UNITED STATES DEPARTMENT OF THE TREASURY

Presentation to the

Treasury Borrowing Advisory Committee

U.S. Department of Treasury

Office of Debt Management

May 3, 2011
UNITED STATES DEPARTMENT OF THE TREASURY

Agenda

• Fiscal Developments

– Tax Update

– MBS Portfolio

– Non-Marketable Treasury Security Update

– Deficit Forecasts

– Debt Limit

• Auction Demand & Market Trends

– Coverage Ratios

– Investor Class Data

• Portfolio Metrics

– Nominal Coupons and Bills

– Treasury Supplementary Financing Program

– TIPS

– Average Maturity

– Percentage of Debt Maturing in Upcoming Years

• Long-term Challenges

– Office of Management and Budget (OMB) Forecasts

– Deficit Reduction Plans

2
UNITED STATES DEPARTMENT OF THE TREASURY

FISCAL DEVELOPMENTS

3
UNITED STATES DEPARTMENT OF THE TREASURY

Growth in Individual Tax Receipts Continued in Q2 FY 2011

4

-40%

-20%

0%

20%

40%

60%

M

ar-0

0

Jun-0

0

S

e

p-0

0

D

ec-0

0

M

ar-01

Jun-01

S

e

p-01

D

ec-01

M

ar-0

2

Jun-0

2

S

e

p-0

2

D

ec-0

2

M

ar-0

3

Jun-0

3

S

e

p-0

3

D

ec-0

3

M

ar-0

4

Jun-0

4

S

e

p-0

4

D

ec-0

4

M

ar-0

5

Jun-0

5

S

e

p-0

5

D

ec-0

5

M

ar-0

6

Jun-0

6

S

e

p-0

6

D

ec-0

6

M

ar-0

7

Jun-0

7

S

e

p-0

7

D

ec-0

7

M

ar-0

8

Jun-0

8

S

e

p-0

8

D

ec-0

8

M

ar-0

9

Jun-0

9

S

e

p-0

9

D

ec-0

9

M

ar-10

Jun-10

S

e

p-10

D

ec-10

M

ar-11

Withheld Taxes Nonwithheld Taxes Corporate Taxes

Q

Note: Adjusted for 9/11/01 Corporate Tax Receipts disruption

Source: Monthly Treasury Statement

Quarterly Tax Receipts

Year-over-Year Percentage Change

A closer look at Q2 FY11 ending March-2011:

Withheld Taxes: +3%

Nonwithheld Taxes: +5%

Corporate Taxes: -31%

Note: Data plotted is year-over-year changes in quarterly receipts
UNITED STATES DEPARTMENT OF THE TREASURY

April Tax Receipts Show Strength

5

A Closer Look at April 2011

5-Year Average Receipt Composition FY2006-2010

Receipt Category Avg. % of Annual Receipts

Withheld 69%

Corporate 14%

Nonwithheld 17%

Receipt Category Composition Y/Y % Change Y/Y Change $Billions

Withheld 42% 1% $2

Corporate 9% -6% -$2

Nonwithheld 49% 29% $37
UNITED STATES DEPARTMENT OF THE TREASURY

Treasury Sales of MBS Will Reduce Borrowing Needs

6

-20

-10

0

10

20

30

40

50

10-May-201024-May-2010

7-Jun-2010

21-Jun-2010

5-Jul-2010

19-Jul-2010

2-Aug-2010

16-Aug-201030-Aug-201013-Sep-201027-Sep-2010

11-Oct-201025-Oct-2010

8-Nov-2010

22-Nov-2010

6-Dec-2010

20-Dec-2010

3-Jan-2011

17-Jan-201131-Jan-2011

14-Feb-201128-Feb-201114-Mar-201128-Mar-2011

11-Apr-2011

FNMA Current Coupon 30yr TSY OAS

2/11/11 GSE White

Paper Released

3/21/11 US

Treasury

Announces

MBS

Portfolio

Disposition

Tsy OAS Source: JP Morgan

Agency-Guaranteed MBS Portfolio

Proceeds from Sales

by Treasury

Principal and

Interest Payments

Total Taxpayer

Recoveries

Cumulative through February 2011 0 $100.8 billion $100.8 billion

March 2011 $3.8 billion $3.2 billion $7.0 billion

April 2011 $10.3 billion $2.8 billion $13.1 billion

Cumulative through April 2011 $14.1 billion $106.8 billion $120.9 billion
UNITED STATES DEPARTMENT OF THE TREASURY

Treasury’s Current MBS Holdings

7

Note: Data through 4/29/2011

MBS Outstanding Float Source: JP Morgan

FNMA $1.36B

FNMA $15.70B

FNMA $18.84B

FNMA $16.35B

FNMA $7.91B

FNMA $0.05B

FRE $24.29B

FRE $18.35B

FRE $8.27B

FRE $1.88B

FRE $0.00B

0%

5%

10%

15%

4.0% 4.5% 5.0% 5.5% 6.0% 6.5%

UST % of Total (FNMA) UST % of Total (FRE)

Coupon

Treasury Holdings of FNMA & FRE 30-Year

As a % of Outstanding Float (ex-CMO)

FRE $4.16B
UNITED STATES DEPARTMENT OF THE TREASURY

Non-Marketable Redemptions Continued in Q2 FY 2011

8

Source: Monthly Treasury Statement

-$30

-$20

-$10

$0

$10

$20

$30

Q1

FY2005

Q3 Q1

FY2006

Q3 Q1

FY2007

Q3 Q1

FY2008

Q3 Q1

FY2009

Q3 Q1

FY2010

Q3 Q1

FY2011

Savings Bond Foreign Series SLGS

Net Non-marketable Issuance

In Billions $
UNITED STATES DEPARTMENT OF THE TREASURY

Primary Dealer and Government Deficit Estimates

FY 2011-2013 Deficit and Borrowing Estimates In Billions $

Primary

Dealers* CBO OMB

FY 2011 Deficit Estimate 1,431 1,480 1,645

FY 2012 Deficit Estimate 1,149 1,100 1,101

FY 2013 Deficit Estimate 920 704 768

FY 2011 Deficit Range 1,300-1,682

FY 2012 Deficit Range 1,025-1,300

FY 2013 Deficit Range 700-1,100

FY 2011 Marketable Borrowing Range 1,124-1,550

FY 2012 Marketable Borrowing Range 1,000-1,350

Estimates as of: Apr 2011 Jan 2011 Feb 2011

*Based on Primary Dealer feedback on April 29, 2011. Deficit estimates are averages.

9
UNITED STATES DEPARTMENT OF THE TREASURY

Treasury Expects to Reach the Debt Limit on May 16

10

4

6

8

10

12

14

16

19

9

7 - F

e

b

19

9

7 - Aug

19

9

8 - F

e

b

19

9

8 - Aug

19

9

9 - F

e

b

19

9

9 - Aug

2

0

0

0 - F

e

b

2

0

0

0 - Aug

2

0

01 - F

e

b

2

0

01 - Aug

2

0

0

2 - F

e

b

2

0

0

2 - Aug

2

0

0

3 - F

e

b

2

0

0

3 - Aug

2

0

0

4 - F

e

b

2

0

0

4 - Aug

2

0

0

5 - F

e

b

2

0

0

5 - Aug

2

0

0

6 - F

e

b

2

0

0

6 - Aug

2

0

0

7 - F

e

b

2

0

0

7 - Aug

2

0

0

8 - F

e

b

2

0

0

8 - Aug

2

0

0

9 - F

e

b

2

0

0

9 - Aug

2

010 - F

e

b

2

010 - Aug

2

011 - F

e

b

Debt Subject to Limit Debt Limit

Total Public Debt Outstanding Subject to the Statutory Debt Limit

Current Debt Ceiling: $14.294 Trillion

Current Debt: $14.230 Trillion

Headroom: $64 Billion

Note: Data through 4/28/2011
UNITED STATES DEPARTMENT OF THE TREASURY

Extraordinary Actions Used in the Past Do Not Provide as Much Flexibility

11

Fiscal Year 1996

# of Days of Debt Limit Impasse 136

Tools G-Fund, CSRDF, ESF, FFB, SLGS

Fiscal Year 2002

# of Days of Debt Limit Impasse 85

Tools G-Fund, CSRDF, SLGS

Fiscal Year 2003

# of Days of Debt Limit Impasse 93

Tools G-Fund, CSRDF, ESF, FFB, SLGS

Fiscal Year 2005

# of Days of Debt Limit Impasse 37

Tools G-Fund, CSRDF, ESF, FFB, SLGS

Fiscal Year 2006

# of Days of Debt Limit Impasse 29

Tools G-Fund, CSRDF, ESF, FFB, SLGS

Fiscal Year 2011

# of Days of Debt Limit Impasse ???

Tools G-Fund, CSRDF, ESF, SLGS

There have been 6 occasions over the past 15 years

where Treasury has been forced to use

extraordinary actions to continue to fund government

operations.

Some combination of the following actions have

been used during these episodes:

• Suspension of issuance of new State and Local

Government Securities (SLGS)

• Suspension of investments in:

o the Government Securities Investment

Fund (G-Fund)

o the Exchange Stabilization Fund (ESF)

o the Civil Service Retirement and Disability

Fund (CSRDF)*

• Federal Financing Bank (FFB) swap transactions

These periods lasted between 29 and 136 days. In

each of these cases, the extraordinary actions

undertaken by Treasury were sufficient to continue

funding the government.

However, given financing needs, these tools will not

sustain borrowing beyond early August.

*Also includes the redemption of existing investments
UNITED STATES DEPARTMENT OF THE TREASURY

AUCTION DEMAND & MARKET TRENDS

12
UNITED STATES DEPARTMENT OF THE TREASURY

Coverage Ratios Have Remained Strong in FY 2011

13

Source: Treasury Auction Data; Through 4/25/2011

1.0

1.5

2.0

2.5

3.0

3.5

$0

$500

$1,000

$1,500

$2,000

$2,500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011YTD

Weighted Average Coverage Ratio on Nominal Notes and Bonds

In Billions $, Coverage Ratio

Gross Private Issuance Weighted Average Coverage Ratio
UNITED STATES DEPARTMENT OF THE TREASURY

Smaller Dealers Have Increased Nominal Coupon Auction Participation

14

Source: Treasury Investor Class Data; Data through 4/15/2011*FY2006 through FY2010

SOMA 3%

Primary Dealers

47%

Other

Dealers &

Brokers

10%

Investment

Funds 17%

Foreign &

International

22%

FY2011 YTD: Average Investor Class Allotments

SOMA 9%

Depository

Institutions 1%

Individuals 1%

Primary Dealers

52%

Other Dealers &

Brokers 4%

Investment

Funds 14%

Foreign &

International

19%

Five-Year Average of Investor Class Allotments*
UNITED STATES DEPARTMENT OF THE TREASURY

Smaller Dealers Have Also Increased Bill Auction Participation

15

Source: Treasury Investor Class Data; Data through 4/15/2011*FY2006 through FY2010

SOMA 12% Individuals 4%

Primary

Dealers 54%

Other Dealers

& Brokers 7%

Investment

Funds 13%

Foreign &

International

10%

Other 1%

Five-Year Average of Investor Class Allotments*

SOMA 3% Individuals 2%

Primary Dealers

55%

Other Dealers &

Brokers 12%

Investment

Funds 14%

Foreign &

International

13%

FY2011 YTD: Average Investor Class Allotments
UNITED STATES DEPARTMENT OF THE TREASURY

PORTFOLIO METRICS

16
UNITED STATES DEPARTMENT OF THE TREASURY

Nominal Coupons and Bills as a Percentage of the Portfolio

17

24%

15%

20%

25%

30%

35%

40%

Jan-0

0

Apr-0

0

Jul-0

0

Oct-0

0

Jan-01

Apr-01

Jul-01

Oct-01

Jan-0

2

Apr-0

2

Jul-0

2

Oct-0

2

Jan-0

3

Apr-0

3

Jul-0

3

Oct-0

3

Jan-0

4

Apr-0

4

Jul-0

4

Oct-0

4

Jan-0

5

Apr-0

5

Jul-0

5

Oct-0

5

Jan-0

6

Apr-0

6

Jul-0

6

Oct-0

6

Jan-0

7

Apr-0

7

Jul-0

7

Oct-0

7

Jan-0

8

Apr-0

8

Jul-0

8

Oct-0

8

Jan-0

9

Apr-0

9

Jul-0

9

Oct-0

9

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Bills

Percentage of Total Portfolio Notes: Includes SFP and CMBs

Average 2000 - 2007

Last: 20% as of 3/31/2011

69%

50%

55%

60%

65%

70%

75%

80%

Jan-0

0

Apr-0

0

Jul-0

0

Oct-0

0

Jan-01

Apr-01

Jul-01

Oct-01

Jan-0

2

Apr-0

2

Jul-0

2

Oct-0

2

Jan-0

3

Apr-0

3

Jul-0

3

Oct-0

3

Jan-0

4

Apr-0

4

Jul-0

4

Oct-0

4

Jan-0

5

Apr-0

5

Jul-0

5

Oct-0

5

Jan-0

6

Apr-0

6

Jul-0

6

Oct-0

6

Jan-0

7

Apr-0

7

Jul-0

7

Oct-0

7

Jan-0

8

Apr-0

8

Jul-0

8

Oct-0

8

Jan-0

9

Apr-0

9

Jul-0

9

Oct-0

9

Jan-10

Apr-10

Jul-10

Oct-10

Jan-11

Nominal Coupons

Percentage of Total Portfolio

Average 2000 - 2007

Last: 74% as of 3/31/2011
UNITED STATES DEPARTMENT OF THE TREASURY

Balances in the SFP Have Fallen as the Debt Limit Approaches

18

$0

$100

$200

$300

$400

$500

$600

$700

$800

S

e

p-0

8

Oct-0

8

N

o

v-0

8

D

ec-0

8

Jan-0

9

F

e

b-0

9

M

ar-0

9

A

pr-0

9

M

a

y-0

9

Jun-0

9

Jul-0

9

Aug-0

9

S

e

p-0

9

Oct-0

9

N

o

v-0

9

D

ec-0

9

Jan-10

F

e

b-10

M

ar-10

A

pr-10

M

a

y-10

Jun-10

Jul-10

Aug-10S

e

p-10

Oct-10

N

o

v-10

D

ec-10

Jan-11

F

e

b-11

M

ar-11

Treasury Supplementary Financing Program Cash Balance

In Billions $

Max: $560B

Min: $5B

12/30/09

$200B 3/31/11:

$5B
UNITED STATES DEPARTMENT OF THE TREASURY

TIPS Issuance Will Continue to Increase

19

Note: Data through 4/21/2011

0%

3%

6%

9%

12%

$0

$25

$50

$75

$100

1997 1999 2001 2003 2005 2007 2009 2011YTD

TIPS

Calendar Year Issuancein Billions $, PercentageofPortfolio

5-Year (L) 10-Year (L) 20-Year (L) 30-Year (L) TIPS as % of the Portfolio (R)
UNITED STATES DEPARTMENT OF THE TREASURY

Average Maturity of the Debt Continues to Lengthen

20

Note: Data through 3/31/2011

40

45

50

55

60

65

70

75

19

8

0

19

81

19

8

2

19

8

3

19

8

4

19

8

5

19

8

6

19

8

7

19

8

8

19

8

9

19

9

0

19

91

19

9

2

19

9

3

19

9

4

19

9

5

19

9

6

19

9

7

19

9

8

19

9

9

2

0

0

0

2

0

01

2

0

0

2

2

0

0

3

2

0

0

4

2

0

0

5

2

0

0

6

2

0

0

7

2

0

0

8

2

0

0

9

2

010

2

011

Average Maturity of Marketable Debt

In Months

Average Maturity (Outstanding)

Current 60.4 as of 3/2011

Average 58.1

Min 42.4 in 4/1980

Max 70.9 in 5/2001

Statistics on Average Maturity since CY1980
UNITED STATES DEPARTMENT OF THE TREASURY

Percentage of Debt Maturing in the Near-Term Remains at Historic Lows

21

Note: Data through 3/31/2011

20%

30%

40%

50%

60%

70%

Jan-9

0

Jul-9

0

Jan-91

Jul-91

Jan-9

2

Jul-9

2

Jan-9

3

Jul-9

3

Jan-9

4

Jul-9

4

Jan-9

5

Jul-9

5

Jan-9

6

Jul-9

6

Jan-9

7

Jul-9

7

Jan-9

8

Jul-9

8

Jan-9

9

Jul-9

9

Jan-0

0

Jul-0

0

Jan-01

Jul-01

Jan-0

2

Jul-0

2

Jan-0

3

Jul-0

3

Jan-0

4

Jul-0

4

Jan-0

5

Jul-0

5

Jan-0

6

Jul-0

6

Jan-0

7

Jul-0

7

Jan-0

8

Jul-0

8

Jan-0

9

Jul-0

9

Jan-10

Jul-10

Jan-11

Percentage of Debt Maturing in Next 12 to 36 Months

Maturing in 12 Months Maturing in 24 Months Maturing in 36 Months
UNITED STATES DEPARTMENT OF THE TREASURY

LONG-TERM CHALLENGES

22
UNITED STATES DEPARTMENT OF THE TREASURY

OMB FY 2012 Budget Projections

23

-18%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

-$2,000

-$1,500

-$1,000

-$500

$0

$500

19

5

0

19

5

2

19

5

4

19

5

6

19

5

8

19

6

0

19

6

2

19

6

4

19

6

6

19

6

8

19

7

0

19

7

2

19

7

4

19

7

6

19

7

8

19

8

0

19

8

2

19

8

4

19

8

6

19

8

8

19

9

0

19

9

2

19

9

4

19

9

6

19

9

8

2

0

0

0

2

0

0

2

2

0

0

4

2

0

0

6

2

0

0

8

2

010

2

012

2

014

2

016

2

018

2

0

2

0

Budget Surplus/Deficit

In Billions $, Percentage of GDP

Surplus/Deficit $ (L) Surplus/Deficit % of GDP (R)

OMB FY2012 Budget

Projections
UNITED STATES DEPARTMENT OF THE TREASURY

OMB Long-Term Debt Metrics

24

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

195019521954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008201020122014201620182020

Fiscal Year Interest Expense

In Billions $, Percentage of GDP

Interest Expense (L) Interest Expense as a % of GDP (R) Average Interest Expense as a % of GDP (R)

OMB FY2012 Budget

Projections

Note: Interest costs based on net interest on Treasury debt minus interest on trust funds and other income.

Average 1950-2010:

2%

0

20

40

60

80

100

120

$0

$5

$10

$15

$20

$25

$30

195019521954195619581960196219641966196819701972197419761978198019821984198619881990199219941996199820002002200420062008201020122014201620182020

Fiscal Year Outstanding Debt

In Trillions $, Percentage of GDP

projections Public/Dollar projection intergovdollar Public as a % of GDP (R) Government Accounts as a % of GDP (R) Total Debt as a % of GDP (R)

OMB FY2012 Budget

Projections
UNITED STATES DEPARTMENT OF THE TREASURY

Deficit Reduction Plans

25

Deficit Reduction

Relative to Current Policy Baseline, $ billion

Administration

Framework

(2012-23)

SimpsonBowles

(2012-21)

Ryan Budget

Resolution

(2012-21)

Total Deficit Reduction -4,000 -4,394 -4,685

Spending -2,010 -2,694 -5,325

Security Discretionary -400 -930 -100

Non-Security Discretionary -770 -600 -1,740

Repeal ACA 0 0 -1,410

Medicare/ Medicaid -480 -460 -1,100

Other Mandatory -360 -224 -975

Social Security + Superlative CPI 0 -480 0

Tax Reform -1,000 -1,000 1,420

Interest -990 -700 -780
26 UNITED STATES DEPARTMENT OF THE TREASURY

What adjustments to debt issuance, if any, should Treasury make in

consideration of its financing needs in the short-, medium-, and long-term?
Presentation for:

The TreasBorrowing Advisory Committe

May 3, 2011
The Charge

We would like the Committee to comment on the current state of public pensi f d i h U S H d bli d i i diff i 

ion funds in the U.S. How do public and private pensions differ in 

to asset-liability management? Please discuss how these approaches affecinvestment decisions in fixed income markets. Is there anything Treasur

consider when thinking about the overall composition of the Treasury deconsider when thinking about the overall composition of the Treasury de

and/or other Treasury products?
Part I: Characteristics of Public and Private Pension F
Historical Growth of U.S. Retirement Assets b

y 

 Cate

• Retirement assets totaled approximately $17.5 trillion as of the end of 2010• State and local government plans are almost exclusively defined benefit (DB) plan• In the private sector, defined contribution (DC) plans are larger than defined bene

1820

121416

18

($ trillions)

468

10

Market Value (

02

4

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

200

M

1

1

1

1

1

1

1

1

1

1

1

1

1

2

2

2

2

2

IRAs Defined Contribution PlansPrivate Defined Benefit Plans State and Local Government PensFederal Pension Plans Annuities

Source: Investment Company Institute (ICI)
Historical Growth of Defined Benefit Plans

• Total assets of state and local government DB plans first exceeded corporate DB pl• Since then, state and local government DB plans have grown 66% (4% annually), 

DB plans have grown by 25% (1.7% annually)

• I 2010 n, st t d l l DB l t

a

te an

d local DB plans compri d 57 se

d 57% f th t t l DB k t ($ % o

f the 

t

o

t

al DB mar

k

e

t ($3 t illi 

3

t

rillio

3.52.02.53.0

ue ($ trillions)

0.51.01.5

Market Valu

0.0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Corporate Defined Benefit State & Local Defined Benefit

Source: ICI
Comparison of Private and Public DB Plans

• Private and public DB plans have different characteristics• In general, public plans offer higher benefit payments but require larger contributio

employer and employee

• Importantly, freezing a public DB plan is generally more difficult (due to collective 

agreements, legal protections, etc.), thus reducing the degrees of freedom for public 

Characteristic Private Plans State and Local P

Benefit Formula The most common plan structure sets retirement benefits b

of years of service, salary at/near retirement, and a cons

Median Accrual Rate 1 1.5% 1.9%, if covered by Socia

2.2%, if not covered by Soc

Cost of Living Adjustments Very rare Majority of plans have autom

Median Employee Contribution 

Rates 2

Very rare 5%, if covered by Social 

8%, if not covered by Soci

Median Employer Contribution

Rates 3

8% 8%, if covered by Social 

10 7%. , if not covered by So

if not covered by So

Can Employer Freeze Plan? Generally, yes Generally, not unilat

1. As of 20052. As of 2005. From 2002 – 2009, public employee contribution rates were stable.

p py

3. As of 2005. In 2009, public fund figures were 9.4% and 12.7% respectivelySource: Center for Retirement Research at Boston College (CRR), Public Fund Survey
Complexity and Volatility are Causing Private Firms to Freeze 

• Regulatory, legislative, and accounting changes over the past several deca

private DB plans increasingly complex and have contributed to cash flow 

py y g

pp pvolatility

• As a result, firms have increasingly frozen DB plans

• 59% of Fortune 1 000 companies sponsor a DB 59% of Fortune 1,000 companies sponsor a DB plan (vs 64% in 2004) plan (vs. 64% in 2004)• 21% of Fortune 1,000 companies have frozen at least one of their DB plans (v

PBGC Standard Single Employer Terminations (% of insured plans) Status of DB Plans at Fortune 1,000 Co

37% 

70%80%90%

100%

10%12%14%

Pension Protection

Tax Reform Act & 

Single Employer Pension 

Plan Amendment Act 

(1986)

59%

5%

20%30%40%50%60%

4%6%8%

T E it d Fi l

Pension Protection

Act (2006)

0%

10%

20%

2004 2005 2006 2007 

All DB Plans Active At Least One Fro

0%2%

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

Tax Equity and Fiscal

Responsibility Act (1982)

Sources: National Institute on Retirement Security, PBGC, Towers Watson
DB Coverag g, g 

e is Declining, while DC Coverage is Risi

• DB plan freezes and turnover of the labor force have contributed to a dram

the coverage of DB plans

• The percentage of workers covered by DB plans has declined by over 40 perc

since 1983

• Less than half of the participants in private DB plans (and 55% in public DB 

working for the sponsoring employer

Workers with Pension Coverage, by Pension Type Percent of Active Participants in Defin

working for the sponsoring employer

50%60%70%

60%65%

20%30%40%

50%55%

0%

10%

Defined Benefit Only 401(k) Only Both

1983 1995 2007

40%45%

2001 2002 2003 2004 200

Sources: CRR, PBGC

126 Public DB Plans All Single-Emp
Historical Growth of Public Defined Contribution Pla

• State & Local Defined Contribution plans represent a small portion of the DC mar

• Only two states (MI and AK) have implemented mandatory defined contribu

• Most of the asset growth has been in voluntary contribution plans (similar to 

Availability of Defined Contribution and Hybrid Plans Introduction of State DC and Hybrid Plan

Sources: ICI, CRR
Part II: Survey y of Assets Held by Public and Private F
Asset Allocation Diverging Between Private and Public DB Plans 

• Since the Pension Protection Act was enacted in 2006, corporations have increasingly f

driven investment strategies

Asset Allocation Diverging Between Private and Public DB Plans 

• As a result, corporate DB plans have shifted from equities into fixed income and also inc

duration of their fixed income assets to better match the duration of their liabilities (typ

• Over the past decade, the fixed income allocation of corporate DB plans has expanded f

while the allocation in public DB plans has declined from 29% to 27%

Asset Allocation for Corporate DB Plans Asset Allocation for Public DB Plans

while the allocation in public DB plans has declined from 29% to 27%

• Both have increased allocations to alternative strategies (such as real estate, private equ

funds)

8% 12% 17%

70%80%90%

100% 9% 10%

70%80%90%

100%

39%

64% 61% 43%

20%30%40%50%60%70%

63% 61%

20%30%40%50%60%

26% 26%

39%

0%

10%

20%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Cash Fixed Income Equity Alternatives & Other

29% 26% 

0%

10%

20%

2000 2001 2002 2003 2004 2005 

Cash Fixed Income Equity 

Source: Pensions & Investments (P&I)
Comp gg arison of Funding and Accounting Rules

• Differences in accounting and funding requirements impact asset allocation• Under proposed accounting standards for private plans, the expected return on pension assets w

through the income statement. This may cause private plans to increase their allocations to fix

Private DB Public 

Accounting Rules

Source Primarily FAS 87 and 158 Primarily GASB Funded Status on BalanceSheet?

Yes. Net asset for all overfunded plans + net 

liability for all underfunded plans

No. Incur a liability if annu

the annual required con

Pension Asset Valuation Generally at fair value Typically 3-5 yeaLiability Discount Rate Liability Discount Rate Based on high Based on high-quality quality Based on expec

corporate bond yields. Discount rate 

unaffected by asset allocation.

Based on expec

return. Assumes spons

Income Statement Impact of Asset Allocation

More aggressive portfolio Æ Higher expected 

return Æ Lower pension expense

More aggressive portfolio Æ 

Æ Lower ARC Æ Low

Funding RulesSource Primarily ERISA and PPA No uniform reAnnual Required Contribution Normal Cost + Underfunding

ti d 2

GASB recom

amortized over seven years N l C t + U d f di 

2 Normal Cost + Underfundi

years

1. Funded status (using actuarial value of assets and a discount rate equal to the expected return) is reported on a separate sch

2. Unlike the funded status reflected on balance sheet (which compares assets to the projected benefit obligation), funding reqwith respect to the accumulated benefit obligation (which excludes future salary growth). Congress enacted pension funding r

sponsors to temporarily extend the amortization period.Sources: Credit Suisse, JP Morgan
Asset Allocation Diverging Between Private and Public DB Plans 

• Surveys indicate that asset allocation trends between corporate and public DB plan

continue over the next few years

Asset Allocation Diverging Between Private and Public DB Plans 

• 41% of corporate DB plan sponsors intend to increase their allocation to long corp

the next one to two years (35% planning to increase allocation to long governmen

• Both corporate and public plans intend to reduce exposure to U.S. equities

Net Share of Sponsors Planning toSignificantly Increase Exposure over Next 3 Years Asset Allocation for Corporate DB Plans o

21%

20%

4%

3%

61%

56%

High Yield

Global Equity

US Small Cap Equity

US Large Cap Equity

32%

29%

27%

21%

TIPS

Emerging Markets Equity

Non-US Equity

High Yield

41%41%

35%

0% 20% 

Long Corporate Bonds

US Investment Grade Fixed Income

Long Government Bonds

Sources: Empirical Research, Pyramis

0% 20% 

% planning to increase % planning no chan
Private DB More Concerned About Volatility, Public DB Abou

• Surveys of plan sponsors indicate that corporate DB plan sponsors are primarily con

volatility, while public DB plan sponsors are more concerned with improving their 

• When asked to define volatility, corporate DB plan sponsors were more concerned with 

volatility, while public DB plan sponsors were more concerned with asset volatility

• This difference in focus is likely the result of differences in regulatory and accounti

well as the lower funded status of public plans

Top Concerns of Corporate and Public DB Sponsors over the Next Decade

40%45%25%30%35%

5%

10%15%20%

0%

Volatility Current

funding status

Risk

management

Low return

environment

Ability of ourmanagers to

generate

excess returns

(alpha)

Impact of new

regulatory and

accounting

changes

Liquidity

Source: Pyramis

Corporate DB Plan Sponsors Public DB Plan Sponsors
DC Plan Asset Allocation

• Participants in corporate DC plans have been gradually de-risking

• Cash, stable value, and fixed income in aggregate have risen from 24% to 33% o• Total equity allocation has declined 4 percentage points driven by a decrease in 

equity allocation has declined 4 percentage points, driven by a decrease in 

company stock

• However, corporate DC plans still appear to have riskier asset allocations than p

• Changes in the risk profile of public DC plans, meanwhile, appear more muted

• Equity allocation has declined slightly, offset by an increase in alternative invest• Fixed income assets have been re-allocated to stable value

Corporate DC Corporate DC vs Public DC Asset Allocation as of 2010 Public DC Asset Allocation as of 2010 Change in Asset Allocation: 2010 Change in Asset Allocation: 2010 vs 2006 

2006 

4%6%8%

50%60%

-4%-2%

0%2%

10%20%30%40%

-8%-6%

Sponsoring

Co Stock

Equity Alternatives

& Other

Fixed 

0%

10%

Sponsoring

Co Stock

Equity Alternatives

& Other

Fixed

income

Stable value Cash

Corporate Defined Contribution Public Defined Contribution

Source: P&I

Corporate Defined Contribution 
Part III: Public and Private Pension Fund Liabilities 
What Drives the Growth of Pension Liabilities?

Each year workebased on a predetypically linked to of service

Benefit Accruals

Wage / Salary Growth Changes in the 

future value of

Estimates of futuinclude an assumwages over the wbeneficiaries

Inflation 

future value of

benefits

Many public plancost of living adjuinflation. Private benefit

Increasing Longevity

Longer lives in regreater liability as until death, not to 

Chan

ges in the 

Private pension plinked to the yield corporate bonds, 

lt i t i l 

Discount Rate

g

present value of benefits

result in material 

value of the liabilfixed discount ratinsulates the liabvolatility
Measuring gp Pension Funding Gaps 

• Pension funding gaps fluctuate with pension assets and liabilities• Main drivers of pension assets Main drivers of pension assets

1. Investment Return (most volatile component)2. Benefit Payments3. Contributions (generally, but not necessarily, increase in response to reductions in fund

• Md f ain drivers of pension l bl ia i ities

1. Service cost + Interest cost2. Benefit Payments3. Changes in actuarial assumptions, especially the discount rate

• Due to differing accounting standards, funding gaps for public and private funds ar

comparable

• The choice of discount rate is p yp g 

articularly important in calculating the funded sta

• Corporate DB plans are discounted using high-quality corporate bond yields

• Reflects credit risk of strong corporations• In 2010, yields in the 5.5% - 6% range were generally used

• State & Local DB plans are discounted using an assumed long-term rate of return on pla

• Th t ti l h g d t il ti d t t l l 

These return assumptions rarely change, and are not necessarily tied to actual pla

• Currently, the average public plan discount rate is about 8%• Discounting public plans using high-quality municipal bond yields may be a bette

• In contrast, discounting each entity’s pension obligation using the sponsor’

poor choice because it would reduce the pension obligation as the sponsor’

deteriorates
Funded Status of Public Pensions

• Public pension liabilities are valued using a discount rate that is linked to the exp

plan assets, which does not fluctuate based on movements in interest rates or cred

• Assets are measured using either a mark-to-market valuation or a smoothed actua

resulting in different levels of estimated funded status

• St g k t t i i g th f d d t t k t l b i A 

Stron

g mar

k

e

t re

turns are improvin

g the 

fun

d

e

d s

t

a

tus on a mar

k

e

t value 

basis. 

A

are continuing to decline as they still do not fully incorporate the financial crisis.

Estimated Funded Status of 125 State DB Plans over Time Estimated Funded Status of 125 State DB Plans over Time Estimated Funded Status of 125 State DB 

Estimated Funded Status of 125 State DB 

303540

n95%s

90%

100%

93%

100%110%

10152025

Number of Plan 73% 81% 81% 86% 81% 95% 88% 90% 74% 89% 88% 86% 86% 87% 85% 79% 77% 70% 80% 90%

05

0% to

50%

50% to

60%

60% to

70%

70% to

80%

80% to

90%

90

10

69%

65%

60%

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Current

Market Value Funding Ratio Actuarial Value Funding Ratio

Market Value of Assets 

Source: Wilshire, JP Morgan

Market Value Funding Ratio Actuarial Value Funding Ratio
How Larg 

e is the State and Local Government Pensio

• Public plans report their liability using a discount rate that is equal to the expected return on 

• Based on “as reported” figures (adjusted for recent market movements), plans are ~78% fund

discount rate were to be used,p g lan funding would be sig y( ) nificantly worse (shown below). 

• To calculate the increase in taxes necessary to fund accrued benefits, we assume that 22-yea

pension obligation bonds are issued to fully fund the pension and then solve for the upfront 

is necessary to pay off the debt. If yet-to-be-accrued benefits for current employees are taken 

figures are even larger (see subsequent slides).

F

Lia

42%

% of PI % of taxes Unfunded gap % funded

1 6% $4 3tn

Tax increase 

16% Lia

55%42%

$2.6tn$4.3tn

0.6%1.6%

6%

16%

78%

Assets

Present 

Liability

0.3% 3% $0.9tn

Note: For the tax increase analysis, the yield on the pension obligation bonds equals the discount rate. If future asset returns are lower tha

would need to be increased more than indicated above. “% of PI” indicates the tax increase as a % of personal income. “% of taxes” indicathe existing state and local tax burden. Source: JP Morgan
Projected Benefit Payments for Current State and Local E

• Already earned vested benefits (dark blue area) will peak at ~$380 billion per year in 2026• If employees’ future service and salary increases are also included (all shaded areas), annual b

peak at ~

$ 4 660 billion in 20

41

• This analysis does not take into account that new employees will be hired to replace retiring 

many of those new employees will retire during the illustrated timeframe)

700500600

efits ($bn)

200300400

al Pension Bene

0

100200

Annua

2011 2021 2031 2041 2051 2061 2071 2081

Including all future service (projected value of benefits, PVB)Most commonly reported method (entry age normal, EAN)Including salary growth (projected benefit obligation, PBO)

Source: JP Morgan, based on work by Robert Novy-Marx and Joshua Rauh

g y g (p j g , )

Termination value (accumulated benefit obligation, ABO)
Required State Adjustments To Fund Benefits for Current State Empl

• When including the full costs of future service and salary increases (PVB on th

total state and local gap increases to $3.9 trillion (of which the state portion is 

• Th fi l dj t t i d t ti f th li biliti i ig ifi tl f 

Required State Adjustments To Fund Benefits for Current State Empl

States would have to dedicate 16% of their current revenue, on average, to fully fund their pension plans

• The fiscal adjustment required to satisfy these liabilities varies significantly fro

Which would mean increasing taxes bpersonal income (from 9.8% to 10.6%

20 0.8% a15

tes

4 states would have to 

dedicate more than 30% 

of their current revenue 

to service the bonds that 

would be required to fund 

their pension systems

1520

es

2 s

10

Number of Stattheir pension systems

16% average

10

umber of Statey

th

5 5

N

Note: Pensions discounted at a yield curve of taxable muni discount rates. Revenue is FY2011 total governmental funds excluding f

revenue data: FY2009 and FY2010 CAFRs and NCSL survey of legislative analyst projections for FY2011. Unfunded pension liabili

f i d l i d li i hi C f i i f d d i 22 f ll i 

0

% of Revenues

0% 5% 10% 15% 20% 25% 30% 35% 40% 0% 0.5% 1.0% 1.5

0

% of Personal Income i

future service and salary increases and eliminate asset smoothing. Cost of servicing unfunded pensions assumes 22-year fully amorti

taxable muni rate) to pay for the entire unfunded liability. Source of personal income in each state: Tax Foundation. 

Source: JP Morgan
Alternatives to Raising Taxes

• Aside from raising taxes, states have other levers at their disposal• The chart below illustrates one possible solution that relies equally on cutting 

increasing employee contributions, reducing COLAs, and increasing retiremen

0.8%

Cut state 

spending 

by 3 5%

Reduce 

COLAs

to zero

-0.2%

-0.2%

by 3.5%

of budget Increase 

employee 

contributions 

by 8.5%

of salaries

-0.2%

As with the chart on the right side of the previous page, all numbers show the adjustment as a p

li i h

Raise taxes Dedicate more existing resources to pensions Reduce pension b

Employee contributions assume that each percentage point increase raises $250 per member per year. Present value of COLA reductincreases based on “Policy Options for State Pensions Systems and Their Impact on Plan Liabilities” presented by Joshua Rauh and RJackson Hole in August of 2010.

personal income in the state

Source: JP Morgan
Limited Leg gg al Precedents to Changing Benefits

Decreasing cost of living adjustment for retirees Increasing early and full retire

• Colorado’s 2010 legislation, amongst other 

reforms, reduced the COLA to the lesser of 2% or inflation

• Minnesota’s 2010 legislation reduced COLAs

• Rhode Island’s 2009 legisla

crafted to generate as much (e.g., impacting current worespecting the vested rights 

Minnesota s 2010 legislation reduced COLAs

until the plan is 90% funded (COLAs from 2.5% to 2% for SERS, from 2.5% to 1.5% for state police, from 2.5% to 1% for PERS, from 2% to 0% for teachers)

• Increasing the retirem

62, but only for emplyet eligible to retire

Th l l 

• South Dakota’s 2010 legislation ties COLAs 

to a formula based on funded level (3.1% COLA if 100%+ funded, 2.1-2.8% if 90-100%, 

2.1-2.4% if 80-90%, 2.1% if less than 80%)

• The closer an employ

less it impacts him or with caps)

2.1 2.4% if 80 90%, 2.1% if less than 80%) No lawsuits have been filed 

Retirees in all three states have filed lawsuits alleging that the reduction in benefits represents a breach of contract

No lawsuits have been filed 

N t L l t ti b t t Note: Legal protections vary by state

Source: National Conference of State Legislatures
S&P 500 DB Funded Status is Improving and Likely Mana

• After declining to ~77% in 2008, the funded status for S&P 500 companies has im

12/31/2010 (~$192 billion)

• A 50bp increase in the discount rate would improve the status to 90% ( A 50bp increase in the discount rate would improve the status to 90% ( $120bn), ~$120bn), assum

assum

• Employer contributions are sizeable: ~$66 billion in 2009, up from $39 billion in 2008

• In aggregate, $192 billion of pension underfunding ($125 billion after-tax) seems m

• In 2010, S&P 500 companies spent $ $ 299bn on share repurchase and 

$206bn on dividen

• Circumstances vary by sector and company

140% 9.0%110%120%130%

7.5%8.0%8.5%

80%90%

100%

6.0%6.5%7.0%

60%70%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

5.0%5.5%

Sources: Morgan Stanley, Wilshire, Standard & Poor’s, Citigroup

S&P 500 Funded Status (%,LHS) Citigroup Pension Liability Index Yield (%, RHS)
Part IV: Considerations
Potential Fixed Income Inflows from Pension Asset Allocati

• Given expected asset allocation trends, flows into fixed income may increase in the co

• $2.2 trillion of assets in corporate DB plans, $3 trillion in state and local governm

• A 10 percentage point increase in the fixed income allocation for corporate DB plans e

• For comparison, the Barclays Capital Long Corporate and Long Treasury indices 

$744 billion and $661 billion, respectively, as of 3/31/2011

• Currently, corporate DB plans have a fixed income allocation of 39 Currently, corporate DB plans have

a fixed income allocation of 39

%

• However, changes in asset allocation are likely to be gradual. According to the Pyramis 

DB plans cited earlier (pg. 12):

• 39% (net) of plans intend to increase their allocation to long corporate bonds ov• 34% (net) of plans intend to increase their allocation to long govt. bonds over th

• If we assume that increasing the allocation to an asset class means changing the 

percentage points, this would imply purchases of $44 billion of long corporate boof long government bonds *

• Given the lack of near-term catalysts, it appears unlikely that state and local governme

increase their fixed income allocation in the near future

* $2.24 trillion corporate DB assets * 39% increasing allocation to long corporate bonds * 5% increase in allocati

For reference, $88 billion of lon

g (>15 

years) investment 

grade US cor

porate debt was issued in 2010 ($105bn i

, g( y ) g p ( 

Sources: ICI, P&I, Barclays Capital, Pyramis
Imp y/ lications for Treasury / New Product Ideas

• The Treasury may be able to issue new types of securities to assist DB plans in hed

currently difficult to hedge

• Ultra-long T i reasuries

• Pension liabilities are long duration and have meaningful convexity

• Wage inflation-linked Treasuries

• Retirement benefits are often linked to the retiree’s wage at retirement

• TIPS are linked to CPI and may not provide an adequate hedge against wage in• The federal government already calculates wage inflation to index Social Secur

• OPEB liabilities are generally unfunded but could be funded with bonds in the fu

• H l h i fl i Health inflation-li k d i linked treasuries

• Public plans face an estimated unfunded OPEB liability of ~$1 trillion, while S&

are underfunded by approximately $260 billion

• The growth rate of healthcare costs is an important factor in measuring OPEB li

• While in theory the above products may generate new demand, it is important to 

practical implications of issuing a new type of security. For example, dealers have constraints that limit their ability to warehouse new issues (particularly for new tThis may g /g y y lead to storage costs / higher yields for the Treasury.

• Average participation in 30-year bond auctions by various investor types (Aug ‘06 – p

• Pension and retirement funds: 0.14% (essentially zero direct participation)

• Dealers: 54%• Investment Funds: 25%

Sources: Pew Center on the States, Standard & Poor’s, US Treasury
UK and Netherlands Offer Alternative Models for Pension Re

g

United Kingdom Netherlan

Assets $1.6 trillion $1.6 trillion $1.1 trillion

(10% public / 90% private)

$1.1 trillion

( roughly evenly split pu

Liability Discount Rate Gilts + margin 

(typically in 0.5-1.5% range)

Euro swap cu

Minimum Funding 

R i

Less formula-driven than in the U.S. 

N h l d N hl h

Three tests need to 

Requirements or 

Net

herlan

ds. 

Nevert

h

eless, t

he 

UK is viewed as one of the most 

stringent frameworks.

Fundin

g

plan must be submitted to 

1) Minimum Test: Assets mu

liabilities. 3 year recovery p

g p

2) Solvenc

y Buffer Test: Sufficie

the regulator. Deficits generally need 

to be rectified over the average 

duration of scheme (~15 years)

) y

a 1-in-40 year market move. Ty

exceed 120-130% of liabilities. 1

if below this le

3) C ti it T t P f th t 

Continuity 

Test: Proo

f th

at c

to run sustainable pe

Accounting Regime IAS 19 IAS 19 (corporate schemes only. 

is industry-wide sc

Avera

ge Fundin

g Position 80-90% ran

ge 107% as of Decemb

Asset Allocation 31% bonds & bills, 41% equities, 

4% cash, 26% other

47% bonds & bills, 32

4% cash, 18% o

Comments Clear trend toward LDI Duration mismatch versus liabili

because it creates solvency lbecause it creates solvency l

increases required 

Sources: Presenting Member’s Firm, OECD
Considerations Reg g ardin Public Pension Reform

• State and local government retirement plans should be structured to satisf

retirees, employees, and taxpayers

• Clear disclosure is needed so that plan beneficiaries, plan sponsors, and in

local government debt can make informed decisions

• While some flexibility in accounting standards is necessary, sponsors should use standard

assumptions/ hdl h /methodologies to the greatest extent possibl d d d ble and standardize reporting d 

ate

• Pension funds should take concrete actions before it is too late. Potential 

1. Adjust benefits for current employees (COLAs, length of service, retirement age, etc) or 

contributions

• Most direct approach. May face legal challenges if attempted unilaterally – once g

“contractual obligations”

2. Contribute actuarially required contribution, funded by raising taxes and/or cutting expe

• Difficult given current state of economy. May be used as a bargaining chip when n

3. Create a new tier of benefits or switch to a DC plan for new employees

• Fewer legal hurdles but does not address the potentially large benefits promised to 

4. Risk sharing - Implement a hybrid “cash balance” plan (low guaranteed return + DC com

• Employees may demand higher current salaries or increased employer match if the

package as inferior to DB package as inferior to DB

5. Improve governance / oversight to ensure that plans are managed effectively by increasin

standards for trustees, or hiring outside professionals

6. Issue pension obligation bonds and use proceeds to improve funded status

• If future returns are lower than the bond yield then the sponsor is worse off