REPORT TO THE SECRETARY OF THE TREASURY 

FROM THE TREASURY BORROWING COMMITTEE OF THE 

PUBLIC SECURITIES ASSOCIATION 

February 5,1992 

Dear Mr. Secretary: 

Reflecting the state of the economy and the associated changes in monetary policy, 

yields on Treasury securities declined significantly throughout 1991. The drop culminated 

with the fourth quarter's 100 basis point cut in the discount rate on December 20. Over 

the year, the discount rate and Fed Funds declined by approximately 250 basis points, 2- 

year notes by just over 200 basis points, and the 30-year bond by less than 60 basis 

points, producing a sharply steeper yield curve. Low end-of-day yields for the 3-month 

bill occurred on December 23, 1991, at 3.85 percent, on January 8, 1992, for the 2-year at 

4.66 percent, and on January 7, 1992, for the 30-year were at 7.39 percent. Since then, 

the market has weakened considerably with the yield curve modestly flatter as short rates 

have increased by about 50 basis points and the 30-year bond just over 40 basis points. 

This weakness occurred because it was the market's view that: 

1) The end of Fed easing may have been seen; 

2) An economic recovery of modest proportion is generally forecasted and 

perceived to be within view; 

3) The supply of corporate debt came at a record $32 billion pace in January; 

4) Politics are dominating the timing, need, and degree of fiscal stimulus; and, 

lastly, 

5) The absolute size of Treasury debt to be issued is large and will grow larger, 

particularly in the last fiscal quarter. 

While market traders and investors focus on forecasts for recovery, recent economic 

data paint an uncertain picture of this and next quarter's GDP, particularly if coupled 

with slowing trade with our principal partners and their restrictive monetary policies. 

Meanwhile, U.S. monetary policy has or will produce interest rate levels that should 

provide economic stability and gradual recovery. This likely will coincide with generally 

low inflation reports. Further, low interest rates should allow cities, counties, states, and 

individual households to gradually improve their financial positions, and with the strong 

stock market, allow businesses to move their capital structures away from debt and toward 

equity. This financial relief should, over time, show its way through in terms of 

increased retail sales and improved consumer and business confidence. 

Fiscal 1992's Federal budget deficit is varyingly estimated to approach $400 billion. 

The Treasury market is highly sensitive to this prospect and the related potential for 

abandonment of the 1990 budget accord, which could begin to have economic impact in the 

second calendar quarter. Given the Government's already large financing needs, proposals 

which widen the deficit in the short run will likely prompt an adverse market response. 

It is within this framework that the Committee recommends that the following 

securities be sold to refund $22.0 billion of maturing and called securities, and to raise 

$17.0 billion of new cash for delivery on February 18. 
-- $14.5 billion 3-year notes due 2/15/95; 

-- $12.5 billion 9 314 year 7 112% notes due 11/15/2001; 

-- $12.0 billion 29 314 year 8% bonds due 11/15/2021. 

The Committee voted 17-0 in support of the size, composition and two reopenings in 

our refunding recommendation. As it relates to the issue of reopenings, current market 

levels put the 10 and 30 year issues well within price ranges where both are solid 

candidates for reopening. It remains our view that large consolidated issues are desirable. 

Such issues are the least disruptive in a crowded marketplace, ameliorate the potential for 

squeezes, and possibly afford the Treasury some of the scarcity value existent in the 

market. Like most on-the-run Treasuries, 10 and 30 year securities attract "special" RP 

rates well below general collateral further attesting to their scarcity. 

The relative size of the refunding and the quarterly refunding cycle are and should 

remain a key market focus. The Committee continues to endorse predictability and 

consistency as a means to lessen undesirable public speculation and associated market 

volatility. The recent protracted speculation over the Treasury's views on the role and 

size of the long bond are a clear example. The following points are offered in support of 

the view that no material change in the 10 and 30 year cycles is appropriate now: 

-- Federal deficits of $400 billion this fiscal year and only slightly less next fiscal 

year mask the roughly $200 billion structural deficits projected into the future. 

Further, all existing Treasury cycles will have to be increased to meet this and 

next quarter's needs before the anticipated $150 billion deficit of the third 

calendar quarter. Reducing any cycle only further increases the burden on 

others. 

-- By holding the 10 and 30 year essentially unchanged, the Treasury would be 

effectively reducing their relative role in debt issuance. 

-- In earlier years, the 20 year cycle was dropped and recently Refcorp issuance 

has ended. Simultaneously, over the last three years, 30 year bonds as a 

percent of total coupon sales have declined from 12.1 percent in 1989 to 11.4 

percent in 1990 and 10.5 percent in 1991. 

-- The 30 year plays a key role in the maintenance of the approximately six year 

average life of privately held marketable debt. The virtues of this specific 

average can be debated, but it is worth noting that it is similar to a number of 

other major foreign nations and approximates results typical in the United 

States during the 1950's and 19603, a period of generally strong economic 

performance. Further, the Treasury is already a major beneficiary of low 

interest rates as 34 percent of the debt matures within one year and 49 percent 

within two years, down from comparable figures in the early 1980's. 
-- In addition, it is possible that existing rollover risk is high, given that 30 year 

absolute rate levels near 7.70 percent are low compared with the period from 

1977 to the present. It is noted that large numbers of corporations, other 

taxable and tax-exempt issuers, and individuals are extending the average life of 

their debt with this possibility in mind. 

-- The 30 year cycle is a unique maturity slot exclusive to the Treasury. Its 

efficacy should not be put at risk or politicized to other considerations. 

-- Shifting a greater portion of financing to intermediate maLurities would, in fact, 

put the Treasury in more direct competition with business and mortgage 

borrowers. 

In closing our comments on this subject, the Committee notes that the public debate 

concerning the prospective role of the 30-year bond in the quarterly refunding, and hence, 

in the entire pattern of Treasury borrowings, has not worked to the Treasury's benefit. 

Any material change at this time runs the risk of being viewed as politically motivated, 

undoing the gains earned over years that routine and consistency have contributed in 

reducing the "uncertainty premium" in Treasury issues. More substantially, there appears 

little historical or theoretical evidence to support the view that shifting the pattern of 

Treasury borrowings would actually have any positive or lasting impact on overall yield 

levels or the overall shape of the yield curve. From year-end, as of 2/3/92, spreads from 

1 to 2 years have increased by 27 basis points, 2 to 5 years by 21 basis points, and 2 to 

10 years by 27 basis points, in part over concern that it is in this range that long-bond 

reductions would be made up. As the volume of debt issued in the above maturity ranges 

greatly outweighs the 30-year sector, the cost to the Treasury and taxpayer could, over 

time, become substantial. The 5, 7, and 10 year range yield back-up can additionally have 

a damaging impact on corporate and mortgage issuers which focus in this sector. Lastly, 

the 10 to 30 year spread has narrowed by 24 basis points since year-end, driven by the 

potential for long-bond reductions. Our recommendation and the cessation of the public 

debate could produce a one-time reversal of the recent, modest 10 to 30 year relative 

yield spread change, at the expense of the intermediate sector. 

For the remainder of the current quarter, the Committee recommends that the 

Treasury sell: 

-- 2-year notes of $14.25 billion and $14.5 billion at auction, raising $8.4 billion of 

new cash; 

-- 5-year notes of $9.75 billion and $10.0 billion at auction, raising $12.5 billion of 

new cash; 

-- A $13.5 billion 52-week bill at auction, raising $2.4 billion of new cash; 

-- Increase the weekly 3 and 6 month bill action sizes to $23.4 billion by end of 

quarter, raising $14.3 billion new cash; 

-- A cash management bill of up to $10 billion to mature 4/16/92, raising $10 billion 

of new cash. 
Summerv of New Cash for Quarter 

Refunding $17.0 billion 

Cash management bills 10.0 

3- & 6 month bills 14.3 

52-week bill 2.4 

2-year notes 8.4 

5-year notes 12.5 

Total $64.6 billion 

Already raised 14.3 

Estimated Foreign Add-ons -5.8 

Net Market Borrowing $84.7 

The Committee recommends a cash balance of $20 billion on March 31. 

The Committee anticipates the need for up to $10 billion of short cash management 

bills in early March to mature April 16. If the need is less or does not materialize fully, 

small further increases to the bills and coupon cycles would be appropriate in satisfying 

Treasury borrowing needs. 

For the April/June quarter, the Committee agrees with the targeted $30 billion endof-quarter balance. Given the potential of an unusually large following quarter marketable 

borrowing requirement, a higher balance by $10 billion or so would not be inappropriate. 

To fund the cash deficit and marketable borrowing of approximately $70 billion, further 

incremental increases in the weekly bills, year bills, coupon cycles, and refunding issues 

will be necessary. The Committee notes our continuing belief that there is a market 

appetite for significant growth in the year bill cycle. We as well support the continuance 

of consistency in the size and composition of the quarterly refunding. 

On the remaining three topics of our Committee Charge -- (1) conditions leading to a 

reopening; (2) type of offering for distributing a reopened issue; and (3) our comments on 

the proposed single-price open auction technique -- the sharing of the differing views 

held by the Committee members lasted several hours, touched and raised broad issues, and 

raised and left unresolved several questions. The Committee welcomes the opportunity to 

play a role in addressing such topics and believes it could contribute to a thorough 

assessment if asked to participate in an off-cycle meeting with the Treasury focused on 

these large topics. 

Some general thoughts were broadly supported. On the issue of determining whether 

a security shortage is sufficiently "prolonged and acute" to warrant reopening, the 

following points were made: 

-- the issue must trade significantly off of the implied cash market yield curve; 

-- the issue must be unusually expensive to recently issued older issues of the 

same maturity (i.e., the old and old, old off-the-run issues of the same 

maturity); 
-- 

-- 

there must be a clear reduction in the issue's trading liquidity; 

the clearing mechanism must evidence fails and other delivery problems; 

-- it is noted that "a special" financing rate below general collateral even 

approaching one percent for a protracted period of time is not necessarily 

sufficient evidence by itself of a disruptive shortage. 

It was further noted that concentration information would first be seen by the 

Treasury, not the marketplace. 

Providing securities through the likes of a "Bond Bank" could provide the Treasury 

with added income by charging a penalty rate when meeting outsized market needs. 

However, because Treasuries are now used for hedging exposures in a wide range of 

financial instruments, providing more collateral might simply lead to much more hedging in 

the securities being lent. Constructive ambiguity in the terms and circumstances of 

availability may be an advantage. 

Concerning the question as to the best way to distribute reopened issues, there was 

general support for a Treasury reopening following broad public notification. The Federal 

Reserve, through a "go around", should set the time of bidding and the delivery date but 

leave open the amount to be awarded. It is important that investors, arbitragers, hedgers, 

and dealers have equal information and time to make a reasoned decision. The Committee 

believes that more discussion of this issue would be productive. 

Lastly, the Committee recognizes that the eventual automation of the auction process 

may provide the Treasury with greater flexibility in pursuing alternatives to the present 

auction procedures. One such alternative is an ascending price, open auction technique. 

An objective of this technique would be to broaden direct investor participation in 

Treasury securities auctions. A number of sophisticated investors may have a higher level 

of comfort participating directly in an auction process that is open and perceived to be a 

fairer process. Also, such an auction process should make an attempt to corner an issue 

more difficult. In the event that such a corner were attempted, the Treasury would 

receive the benefit of the higher auction bids. 

While not reaching a conclusion and supporting further study, the Committee 

discussed some questions and concerns with such an auction technique. Among those are: 

1) Sequential bidding at fixed time intervals will initially be unfamiliar to all 

investors and may be somewhat confusing to all but the most sophisticated. 

Lesser sophisticated or impatient investors may prefer the certainty of the 

when-issued market and transfer the auction risk to dealers, defeating the aim 

of broader auction participation. 

2) If larger, more sophisticated investors develop a preference for direct auction 

participation in an open bidding environment, pre-auction when-issued trading 

activity may then diminish. As a result, the price discovery, when-issued 

process would become less efficient. This, in turn, could subject the Treasury's 

initial price determination effort to start the auction to more uncertainty. 
A greater level of uncertainty among dealers about investors' intentions in the 

new auction process may reduce dealer willingness to establish pre-auction short 

positions in the new issue. Such an outcome could reduce dealers' participation 

in the auction process. 

The new auction proposal would introduce a role for the Treasury in setting the 

initial auction yield. This raises several related concerns. 

First, in a more volatile and uncertain market environment, the Treasury could 

set the initial bid yield at a level that does not draw enough interest to cover 

the size of the auctioned security. Thus, the spector of a failed auction might 

then become a possibility, however remote, as compared to the present auction 

system. 

Second, as a result of significant changes in the market environment, the 

Treasury may decide to vary the spread between the initial bid yield and the 

current market yield available in pre-auction trading. Such adjustments could 

increase market uncertainty and cause market participation to speculate on any 

possible meaning or message inherent in this yield spread variation. 

Third, because of the possible reduction in when-issued trading and associated 

impairment of the price discovery mechanism, the Treasury may not enjoy a 

high enough level of confidence that sufficient dealers will bid for a reasonable 

amount of the new issue at the yield level which is initially established by the 

Treasury. 

More generally, the ascending price, open auction technique introduces auction 

variables which the present system does not contain. Specifically, these include a 

Treasury yield setting function and an uncertain number of bidding rounds before a single 

auction is completed. Also, open bidding may increase the uncertainty about the quantity 

and yield level of direct investor bids. This combination could have a tendency to 

increase volatility surrounding security auctions and could result in unintended increased 

risks for auction participants. 

In conclusion, the prospect of automating the auction process, which the Committee 

welcomes, offers the Treasury the opportunity to improve the manner in which it sells its 

securities and in consequence to lower its cost of borrowing. There is ample time, 

however, for more thorough consideration of any particular technique, a phasing process 

or other auction initiatives before the automation process is implemented. We hope to 

work closely with Treasury in studying these matters. 

Mr. Secretary, that concludes our report and we welcome questions and discussion. 

, 

~or~an-~. Stark 

Chairman