in different categories of securities. The 

smallest increase was in TIPS which increased by $60.6 billion. 

Size and Composition 

of Treasury’s Debt 

Profile Has Changed 

Substantially 

 

3

Federal debt held by the public is the value of all federal securities sold to the public that 

are still outstanding. See GAO, Federal Debt: Answers to Frequently Asked Questions: An 

Update, GAO-04-485SP (Washington, D.C.: August 12, 2004). 

4

Treasury issues two major types of debt securities to the public: marketable and 

nonmarketable securities. Marketable securities, which consist of Treasury bills, notes, and 

bonds and can be resold by whoever owns them while nonmarketable securities, such as 

savings securities and special securities for state and local governments, cannot be resold. 

5

Treasury data states that almost half of the $6.6 trillion in marketable securities is held by 

foreign investors, as of May 2009. 

6

Treasury’s increase in issuance of cash management bills is largely due to establishment of 

the Supplementary Financing Program (SFP). The SFP was created to provide cash for 

Federal Reserve lending and liquidity draining initiatives in response to the financial 

market crisis. According to GAO’s audit of the Bureau of the Public Debt for Fiscal Years 

2008 and 2007, $300 billion in cash management bills were issued in September 2008 under 

the Supplementary Financing Program initiated by Treasury. See GAO, Financial Audit: 

Bureau of the Public Debt’s Fiscal Years 2008 and 2007 Schedules of Federal Debt, 

GAO-09-44 (Washington, D.C.: November 7, 2008). 

Page 4 GAO-09-932 Debt Management
 

Figure 1: Changes in Outstanding Marketable Treasury Securities from December 

31, 2007, to June 30, 2009 (Total Outstanding as of June 30, 2009—$6.6 trillion) 

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Increase in marketable Treasury securities from Dec. 31, 2007 to June 30, 2009

Outstanding marketable Treasury securities as of Dec. 31, 2007

Treasury noteTrea s sury billTrea sTreasury bond sury Inflation Protected s Cash mana Securitie gemnt bill s s 

Dollars (in billions)

Borrowings, by Marketable Treasury Securities

Source: GAO analysis of Treasury monthly statement of public debt data.

$2,488.5

$1,003.9

$558.5 $471.7 $440

$929.3

$562.6

$85.1 $60.6 $440

$3,417.8

Total =

$1,566.5

$643.6 $532.3

Cash

Treasury

Treasury

Treasury

Treasury

management

Inflation

bills

Protected

Securities

bonds

bills

notes

Note: Does not include $11.9 billion in marketable securities outstanding for the Federal Financing 

Bank. Treasury bills and cash management bills are short-term securities that mature in 1 year or less 

from their issue date. Treasury notes mature in more than 1 year, but not more than 10 years from 

their issue date. Treasury bonds mature in more than 10 years from their issue date. Treasury bills, 

notes, and bonds are nominal securities, meaning they are not adjusted for inflation. TIPS are 

adjusted for inflation and have maturities of 5, 10, or 20 years. 

Treasury has raised significant amounts of cash since the onset of the 

economic recession in December 2007 largely by adhering to its regular 

and predictable debt issuance schedule, which is meant to ensure the 

lowest borrowing costs over time. However, Treasury has also turned to 

issuing cash management bills, which are announced shortly before 

auction to fulfill Treasury’s immediate cash needs. After the financial 

market crisis hit in fall of 2008, Treasury raised an unprecedented $1.1 

trillion in under 18 weeks largely by issuing cash management bills. 

Treasury was able to finance such an amount due in part to outsized 

demand among global investors for a safe and liquid financial instrument 

in the midst of the contraction in global economic activity. 

Page 5 GAO-09-932 Debt Management
 

Figure 2: Marketable Securities by Year of Maturity, as of June 30, 2009 (Total 

Outstanding—$6.6 trillion) 

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2031– 

2039

2021–

2030

2016–

2020

2011–

2015

2009–

2010

Dollars (in billions)

(Percentage of total

outstanding securities that

mature during time frame)

Year of maturity

Source: GAO analysis of Treasury monthly statement of public debt data.

(46%)

(32%)

(13%)

(6%)

(3%)

$3,041

$2,083

$864

$424

$188

Note: Does not include $11.9 billion in marketable securities outstanding for the Federal Financing 

Bank, $43 million in matured notes, and $45 million in matured bonds. 

As shown in figure 2, 78 percent (or about $5.1 trillion) of the outstanding 

marketable Treasuries mature by 2015 and will need to be rolled over (or 

refinanced)—potentially at higher interest rates. Because short-term rates 

have been reduced sharply by the decision of the Federal Reserve to set its 

federal funds target near zero, Treasury’s borrowing costs decreased even 

though debt levels increased. (See figure 3.) However, projections from 

both the Congressional Budget Office (CBO) and Office of Management 

and Budget (OMB) assume higher interest rates and higher interest 

payments. CBO’s analysis of the President’s Budgetary Proposals for 

Fiscal Year 2010 assumed that interest rates on 91-day Treasury bills 

would increase from 0.3 percent in 2009 to 4.7 percent in 2015 and that 

interest on 10-year Treasury notes would increase from 2.9 percent to 5.4 

percent over the same period. CBO’s analysis of the President’s Budgetary 

Proposals for Fiscal Year 2010 shows—absent changes in policy—interest 

Page 6 GAO-09-932 Debt Management
 

payments on federal debt more than tripling—to almost $800 billion—by 

2019.7

 (See figure 3.) 

Figure 3: Net Interest Costs and 10-Year Treasury Rates 

0

100

200

300

400

500

600

700

800

900

Estimated net interest outlays

Actual net interest outlays

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Sources: Congressional Budget Office data from their analysis of the President’s budget proposal of actual and estimated

net interest costs and estimated interest rates and Federal Reserve data of actual interest rates.

Dollars (in billions)

Fiscal year

0

1

2

3

4

5

6

7

10-year Treasury nominal interest rate

Percent

Note: Net interest outlays is a cash measure that is defined as interest payments on gross debt less 

interest received on loans and advances, and is affected by the volume of net debt on issue and by 

interest rates. 

Treasury’s Director of ODM and the ODM staff whom we interviewed view 

the current maturity profile as reasonable given economic conditions and 

the massive increase in borrowing that was necessary in a compressed 

time period. They underscored the importance of making any changes to 

the current debt portfolio in a gradual manner to ensure that there will be 

enough demand at a reasonable price and told us that they plan to 

 

7

See Congressional Budget Office, An Analysis of the President’s Budgetary Proposals for 

Fiscal Year 2010 (Washington, D.C.: June 2009). 

Page 7 GAO-09-932 Debt Management
 

gradually transition the portfolio into longer term debt.8 They also told us 

that, given the need to be flexible operationally, Treasury’s debt 

management horizon is shorter than the horizon used by CBO and OMB in 

budget projections and that they are confident about their ability to 

finance the projected budget deficits for 2010 and 2011. 

Fiscal Outlook Will 

Present Continued Debt 

Management Challenges 

As noted, the federal government’s policy response to the financial market 

crisis and the economic recession created a significant increase in both 

debt and debt management challenges. These will not recede when 

stability returns to financial markets and economic growth resumes. CBO 

projects that, absent changes in current policy, the debt held by the public 

will double in 5 years (from 2008 to 2013) and almost triple in 11 years 

(from 2008 to 2019). (See figure 4.) CBO projects that debt held by the 

public will increase from 41 percent of gross domestic product (GDP) in 

fiscal year 2008 to 71 percent by the end of fiscal year 2013. 

 

8

As of August 2009, the average maturity of issuance on the current auction calendar now 

exceeds the average maturity of marketable debt outstanding. 

Page 8 GAO-09-932 Debt Management
 

Figure 4: Debt Held by the Public and Percentage of GDP, 2001 through 2019 

0

2

4

6

8

10

12

14

16

18

Projected debt held by the public

Actual debt held by the public

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Source: Congressional Budget Office data from their analysis of the President’s budget proposal.

Dollars (in trillions)

8.0

9.4

10.3

11.1

11.8

12.6

13.5

14.4 15.4 15.9 17.1

3.3

5.8

5.0 4.6 4.8 4.3 3.9 3.5

Fiscal year

0

10

20

30

40

50

60

70

80

90

Debt held by the public (as a percentage of gross domestic product)

Percentage of GDP

57

65

69 70 71 73 75 77 79 79 82

33

41

36 37 38 37 37

34

The actions that Treasury has taken to increase borrowing in response to 

the economic recession and financial market crisis take place within the 

context of the already serious longer term fiscal condition of the federal 

government. While the administration and Congress have been 

understandably focused on addressing problems with financial markets 

and responding to the economic recession, the government will need to 

apply the same level of intensity to the nation’s long-term fiscal challenge. 

Both our long-term simulations and CBO’s show growing deficits and debt, 

underscoring that the long-term fiscal outlook is unsustainable. Under our 

alternative simulation, by 2025 debt held by the public would exceed the 

historical high of 109 percent of GDP, reached in the aftermath of World 

War II.9

 (See figure 5.) 

 

9

See GAO, The Nation’s Long-Term Fiscal Outlook March 2009 Update, GAO-09-405SP 

(Washington, D.C.: April 30, 2009) and CBO, The Long-Term Budget Outlook (Washington, 

D.C.: June 2009). 

Page 9 GAO-09-932 Debt Management
 

Figure 5: Debt Held by the Public as a Share of GDP under Two Different Fiscal 

Policy Simulations 

Percentage of GDP

Historical high

109 percent in 1946

Fiscal year

Source: GAO’s March 2009 analysis based on the Trustees’ assumptions for Social Security and Medicare. (See GAO,

The Nation’s Long-Term Fiscal Outlook March 2009 Update, GAO-09-405SP (Washington, D.C.: April 30, 2009).

0

50

100

150

200

250

300

350

400

Alternative

Baseline extended

2000200220012000 32005 2025 2010201220112010200920082007200620052004200 32015 20152014201 202020222120202019201820172016 3 202920282027202620252024202 2020320302031203220332020343203552036203732040 839 20422041204020 2045 3 2050 2050204920482047204620452044204

The deterioration in the short-term and long-term budget outlooks, 

combined with expenditures associated with the Troubled Asset Relief 

Program (TARP) and Recovery Act spending, will likely continue to stress 

the existing auction schedule. Treasury has already begun to respond by 

adjusting the auction schedule so that they can conduct more auctions of 

increasingly larger amounts, while simultaneously minimizing borrowing 

costs over the long term. 

According to the major institutional investors that we interviewed, the 

best days of the week for Treasury to conduct auctions are Tuesday, 

Wednesday, and Thursday. However, Treasury is facing an increasingly 

crowded borrowing schedule, often with multiple auctions in a single day. 

For example, during the week of July 27, 2009, Treasury held eight 

auctions, issuing close to $272 billion in securities in one week and holding 

multiple auctions on two of those days. In addition, Treasury has been 

forced to hold and plan auctions on days that it has tried to avoid in the 

past, such as days of major Federal Reserve announcements. Holding 

auctions on these days increases uncertainty for auction participants. 

Page 10 GAO-09-932 Debt Management
 

Market experts believe that the large amount of the debt that must be 

rolled over in the next few years is cause for concern and agree with 

Treasury that it needs to increase the average maturity of its debt portfolio 

and diversify its funding sources. Large and growing borrowing needs put 

a premium on better understanding current and future demand for 

Treasury securities. Two securities that Treasury can currently use to 

reduce the amount of securities that are rolling over in the next 10 years 

are 30-year nominal bonds and 20-year TIPS.10 Treasury has already 

increased the frequency of the issuance of 30-year bonds; first it reopened 

the 30-year bond in February 2009 and then added a second reopening in 

May 2009, effectively issuing the 30-year bond on a monthly basis. 

Treasury should continue to consider options to lengthen its maturity 

profile to mitigate the risks mentioned above. Longer-dated TIPS offer one 

option. The 30-year TIPS was discontinued along with the 30-year nominal 

bond in October 2001, but only the 30-year nominal bond was 

reintroduced. The 20-year TIPS, is currently issued only twice a year, but 

its record as a low-cost funding source has been mixed in part due to a 

lack of liquidity as explained in the next section. 

 

10At the August 2009 Treasury Borrowing Advisory Committee (TBAC) meeting, Treasury 

asked TBAC members to consider whether 30-year TIPS should replace 20-year TIPS. 30-

year TIPS would also serve to reduce the amount of securities that Treasury needs to roll 

over in the next 10 years. 

Page 11 GAO-09-932 Debt Management
 

Treasury’s TIPS program has had varying degrees of liquidity since its 

inception in 1997. Liquidity is a measure of the ease with which investors 

can trade a security. Liquidity is important to Treasury because liquid 

securities can be auctioned at lower rates, and thus cost Treasury less 

money. 

The difference between the breakeven inflation rate—the interest rate on a 

nominal security minus the interest rate on a comparable-maturity TIPS—

and a measure of expected inflation can be used to evaluate the ex-ante 

cost of nominal securities relative to TIPS.11 When this difference is 

positive, nominal securities cost more than TIPS; when it is negative, TIPS 

cost more than nominal securities; and when the difference is zero, the 

cost is approximately equivalent. Two primary factors affect this 

difference. The first is the illiquidity premium associated with TIPS, which 

raises the interest rate on TIPS relative to nominal securities. The second 

is the inflation risk premium, which is the insurance value that investors 

attach to TIPS’ protection against inflation. The inflation risk premium 

reduces the interest rate on TIPS relative to the rate on nominal securities. 

To the degree that the inflation risk premium and illiquidity premium are 

roughly equal, nominal Treasury securities and TIPS of the same maturity 

would cost about the same, on an ex-ante (or before the fact) basis. For a 

more detailed discussion on calculating the cost of TIPS compared to 

nominal securities see appendix II. 

Treasury’s TIPS 

Program Has Had 

Varying Degrees of 

Liquidity Since 

Inception and Major 

Institutional Investors 

Have Expressed 

Concern about 

Treasury’s 

Commitment to the 

Program 

In 1997, when the TIPS program was launched, the initial auctions were 

well-received by investors, with robust bid-to-cover ratios.12 As seen in 

figure 6, the average 10-year breakeven rate minus expected inflation in 

1997 was the largest seen to date on the 10-year TIPS. Thereafter, from 

1998 until about 2004, TIPS liquidity remained relatively poor and the 

gross amount issued by Treasury decreased from 1998 to 2000. 

 

11We use the real-time estimate of expected inflation from the Survey of Professional 

Forecasters maintained by the Federal Reserve Bank of Philadelphia. 

12The bid-to-cover ratio is the ratio between the amounts tendered over the amounts 

accepted at auction. 

Page 12 GAO-09-932 Debt Management
 

Figure 6: Treasury’s Statements of Support for TIPS, Gross TIPS Issuance, and the TIPS Program’s Relative Costs 

0

10

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Year-to-date TIPS issuance

Source: GAO analysis of Treasury data on TIPS issuances and Federal Reserve Bank of Philadelphia's Survey of

Professional Forecasters Inflation Expectations.

Dollars (in billions)

Year

-2.0

-1.5

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1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 May-09

Percent

Treasury speeches and

expansion of TIPSb

$33 $34 $31 $16 $16 $23 $26 $63 $69 $77 $65 $62 $31

Treasury speeches and

expansion of TIPSc

Treasury speeches

and expansion

of TIPSa

a

Treasury official announcement on expansion of TIPS on May 1, 2002. Treasury speech bolstering 

TIPS program on June 3, 2002, October 17, 2002, November 8, 2002, and December 5, 2002. 

b

Treasury official announcement on expansion of TIPS on April 30, 2003. Treasury speech bolstering 

TIPS program on May 20, 2003 and June 26, 2003. 

c

Treasury official announcement on expansion of TIPS on May 4, 2004. Treasury speech bolstering 

TIPS program on April 22, 2004, June 16, 2004, and July 8, 2004. 

Starting in 2002, Treasury sought input from market participants on how 

to improve the TIPS program and made a number of changes to the 

program. Specifically, Treasury increased the amount issued at auction 

and increased the frequency and range of TIPS offerings. In addition, 

Treasury made a number of speeches and official statements to reaffirm 

its commitment to the program and to indicate its dedication to improving 

TIPS liquidity. Some of the major institutional investors we interviewed 

observed that these efforts improved investor confidence in the program 

and ultimately improved the liquidity of TIPS. As seen in figure 6, from 

2004 to 2007, the difference between the average 10-year breakeven rate 

and inflation expectations was positive or near zero, meaning the TIPS 

illiquidity premium was approximately equal to the inflation risk premium 

Page 13 GAO-09-932 Debt Management
 

of nominal securities and indicating that TIPS liquidity improved over that 

period. 

More recently, from 2006 to 2008, Treasury reduced the gross amount of 

TIPS issuance by 19 percent. The major institutional investors that we 

interviewed also perceived that during this time, Treasury’s commitment 

to the TIPS program began to wane, communicating uncertainty about the 

program’s future. These investors believed that the uncertainty 

surrounding TIPS hurt TIPS liquidity in the secondary market. 

In the period following the 2008 financial market crisis, TIPS liquidity 

further deteriorated as demand for the more liquid nominal Treasury 

securities soared. The illiquidity premium, or the extra compensation that 

Treasury has to pay investors to hold TIPS, may have increased during the 

financial crisis due to the increased difficulty of selling holdings of TIPS in 

the secondary market during that time. Major institutional investors whom 

we interviewed reported uncertainty about Treasury’s commitment to the 

TIPS program and suggested increased issuance and positive signaling to 

improve the liquidity of TIPS, thereby reducing the cost of the program to 

Treasury. 

Major Institutional 

Investors Report 

Uncertainty about 

Treasury’s Commitment to 

TIPS and Suggest 

Increased Issuance and 

Positive Signaling to 

Improve the Liquidity of 

TIPS 

Interviews with major institutional investors revealed uncertainty about 

Treasury’s commitment to TIPS. The investors pointed to the 19 percent 

decline in TIPS gross issuance amounts, along with Treasury’s tepid 

signaling on TIPS, as fueling speculation about the future of the program.13

(See figure 6.) As of June 2009, TIPS made up about 8 percent of total 

outstanding marketable Treasury securities, compared to 10 percent in 

September 2007 and 2008. 

As we reported to Treasury, on July 1, 2009, there was agreement among 

the major institutional investors whom we interviewed that Treasury could 

improve liquidity in the TIPS market by signaling to the market its 

commitment to the program and by increasing issuance. Investors 

suggested that Treasury repeat efforts to promote the TIPS program as 

 

13Gross issuance is the total amount issued in a year (whether it is obtaining new money or 

refinancing maturing debt). As we have shown, it has decreased since 2006. The net change 

in total TIPS outstanding from year to year increased during this time, but at a decreasing 

rate (reflecting the decrease in gross issuance). In commenting on this report, Treasury’s 

Director of ODM and ODM staff said that they view this as a stabilization of the TIPS 

program—done to permit a review of the program after its first decade. 

Page 14 GAO-09-932 Debt Management
 

they did from 2002 to 2004. Investors told us that increasing the issuance 

amount at auction or increasing the frequency of auctions would have a 

similar signaling effect and the additional supply would also improve 

liquidity in the secondary market. Most of the investors replied that they 

planned to purchase TIPS in the next year; interest in the 10-year TIPS was 

mentioned most frequently. Some investors stated that their organizations 

would be more likely to participate in the TIPS market if the supply of 

securities was greater and auctions were conducted more frequently. 

Some investors reported wanting to make larger TIPS purchases than was 

possible in the secondary market and also that the long wait between TIPS 

auctions sometimes did not align with their investment needs. Currently, 

there is a 6-month wait between auctions for 5-year and 20-year TIPS and a 

3-month wait between auctions for 10-year TIPS. 

At our briefing, Treasury’s Director of ODM and ODM staff told us that if it 

were to expand the TIPS program, Treasury would face increased 

exposure to auction risk due to the current concentration of bidders at 

auction and the resulting possibility that there may not be enough bidders 

to cover the auctioned amount. But Treasury already has policies in place 

to ensure that potentially undersubscribed auctions are sufficiently 

covered. In addition to these policies, investors we interviewed told us 

that a more formalized line of communication between Treasury and endusers could enable Treasury to better gauge market demand. We are in the 

process of surveying investors on what actions Treasury could take to 

increase participation in TIPS auctions and improve communication with 

end-users of Treasury securities. 

One indicator used to measure demand at a Treasury auction is the bid-tocover ratio, which compares the dollars bid to the dollars accepted at a 

Treasury auction. If the ratio is high, it indicates strong demand for a 

particular Treasury security at auction. There is historical evidence that 

auctions in the TIPS market have bid-to-cover ratios only slightly lower 

than the more robust market for nominal securities. As shown in figure 7, 

for most of the period prior to 2009, TIPS auctions had slightly lower bidto-cover ratios than comparable nominal securities. But more recently, 

differences between TIPS and nominal bid-to-cover ratios have decreased. 

From January to July of 2009, the average bid-to-cover ratio for 5-, 10-, and 

30-year nominal auctions has been 2.30. The average bid-to-cover ratio of 

5-, 10-, and 20-year TIPS auctions has been 2.31 during the same period. 

Page 15 GAO-09-932 Debt Management
 

Figure 7: Bid-to-Cover Ratios for Selected Treasury Securities, July 2003 to July 2009 

Source: GAO analysis of Treasury auction data on 5-year, 10-year, and 30-year nominal Treasury securities and 5-year, 10-year,

20-year, and 30-year TIPS.

Bid-to-cover ratio

0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

3-month nominal moving average

3-month TIPS moving average

Full subscription threshold

20-year TIPS

10-year TIPS

5-year TIPS

10-year note

5-year note

30-year bond

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July Oct. AprJan. July Oct. Jan. Apr. July Oct. Jan. Apr. July Oct. Jan. Apr. July Oct. Jan. Apr. July Oct. Jan. Apr. July

2003 2004

Year

2005 2006 2007 2008 2009

Treasury’s current policies to ensure sufficient coverage of auctions were 

instituted after a 10-year nominal Treasury note auction had a relatively 

low bid-to-cover ratio of 1.2 in May 2003. The more recent, stronger bid-tocover ratios indicate that the market would support increased TIPS 

issuance. A more liquid TIPS market would benefit Treasury. At the same 

time, the cost to Treasury of the TIPS program going forward remains a 

subject of debate. 

Page 16 GAO-09-932 Debt Management
 

TIPS offer a variety of benefits to both Treasury and investors. TIPS 

provide Treasury the opportunity to diversify its investor base because 

TIPS are by design a very different product than nominal securities. In 

addition, TIPS may reduce the cost of nominal securities. The cost against 

which to weigh the benefits of TIPS, however, is unclear. While there is 

agreement on the higher initial cost of the TIPS program, less consensus 

exists on the total cost of the TIPS program to date. 

TIPS Program Offers 

Benefits to Treasury, 

and Measuring Its 

Cost Requires both 

Forward-Looking and 

After-the-Fact 

Analysis 

TIPS Program Could 

Benefit Treasury by 

Diversifying Its Funding 

Sources and Investor Base 

TIPS could benefit Treasury by diversifying its funding sources and 

investor base. Market experts and researchers, including the Securities 

Industry and Financial Markets Association (SIFMA), asserted that TIPS 

could provide Treasury with access to new investors whose needs could 

complement those of investors in nominal securities.14 In a 2004 letter to 

Treasury, the Bond Market Association, now part of SIFMA, stated that 

“the Association continues to believe that the Treasury’s TIPS program is 

likely to ultimately help reduce Treasury’s overall cost of funding by 

attracting a new pool of investors and facilitate better liability 

management.” 

There is direct evidence that TIPS could help Treasury access different 

groups of investors.15 According to research by a New York Federal 

Reserve expert on Treasury markets, between July 30, 2001, and 

December 28, 2005, investment funds (which included mutual funds and 

hedge funds) accounted for 30.2 percent of TIPS sold at auction, but only 

11.5 percent of nominal notes and bonds.16 Whereas, between July 30, 

 

14SIFMA is an organization that represents the shared interests of participants in the global 

financial markets. SIFMA members include international securities firms, U.S.-registered 

broker-dealers and asset managers. SIFMA members are part of TBAC, which meets 

quarterly with Treasury and presents their observations to Treasury on the overall strength 

of the U.S. economy as well as providing recommendations on a variety of technical debt 

management issues. 

15As investors can purchase TIPS in either the secondary market or at auction, 

diversification of Treasury’s end-user investor base might not be directly related to auction 

concentration. 

16Michael Fleming, “Who Buys Treasury Securities at Auction?” Current Issues in 

Economics and Finance, vol. 13, no. 1 (2007). 

Page 17 GAO-09-932 Debt Management
 

2001, and December 28, 2005, the largest group of Treasury holders, 

foreign and international investors, accounted for 8.2 percent of TIPS sold 

at auction and 21.1 percent of nominal notes and bonds. Another example 

of the diversification that TIPS could provide is that pension funds tend to 

purchase a higher share of TIPS securities than nominal Treasury 

securities at auctions. 

While TIPS auctions have been highly concentrated, with just a few 

regular participants, TIPS may exhibit less ownership concentration than 

nominal securities. As of December 2008, the largest TIPS fund (Vanguard 

Inflation-Protected Securities Fund) reported $16.6 billion in TIPS 

holdings, accounting for 3.1 percent of the $530 billion in TIPS outstanding 

on that date. In contrast, Treasury International Capital data shows that 

the largest foreign holder of U.S. Treasury securities (China) reported $727 

billion, accounting for 12.5 percent of the $5.8 trillion in total marketable 

Treasury securities on the same date.17

One indicator of TIPS’ potential to diversify funding sources for Treasury 

is the growth of inflation-protected mutual funds. Both the number and the 

amount of assets under management in inflation-protected funds have 

increased since 2002. As seen in figure 8, the number of inflation-protected 

funds doubled from 20 at the end of December 2002 to 40 at the end of 

May 2009. The amounts of inflation-protected funds under management 

increased from $11.8 billion to $54.4 billion during the same period. The 

mutual fund managers that we interviewed expressed their investors’ 

continued interest in the TIPS program going forward and plan to continue 

to purchase TIPS securities over the next year. According to data from one 

large mutual fund company, between 2003 and 2008 the large majority of 

inflows into its TIPS fund came from non-Treasury funds. 

 

17Treasury International Capital data is available at http://www.treasury.gov/tic. 

Page 18 GAO-09-932 Debt Management
 

Figure 8: Inflation-Protected Mutual Funds and Assets under Management, 

December 2002 to May 2009 

0

10

20

30

40

50

60

Total net assets (in billions)

12/02 12/03 12/04 12/05 12/06 12/07 12/08 5/09

Dollars (in billions)

Date

Source: GAO analysis of Investment Company Institute data.

$11.8

$18.1

$28.3

$36.0 $35.0

$40.6

$46.5

$54.4

0

5

10

15

20

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30

35

40

45

Number of inflation protected Mutual Funds

Number of inflation protected Mutual Funds

41

24

42

40

20

34

41 41

According to market experts, another potential benefit of the TIPS 

program to Treasury is its potential to reduce government borrowing 

costs. If Treasury has to increase the supply of nominal securities 

substantially to fund larger deficits, it may need to raise yields in order to 

attract enough buyers due to the saturation of the nominal Treasury 

market. Therefore, issuing TIPS may make sense as a substantial shift in 

the composition of Treasury issuance into TIPS from nominal Treasuries 

could lead to lower interest rates paid on the remaining nominal Treasury 

issuance. This argument has been cited as a benefit by a number of market 

experts, but additional research is required. Treasury’s access to auction 

data puts ODM staff in a unique position to conduct a comprehensive and 

ongoing analysis of the impact that TIPS have on the cost of nominal 

securities. In commenting on this report, Treasury told us that ODM staff 

have reviewed such data. They note that TIPS have remained less liquid 

than nominal securities and are considering approaches to improve the 

inflation-indexed market. 

Page 19 GAO-09-932 Debt Management
 

Treasury securities have the potential to provide a number of social, fiscal, 

and monetary benefits. All Treasury securities provide investors with 

virtually zero credit risk. Only TIPS, however, provide zero inflation risk, 

making them one of the most effective ways for risk-averse households to 

meet their savings needs. In contrast, one of the downsides of nominal 

Treasury securities is that in the event of unexpected inflation, the real 

return to investors will be less than expected. Investors in nominal 

Treasury securities assume the risk of inflation eroding their expected 

return, but inflation-protected investments, such as TIPS, shift the inflation 

risk to the issuer. 

Economists have noted that governments are better able to bear inflation 

risk because periods of inflation are often associated with increased 

revenues. Economists have also noted that TIPS could make the Federal 

government more accountable for the inflationary consequences of its 

actions in the form of higher payments on TIPS, if inflation increases. The 

results of TIPS auctions also provide useful information to policymakers 

on inflation expectations. In this respect, TIPS auctions help provide a 

measure of market inflation expectations, which can be taken into account 

when making monetary policy decisions.18

Ex-ante vs. Ex-post Analysis 

Ex-ante is Latin for beforehand. In models with uncertainty, ex-ante values are expected 

values that are calculated before the uncertainty is resolved. 

Ex-post is Latin for after the fact. In models with uncertainty, ex-post values are the 

realized or actual values that are calculated after the uncertainty has been resolved. 

In the context of nominal interest-bearing government securities, investors are assumed 

to demand compensation for expected inflation. Ex-ante expectations about inflation are 

assumed to be formed rationally, meaning that expectations will be identical to optimal 

forecasts using all available information. Ex-post, realized inflation rates may differ from 

ex-ante expected values, but these differences should not be systematically positive or 

negative. 

For a sufficiently lengthy time horizon the cost of TIPS relative to nominal Treasury 

securities should be the same when calculated on both an ex-ante and ex-post basis, all 

else equal. For shorter time horizons, the difference between expected and realized 

inflation values may appear to be persistent; thus, the ex-ante approach may be 

preferred to assess the cost of TIPS relative to nominal Treasury securities over the short 

term. 

Forward-Looking Analysis 

of TIPS Program’s Costs 

Adds an Important 

Perspective to Evaluating 

the Role of TIPS as Part of 

Treasury’s Debt Portfolio 

 

18William C. Dudley, Jennifer Roush, and Michelle Steinberg Ezer, “The Case for TIPS: An 

Examination of the Costs and Benefits,” FRBNY Economic Policy Review (July 2009). 

Page 20 GAO-09-932 Debt Management
 

Market experts have measured costs of TIPS in two primary ways. The 

first approach evaluates TIPS on an ex-post (after the fact) basis. That is, 

the cost of TIPS and nominal securities are compared based on what 

inflation actually was during a given time period.19 Economists conducting 

ex-post analyses have concluded that the TIPS program has been less costeffective for Treasury than nominal securities. A 2008 study by a Federal 

Reserve economist estimated that the total cost of the TIPS program 

through October 2007 was between $4.5 billion and $7.5 billion.20 Based on 

TIPS issued through July 2009, Treasury’s ODM estimated the total cost of 

TIPS at $10 billion to date. This more recent study includes the anomalous 

period characterized by the financial market crisis and the related flight to 

quality which made nominal securities relatively inexpensive for Treasury. 

Economists generally agree that part of the relatively higher cost of the 

TIPS program can be attributed to its start-up costs. According to market 

experts and the major institutional investors that we interviewed, other 

factors that may have contributed to the relatively higher cost to Treasury 

of the TIPS program to date are investors’ perceptions of Treasury’s lack 

of commitment to the program and the relatively low inflation experienced 

throughout the life of the program. Since the TIPS program was 

introduced, the annual Consumer Price Index for All Urban Consumers 

(CPI-U) percent change never exceeded 3.8 percent, which is low by 

historical standards. The CPI-U averaged 7.08 percent and 5.55 percent 

during the 1970s and 1980s, respectively. 

In contrast, other economists who have studied the issue argue that from 

an ex-ante (before the fact) basis, TIPS are not more costly to issue than 

nominal securities and that the relative cost of the TIPS program to date in 

part reflects start-up costs that will not be incurred again.21 One recent 

study by Treasury’s ODM found that TIPS are not less costly when 

measured on an ex-ante basis, but this study includes the anomalous 

period characterized by the financial market crisis and the related flight to 

 

19For the total cost of the TIPS program, ex-post analysis computes the cost of TIPS going 

forward if future inflation follows an assumed path. 

20Jennifer Roush, “The ‘Growing Pains’ of TIPS Issuance,” Finance and Economic 

Discussion Series (2008). 

21Jennifer Roush, “The ‘Growing Pains’ of TIPS Issuance,” Finance and Economic 

Discussion Series (2008); William C. Dudley, Jennifer Roush, and Michelle Steinberg Ezer, 

“The Case for TIPS: An Examination of the Costs and Benefits,” FRBNY Economic Policy 

Review (July 2009); and Pu Shen, “Developing a Liquid Market for Inflation-Indexed 

Government Securities: Lessons from Earlier Experiences,” Economic Review (First 

Quarter 2009). 

Page 21 GAO-09-932 Debt Management
 

quality which made nominal securities relatively inexpensive for Treasury. 

Another ex-ante study, noted that if the TIPS program were as liquid as the 

market for off-the-run nominal Treasuries, Treasury would have realized 

total cost savings from the TIPS program of $22 billion to $32 billion.22

Over the short run, economists recognize that an assessment of TIPS 

program’s relative costs depends on whether Treasury or the investor is 

the beneficiary from differences in expected and actual inflation. The time 

horizon of the analysis affects the results since, over the long run, the 

average amount by which actual inflation exceeds expected inflation will 

roughly equal the average amount when the opposite is true.23 Therefore, 

some market experts argue that TIPS should be evaluated on an ex-ante 

basis, for example, by finding the difference between the breakeven 

inflation rate (the nominal-TIPS yield differential) and a survey-based 

measure of inflation expectations at the time of the TIPS auction. This 

difference is independent of inflation surprises and provides a measure of 

the net savings or loss incurred by Treasury. 

Faced with the economic recession and the ensuing 2008 financial market 

crisis, Treasury is to be commended for its success in raising 

unprecedented amounts of cash in a very short amount of time. Absent 

policy changes, the medium- and long-term fiscal outlook mean that 

Treasury will need to raise increasing amounts of cash, and build 

borrowing flexibility by increasing the term to maturity of its debt 

portfolio, while retaining its focus on reducing its overall borrowing cost. 

While questions remain about how to evaluate the cost of the TIPS 

program, TIPS have the potential to provide Treasury with a number of 

benefits and help Treasury achieve its debt management objectives. 

Concluding 

Observations 

On July 1, 2009, we briefed Treasury’s ODM on the findings from our 

analysis and interviews with major institutional investors. Treasury later 

posed questions about ways to improve the TIPS program to the Primary 

Dealers and TBAC. At the August 2009 TBAC meeting, members discussed 

TIPS. Following the meeting, Treasury’s Deputy Assistant Secretary for 

 

22Off-the-run securities are securities that are no longer on-the-run (or the most recently 

auctioned security of a given maturity). 

23William C. Dudley, Jennifer Roush, and Michelle Steinberg Ezer, “The Case for TIPS: An 

Examination of the Costs and Benefits,” FRBNY Economic Policy Review (July 2009); and 

Dean Croushore, “An Evaluation of Inflation Forecasts From Surveys Using Real-Time 

Data,” Federal Reserve Bank of Philadelphia Working Papers (December 2008). 

Page 22 GAO-09-932 Debt Management
 

Federal Finance reaffirmed Treasury’s commitment to TIPS and 

announced plans to gradually increase issuance of TIPS. 

The Secretary of the Treasury should take the following actions to 

improve TIPS liquidity in the context of projected sustained increases in 

federal debt: 

Recommendations 

• increase TIPS issuance, 

• issue TIPS with longer-dated maturities, and 

• conduct more frequent TIPS auctions. 

The Secretary should continually review the appropriate composition of 

the TIPS program, and consider: 

• the impact of Treasury’s public statements and TIPS issuances on TIPS 

liquidity, 

• how both ex-ante (before the fact) and ex-post (after the fact) analyses 

are valuable for evaluating the cost of TIPS, recognizing the anomalous 

nature of market data from periods such as the 2008 financial market 

crisis, 

• the ways in which the TIPS program can diversify Treasury’s investor 

base and funding sources, and 

• the degree to which TIPS impact the cost of nominal securities. 

We requested comments on a draft of this report from the Secretary of the 

Treasury and received comments on behalf of the Treasury from its 

Deputy Assistant Secretary of Federal Finance. Treasury took note of our 

findings, conclusions, and recommendations, and said they were 

consistent with their commitment to increasing TIPS issuance in the 

context of projected sustained increases in federal debt. Treasury 

reiterated that they are committed to issuing TIPS in a regular and 

predictable manner across the yield curve, and noted that they are an 

important part of their overall debt management strategy. Treasury also 

noted that it is always reviewing the appropriate composition of the TIPS 

program. 

Agency Comments 

We are sending copies of this report to the Secretary of the Treasury and 

other interested parties. We will also make copies available at no charge 

on the GAO Web site at http://www.gao.gov. If you or your staff have any 

questions about this report, please contact Susan J. Irving at (202) 512-

6806 or irvings@gao.gov. Contact points for our Offices of Congressional 

Page 23 GAO-09-932 Debt Management
 

Relations and Public Affairs may be found on the last page of this report. 

GAO staff who made major contributions to this report are listed in 

appendix III. 

Sincerely yours, 

Director, Federal Budget Analysis 

Susan J. Irving 

Strategic Issues

Page 24 GAO-09-932 Debt Management
Appendix I: Tre

Sec

asury Inflation Protected 

urities 

Page 25 GAO-09-932 

Appendix I: Treasury Inflation Protected 

Securities 

Treasury Inflation Protected Securities (TIPS) are marketable securities 

for which the principal is adjusted by changes in the Consumer Price 

Index for All Urban Consumers (CPI-U).1

 With inflation (a rise in the 

index), the principal increases. With deflation (a drop in the index), the 

principal decreases for the purpose of calculating interest payments, but 

the principal to be repaid at maturity is at least par value (or the principal 

amount at date of original issuance). Although the inflation-adjusted 

principal is paid by the Department of the Treasury when the security 

matures, interest payments are made every 6 months. TIPS are the only 

Treasury security that secures the investor a return on the investment that 

is guaranteed in purchasing power terms rather than in dollar terms. 

Overview 

At maturity, Treasury pays investors the greater of the inflation-adjusted 

principal amount or the par value. That is, investors are protected against 

both increases in inflation and the loss of the original principal. During the 

lifetime of a TIPS, the principal could decline with deflation below the 

original par value, so the coupon payment could fall below their originally 

stated dollar amounts, but at maturity the principal will be redeemed at no 

less than the original face amount. 

Principal 

Interest is paid every 6 months at a fixed rate, which was determined at 

auction when the security was first sold. However, because the rate is 

applied to the adjusted principal, interest payments may vary from one 

period to another. Interest payments are based on the inflation-adjusted 

principal on the date of the interest payment.2

 In a period of inflation, the 

principal is adjusted upward so the interest payment increases. In the 

event of deflation, the principal is adjusted downward, and the interest 

payment decreases.3

 

Interest Payments 

 

1

The index for the inflation rate is the Bureau of Labor Statistic’s nonseasonally adjusted 

U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U). TIPS 

are indexed to a lagged value of the CPI by 3 months, rather than the contemporaneous 

value. 

2

The amount of each interest payment is determined by multiplying the adjusted principal 

by one-half the interest rate. 

3

Even though the principal is adjusted downward for the purpose of the calculation of 

interest payments, the original principal amount on the date of issuance is returned to the 

investor at maturity. 

 Debt Management
Appendix I: Treasury Inflation Protected 

Securities 

Below is an illustrative example of how to calculate the inflation 

adjustments to the principal and the semi-annual interest payments (note 

that CPI-U numbers and rates are purely hypothetical). 

How to Calculate an Inflation-Indexed Security Interest and Principal 

An inflation-indexed security with par value of $1,000,000 was purchased on April 15, 

2003, with a coupon rate of 3.5 percent. The first semi-annual interest payment date for 

this inflation indexed security is October 15, 2003. The reference CPI-U number for the 

issue date was 120. The reference CPI-U number for the first interest payment was 135. 

The inflation adjusted principal on October 15, 2003 was: 

 $1,000,000 x 135/120 = $1,125,000 

The interest payment was: 

 $1,125,000 x 0.035/2 = $19,687.50

Both interest payments and the inflation adjustments applied to the 

principal of TIPS are subject to federal tax. The accrued increase in 

principal caused by the inflation adjustment is taxable in the year in which 

it is accrued, which is the standard structure for all other Treasury 

securities. However, with TIPS the increase in principal is an unrealized 

gain because the principal is not received until the bond matures. This is 

not an issue if TIPS are held in a tax-deferred account. 

Taxation 

Treasury currently auctions 5-, 10-, and 20-year TIPS. Treasury used to also 

issue 30-year TIPS, but discontinued doing so in 2001. Treasury currently 

auctions TIPS on a quarterly basis. The 5-year TIPS is issued in April and 

reopened in October.4

 The 10-year TIPS is issued in January and July, with 

reopenings in April and October, and the 20-year TIPS is issued in January 

and reopened in July. 

Auction Schedule 

 

4

In a reopening, Treasury sells an additional amount of a previously issued security. The 

reopened security has the same maturity date and interest rate as the original security. 

However, as compared to the original security, the reopened security has a different issue 

date and can have a different purchase price. 

Page 26 GAO-09-932 Debt Management
Appendix I: Treasury Inflation Protected 

Securities 

TIPS are sold in increments of $100, with a required minimum purchase of 

$100. Treasury issues TIPS in electronic form. At auction, an investor can 

place competitive or noncompetitive bids for TIPS. However, 

noncompetitive bids are limited in a single auction to $5 million while 

competitive bids are limited to 35 percent of the initial offering amount.5

 

Investors can hold TIPS until they mature or sell them in the secondary 

market before they mature. 

Purchasing TIPS 

 

5

A competitive bid is a bid to U.S. Treasury to buy Treasury securities at a particular yield. 

A noncompetitive bid is a method of purchasing Treasury securities at auction, without 

having to submit a price or a yield. Unlike competitive bids, noncompetitive bids are 

always accepted. 

Page 27 GAO-09-932 Debt Management
Appendix II: The Cost of Treasury Inflation 

Protected Securities Compared to Nominal Appendix II: The Cost of Treasury Inflation Securities 

Protected Securities Compared to Nominal 

Securities 

For a sufficiently lengthy time horizon the cost of Treasury Inflation 

Protected Securities (TIPS) relative to nominal Treasury securities should 

be the same when calculated on both an ex-ante (before the fact) and expost (after the fact) basis, all else equal. 

The following arithmetic illustrates the approximate equivalence between 

ex-ante and ex-post evaluations of the cost of TIPS relative to nominal 

securities.1

 

Ex-Post Calculation of the Nominal-TIPS Cost Difference 

Nominal yield = real yield + expected inflation + inflation risk premium 

TIPS yield = real yield + illiquidity premium 

Ex-post evaluation of the cost difference between nominals and TIPS adds actual inflation 

to the TIPS yield, so ex-post: 

TIPS yield = real yield + illiquidity premium + actual inflation 

Ex-post, therefore, the nominal-TIPS cost difference is: 

real yield + expected inflation + inflation risk premium - 

real yield - illiquidity premium - actual inflation 

In the long run, expected inflation should equal actual inflation on average, so the ex-post 

nominal-TIPS cost difference reduces to: 

inflation risk premium - illiquidity premium 

 

1

While the cost difference between nominal Treasury securities and TIPS is primarily 

driven by illiquidity and inflation risk premiums, the relative cost also reflects such 

technical market factors as the taxation difference between TIPS and nominal issuances, 

the convexity of difference between real and nominal yields, and the price of TIPS 

embedded deflation floor. 

Page 28 GAO-09-932 Debt Management
Appendix II: The Cost of Treasury Inflation 

Protected Securities Compared to Nominal 

Securities 

Ex-ante calculation of the cost difference between nominals and TIPS 

subtracts a survey-based measure of expected inflation from the nominalTIPS cost difference. 

Ex-Ante Calculation of the Nominal-TIPS Cost Difference 

Real yield + expected inflation + inflation risk premium - surveyed inflation 

expectation - real yield - illiquidity premium 

If the survey accurately captures expected inflation, then expected inflation equals 

surveyed expected inflation and this ex-ante difference reduces to: 

Inflation risk premium - illiquidity premium 

Again, over the long run, if expected inflation = surveyed expected 

inflation = actual inflation, ex-ante and ex-post calculations of the cost of 

TIPS relative to nominals should be approximately the same. However, the 

possibility of persistent inflation surprises in one direction over a few 

years suggests using the ex-ante approach over shorter horizons. 

The cost of TIPS compared to nominal securities increased substantially in 

fall 2008 when the subprime crisis intensified.2

 During the latter part of 

2008, TIPS yields rose while nominal yields declined resulting in near 

historic lows in the breakeven inflation rate, approaching zero by the end 

of 2008. During 2009, breakeven rates generally rose from their late-2008 

lows and reached the 2 percent range in early August. 

Disentangling the 

Drivers of Recent 

Shifts in the NominalTIPS Yield Differential 

(Breakeven Inflation 

Rate) 

 

2

Ingo Fender, Corrinne Ho, and Peter Hordähl, “Overview: investors ponder depth and 

duration of global downturn,” BIS Quarterly Review (March 2009). 

Page 29 GAO-09-932 Debt Management
Appendix II: The Cost of Treasury Inflation 

Protected Securities Compared to Nominal 

Securities 

Disentangling the Drivers of Recent Shifts in the Nominal-TIPS Yield Differential 

(Breakeven Inflation Rate) 

The sharp decline in breakeven inflation rates in late 2008 can be attributed to a 

combination of liquidity and technical market factors. Strong flight-to-liquidity flows during 

the market upheaval boosted the demand for nominal Treasury securities. Because TIPS 

markets are less liquid than nominal Treasury markets, this reduced the breakeven 

inflation rate. 

In addition, technical market factors closely linked to liquidity effects appear to have 

contributed to the decline in breakeven inflation rates. Lehman Brothers owned TIPS as 

part of repo trades or posted TIPS as counterparty collateral. Because of Lehman’s 

bankruptcy, the court and its counterparty needed to sell these TIPS, which created a 

flood of TIPS on the market. There appeared to be few buyers and distressed market 

makers were unwilling to take positions in these TIPS. As a result, the TIPS yields rose 

sharply. 

Inflation expectations and the inflation risk premium, two other important determinants of 

the nominal-TIPS yield differential, appear to have had negligible roles in the recent shifts 

in the yield differential. The median survey value of 10-year inflation forecasts compiled by 

the Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters displayed 

little variation over the last 2 years, which implies that long-term inflation expectations 

remained stable. Estimates also suggest that the inflation risk premium has remained 

relatively small and fairly stable. 

Some financial economists view the experience with TIPS yields after the Lehman 

bankruptcy as a highly abnormal market situation where liquidity issues suddenly created 

severe financial anomalies. They suggest that this was an unrepresentative episode and 

that observations from this period could be ignored. 

See John Campbell, Robert Shiller, and Luis Viceira, “Understanding Inflation-Indexed Bond 

Markets,” Working Paper Presented Brookings Institute (March 2009); and Ingo Fender, Corrinne Ho, 

and Peter Hordähl, “Overview: investors ponder depth and duration of global downturn,” BIS 

Quarterly Review (March 2009). 

Page 30 GAO-09-932 Debt Management
Appendix III: GAO

A

 Contact and Staff 

cknowledgments 

Page 31 GAO-09-932 

Appendix III: GAO Contact and Staff 

Acknowledgments 

Susan J. Irving, (202) 512-6806 or irvings@gao.gov 

In addition to the contact named above, Jose Oyola (Assistant Director), 

Tara Carter (Analyst-in-Charge), Mark Kehoe, Erik Kjeldgaard, Richard 

Krashevski, Margaret McKenna and Jason Vassilicos made contributions 

to the report. Julie Matta, Rick Cambosos, Stuart Kaufman, and Greg 

Wilmoth also provided key assistance. 

 Debt Management

GAO Contact 

Staff 

Acknowledgments 

(450777) 
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