Presentation to the 

Treasury Borrowing Advisory Committee

U.S. Department o

Offi f D bOffice of Deb

Nov
Federal Budget Deficits FY2007 to FY2009

-1,600 

$ Billions

Fiscal Year to Date Deficits

(monthly data) 

2007 Y-O-Y % Change

2008 2009

-1,400-1,200

2008 2009

-765

-957

-802

-99

-1,000

-800

-311 -319269

-371

-483

-455

-402

-485

-569

-600-400

-49

-122

-80

-42

-162

-258

-81

-148

-121

-157

-274

-163

-56

-154-106-88

-263

311

-152

319-269

-237

-200

0

Office of Debt Management

Oct-06

Nov-06

Dec-06

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May09
Federal Outlays and Receipts

O tl

-500

0

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

Outlays

FY07 FY08 FY09

-2,000-1,500-1,000

$ Billion

-3,500-3,000-2,500

2,5003,000

Receipts

FY07 FY08 FY09

1,0001,5002,000

$ Billion

Office of Debt Management

0

500

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug
Tax Receipts Continue to Decline

40%

Rolling 12-Month Growth Rates

Corp TaxesWH Taxes

20%30%

WH TaxesnWH Taxes

0%

10%

-20%-10% -40%-30% 

Office of Debt Management

-50%

Mar-82

Mar-83

Mar-84

Mar-85

Mar-86

Mar-87

Mar-88

Mar-89

Mar-90

Mar-91

Mar-92

Mar-93

Mar-94

Mar-95

Mar-96

Mar-97

Mar-98

Mar-99

Mar-00

Mar-01

Mar-02

Mar-03

Mar-04

Mar-05

Mar-06

Mar-07
Treasury Marketable Financing in FY2008 and FY2009

Treasury Marketable Financing

FY 2009 FY 2008

($ Billions) October 1, 2008 - September 30, 2009 October 1, 2007 - Septemb

Issued Matured

Net SOMA 

Activity * 

Net Cash 

Raised Issued Matured

Net SO

Activit

Bills (includes SFPs) $6,920.5 $6,417.8 $0.0 $502.7 $4,632.9 $4,101.2 ($152

Nominal coupons $1,886.6 $640.7 $0.0 $1,245.9 $814.6 $626.2 ($5.5

TIPS $58.5 $20.8 $0.0 $37.7 $61.9 $21.8 $3.5 Total $8,865.6 $7,079.3 $0.0 $1,786.3 $5,509.5 $4,749.2 ($153* Note: Negative SOMA activity represents redemptions : Negative SOMA activity represents redemptions. 

Positive SOMA activity represents additional issuance of securities, made possible by redemptions in maturing securities

with the same settlement date; these are offsetting transactions and are net cash neutral.

Office of Debt Management
Cumulative Net Financing Flows since FY2007

SFP Amounts CMBs RegBills TIPS Notes Bonds Net Mktable Borrowing

Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 J

Office of Debt Management

FY 2007 FY 2008 FY 2
Cumulative Net Coupon Issuance since FY 2007

350400

2-year (LHS) 3-year (LHS)5-year (LHS) 7-year (LHS)

200250300

Billions)

10-year (LHS) 30-year (LHS)Total (RHS)

100150

e Net Issuance ($ 

0

50

Cumulative

-150-100

-50

Office of Debt Management

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09
Treasury Cash Balances

125150175

$ Billions Treasury Daily Operating Cash Balance Excluding SFPs

FY 2007 FY 2008FY 2009 FY 2010

Note: Dat

Dec. 15 Apr. 15 Jun. 15

5075

100

125

0

25

Oct Nov Dec Jan Feb Mar Apr May Jun Jul A

800

$ Billions Daily Treasury Operating Cash Balances Note: Dat

500600700800

Cash Balance w/o SFPs Cash Balance w/SFP

200300400

Office of Debt Management

0

100

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 
Portfolio Distribution

Nominal Coupons as a Share 

33%35%37%

Bills as a Share of Total Portfolio

All Bills Regular Bills

23%25%27%29%31%

g

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 

17%19%21%

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09

Total Portfolio

11%12%13%

TIPS as a Share of Total Portfolio

TIPS Nominal Standard Bills CMBs/S

7%8%9%10%

Office of Debt Management

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 

5%6%

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09
Monthly Change in Debt Outstanding versus Average Maturi

500600

$ Billions A

GSE Preferred Stock Purchase 

Program begins Oct 2008 Issuance of SFP bills begins Sept 2008 SFP bills peak at $560 B Nov 2008

400

Capital Purchase Program $115 B dispersed Oct 200$36 B disbursed Nov 2008

200300

Bulk of $168 B Stimulus

tax rebates disbursed

May - Aug 2008 •Average Maturity Oct 2008: 48.5 months Bills o/s: $1.9 T and Coupons o/s: $3.8 T

•Average Maturity Sept 2009: 52.7 monthsBills o/s: $1.9 T and Coupons o/s: $5.0 T

0

100

-200-100

7

7

7

7

7

7

7

7

7

7

7

7

8

8

8

8

8

8

8

8

8

8

8

8

9

9

9

9

9

Bills Coupons Average Maturity

Tax year 20refunds peaFeb 2009

$40 BAIGInvestmentNov 2008

Office of Debt Management

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09
Debt Maturity Measures

90 

Months 

Average Matur

708060 4050

Average Maturity of Marketable Debt Outstanding

3040

1/ Rolling 4-quarter average

Office of Debt Management

20 

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 

Rolling 4-quarter average
Maturing Coupons

8090

$ Billions November 15, 2009-August 15, 2039

2 YR NOTE 3 YR NOTE 5 YR NOTE 10 YR NOTE 30 YR BOND7 YR NOTE 5 YR IIS NOTE 10 YR IIS NOTE 20 YR IIS BOND 30 YR IIS BOND

*Based on coupon secur

In the next 5 years 73 days will have maturities greater

6070

In the next 5 years, 73 days will have maturities greater

than $20 billion and 46 days greater than $30 billion.

40502030

0

10

Office of Debt Management

15-NOV-2009

15-FEB-2010

15-MAY-2010

15-AUG-2010

15-NOV-2010

15-FEB-2011

30-JUN-2011

15-NOV-2011

15-FEB-2012

15-MAY-2012

15-AUG-2012

15-NOV-2012

31-MAR-2013

15-JUL-2013

15-NOV-2013

28-FEB-2014

30-JUN-2014

15-NOV-2014

15-NOV-2015

15-MAY-2016

31-AUG-2016

15-JUL-2017

15-JUL-2018

15-JUL-2019

15-MAY-2021
Primary Dealer and Government Deficit Estimates

FY 2010 Deficit Estimates $ Bil

Primary 

Dealers* CBO OMB

Current: 1 393 , 1 381 , 1 502 ,Range based on average absolute forecast error** 1,203-1,583 1,081-1,681 1,219-1,Estimates as of: Oct 09 Aug 09 Aug 0FY 2010 Marketable Borrowing Range*** 1,200-1,750FY 2011 Marketable Borrowin

g g Ran

ge*** 725-1,400

* Primary Dealers reflect average estimate. Based on Primary Dealer feedback on October 29, 2009.** Ranges based on errors from 2005-2009.*** Based on Primary Dealer feedback on October 29, 2009.

Office of Debt Management
OMB Long-term Deficit and Borrowing Projections

600700800 Interest Expense as 

Interest Expense as % of 

GDP (RHS) 100%

120%140%

202530

Debt as % of GDP

Held by PublicHeld by Govt

Gross Debt % of GDP (RHS)

OMB 8/09 MSR (LHS)

(LHS)

200300400500

$Billions

GDP (RHS)

10-Avg 

40%60%80%

1015

20

Held by Public% (RHS)

$Trillions

Annual Sur

plus/

0

100

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

Interest Expense (LHS)

0%20%

05

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

(RHS)

Held by Govt Accts% (RHS)

400

-200

0

200400

 

p 

Surplus/Deficits (LHS)

1,5002,000

10%12%14%

Net Marketable Borrowing as % of GDP

OMB 8/09 

MSR

1 200

-1,000

-800-600-400

$ Billions Surplus/Deficits as a 

% of GDP (RHS)

5001,000

2%4%6%8%

$Billions Net Marketable Borrowing as % of GDP (LHS)

Office of Debt Management

-1,600-1,400-1,200

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

-500

0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

-4%-2%

0%

Net Marketable Borrowing (RHS)
Rescheduled 4-Week Bill Auctions Due to Calendar Constra

2:00 PM

Rescheduling of 4-Week Bill Auctions Due to Conflicts

FY2008 - FY2009

1:30 PM2:00 PM1:00 PM

lose Time

12:00 PM12:30 PM

Bill Auction C In FY2009, the frequency with which 4-w

were rescheduled to 11:30 AM increased 

11:30 AM

7 auctions in FY2008 23 auctions in FY2009

Office of Debt Management

11:00 AM

Oct-07 Jan-08 Apr-08 Jul-08 Nov-08 Feb-09 May-09 
4-Week Bill Coverage Ratios and Offering Amounts

5 506.00

1:00 p.m. Close 11:30 a.m. Close

4.505.005.503.504.00

erage ratio

2.50

Cov 3.00e

1 001.502.00

Office of Debt Management

1.00

0 5 10 15 20 25 30 35 

Amount Offered (in Billions)
Potential Cost Saving of Moving to 30-Year TIPS

3 54.03.03.5

d

2.02.5

Yiel

1.01.5

006

007

007

007

007

008

008

008

008

009

009

009

Source: Barclays Live

10/10/20

1/10/20

4/10/20

7/10/20

10/10/20

1/10/20

4/10/20

7/10/20

10/10/20

1/10/20

4/10/20

7/10/20

10yFwd10y zcis 20yFwd10y zcis

Office of Debt Management

Source: Barclays LiveGraph shows 10-year and 20-year forward zero-coupon inflation levels for 10 years derived from Zero Coupon Inflation Long-term inflation expectations are assumed to be stable; therefore, an upward sloping curve demonstrates an increas
What adjustments to debt issuance if any should Treasur

What adjustments to debt issuance, if any, should Treasur

consideration of its financing needs in the short, medium, aterm? 

Office of Debt Management
TBAC Presentation to Treasu

November 3, 2009
TBAC Presentation to Treasu

Exit Strategies

November 3, 2009
Outline

•Importance of the Exit Strategy•Form and likely Sequence

•Removal of Excess Reserves•Ending the MBS purchase program•Raising the Funds rate target

•Implications for the Treasury and related markets•Potential policy errors•Conclusions/Recommendations
Importance of the Exit Strategy

•Near zero interest rates have had a significant impact on investor many asset classes•Many investors can not stay in cash or earn zero for long

•Pension funds•Insurance companies•Endowments•Retired individuals living on income

•Zero yields on money market funds have pushed investors into lonasset classes•The return of low cost financing as repo markets have reopened (aand other Fed programs) has pushed leveraged investors into longerassets classes•The increased demand has benefited Treasuries somewhat, but haassets such as corporate bonds and securitized assets even more•When the markets anticipate the move away from zero, the impacdated risk assets may be significant due to reduced investor deman
Importance of the Exit Strategy

•Investors have been moving out of cash and into longer-dated risk markets have stabilized and cash earns zero•This can be seen in mutual funds flows

-300-200-100

0

100200300400

Q108 Q208 Q308 Q408 Q109 Q209 Q309

-80-60-40-20

0

20406080

100120140

Q108 Q208 Q308 Q408 Q109 Q209 Q309

-60-50-40-30-20-10

0

102030

Q108 Q208 

$ billions Money Market Funds US Fixed Income Mutual Funds US Eq
Importance of the Exit Strategy

The sponsorship for longer dated risk assets has led to lower yields

01234567

Jun/2008 Sep/2008 Dec/2008 Mar/2009 Jun/2009 Sep/2009

10yr treasuryCurrent coupon mortgage

05

10152025

Jun/2008 Sep/2008 Dec/2008 Mar/200

IG Corporates (BarclayHY Corporates (Barclay10-yr Super Senior CMB

% yield
Form and Likely Sequence of the Fed’s Exit Strategy

• The Fed has a very difficult task to get the form and timing cor

• Importance of the first move• Uncertainty and fragility of the economic recovery• Dependence of housing and other sectors on low rates

• As a result, predicting the form and timing of the exit strategy • The most likely sequence appears to be 

1. Draining excess reserves 2. Ending MBS purchases3. Raising the Funds rate target
Form and Likely Sequence: This Tightening Cycle is Differen

0%1%2%3%4%5%6%7%8%9%

10%

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Funds rate targetReserve balances with theFederal Reserve Banks

$ bil
Form and Likely Sequence: Excess reserves to neutralize
Form and Likely Sequence: Alternatives for Neutralizing Res

•Raise the funds rate and thereby the rate paid on excess reserves

•Increases opportunity cost of using reserves•Potential complication(s): requires Fed to raise the funds rate

•Reverse repurchase agreements

•Banks and perhaps money markets potential counterparties•Changes composition of Fed’s liabilities•Potential complication(s): reverse repos for TSYs cleaner than for Mdraining reserves unclear

•Term deposits 

•Banks move overnight reserves into term facility •Potential complication(s): Mechanism for setting rate and bank utilizimplications for LIBOR market

•Sell assets

•Shrinks asset and liability sides of the balance sheet•Potential complication(s): Private appetite for additional MBS and Tunclear
Form and Likely Sequence: Reverse Repos

•Direct with Dealers

•Initial capacity $150 - $200 billion•Tier one capital relief could boost capacity in some instances•Unlimited term

•Direct with Money Market funds

•Initial capacity near $1000 billion•Term less than 7 days•Requires cumbersome setup

•TALF Model

•Banks are agents; allow access to MM with cumbersome setup•No incentive for Banks

Market implications

•Compete with other short-term investments•Upward pressure on bill rates
Form and Likely Sequence: balance sheets, reserves and treasury d

Treasuries and agencies 163.2Other 65.7Total 228.9

Change in securities from Dec 17th

Cumulative change in composition of bank assets

•Loans and leases detrillion to $6.7 trillioyear•Declines are being psecurities purchases, Treasuries •Reserves being mov

-600-500-400-300-200-100

0

100200300

Dec/2008 Feb/2009 Apr/2009 Jun/2009 Aug/2009

Securities in bank creditLoans and leases in bank creditCash assets

$ billions
Form and Likely Sequence: Ending MBS Purchases

The Fed’s purchases of MBS have had a significant impact on valuat

0%

10%20%30%40%50%60%70%80%90%

100%

3.5 4 4.5 5 5.5 

FNFG

MBS Spreads Fed Holdings as % of Total O

-50

0

50

100150200250

2003 2004 2005 2006 2007 2008 2009

Libor OASZero vol spread

bps
Form and Likely Sequence: Ending MBS Purchases

Housing market still fragile and needs low mortgages rates

-25-20-15-10

-5

05

101520

2001 2002 2003 2004 2005 2006 2007 2008 2009

Case Shiller HPI,y/y

0%5%

10%15%20%25%30%35%40%45%

2004 2005 2006 2007 2008 2009

SubprimeAlt-AOption ARMPrime jumboAll

0

200400600800

1,0001,2001,400

2005 200

Jumbo SubprimNon Ag

$ billion

House Prices 60 days+ Mortgage Delinquencies Gros

percent
Form and Likely Sequence: Raising the Fed Funds Rate

•Markets pricing in the first move in the first half of 2010 and expetightening similar to the past•Another possibility is a discreet initial move (to 1% for example) to emergency level followed by a pause and then gradual tightening

0.01.02.03.04.05.06.0

2005 2006 2007 2008 2009 2010 2011 2012

Funds rate targetEurodollar curve

percent
Market Implications: Net Fixed Income Supply

-1000

-500

0

500

100015002000250030003500

2003 2004 2005 2006 2007 2008 2009 2010

Corporate and fobondsMunicipalsAgency/GSE-bacTreasury securitOpen market paTotal after Fed pTotal

E E

$ billions
Market Implications: Net Fixed Income Purchases

$ billions
Market Implications: Concern about higher real rates rather than inf

5yr5yr Forward TIPS Inflation Expectations Volatility S

(1y10yr 100 high vs. 10

0.00.51.01.52.02.53.03.54.0

2005 2006 2007 2008 2009

-10

-5

05

101520253035

2005 2006 2007 2

bps percent
Market Implications: Issuance and debt outstanding

0%

10%20%30%40%50%60%70%80%

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

BillsBondsTIPS2yr - 10yr

0%

10%20%30%40%50%60%70%

1980 1983 1986 1989 1992 1995 

BillsBondsTIPS2 - 10yr

Quarterly Issuance Marketable Debt 
Market Implications: Average Maturity of the Debt

0

1020304050607080

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

Average maturity of debprojectedCore CPI, y/y (right)10yr Treasury (right)

months p
Market Implications: More TIPS Issuance

Advantages•Diversify and broaden the buyer base of Treasury debt in time of extreme •Potentially further lower the funding cost of nominals if TIPS remove some premium•Further extends average maturity of issuance and debt•Limited risk because tax receipts effectively hedge Treasury inflation expoDisadvantages•Given low breakevens, there is potential for higher explicit cost relative to •If there is substantial further disinflation or deflation, buyer base for TIPS as issuance increases

TIPS as Percentage of Nominals Outstanding

0%2%4%6%8%

10%12%14%

1997 1999 2001 2003 2005 2007 2009
Potential Policy Errors

Fiscal considerations•Lack of budgetary restraint

•Big issue for non-US investors•Need spending cuts or tax revenue increases as economy stab•Need to refrain from a second fiscal stimulus

Monetary considerations•Liquidity programs

•Many of the programs addressing the money markets and finanremoved now•TALF is still needed to restart the shadow banking system, pamore difficult assets

•MBS program

•Housing market still needs low rate•Stopping purchases vs. selling MBS

•Traditional policy

•Raising rates too soon is the bigger risk
Conclusions

•The Fed’s exit strategy is a significant challenge and the form and a significant impact on the broad financial markets•The likely first step will be the use of reverse repos to remove excfrom the banking system•The eventual increase in the Fed funds rate target will have the band will likely come at a time when supply of fixed income securitieand the Fed has stopped purchasing longer-dated securities•The Treasury should continue to have a very transparent plan to ingiven the growing deficit and 

•Extend average maturity•Issue more inflation-linked debt
Treasury Borrowing Advisory Committe

Optimal Issuance Strategy

Quarterly MeetingNovember 3 2009 November

3, 2009
Questions

Given the recent trends in the economy and the government’s fiscal position, please displan to lengthen the average maturity of the portfolio in the medium term. Is there an maturity range given structural financing needs in the medium and long term? Does it maturity range, given structural financing needs in the medium and long term? Does it 

apply asset-liability management to Treasury’s marketable debt portfolio? Can you discfinancing and risk management by other sovereign nations and how they might be applTreasury debt management?
Agenda

♦ Background♦ Optimization Model/Debt management strategies♦ Conclusions:

1 Inflation higher interest rate and roll over risk should be the primary c1. Inflation, higher interest rate and roll over risk should be the primary c

Treasury’s debt management strategies.2. In most scenarios, it is prudent to lengthen maturities significantly from 

average maturity of 50 months Our base case is to extend to 74 months average maturity of 50 months. Our base case is to extend to 74 months, 

extend to 96 months.3. The objective of lowest borrowing cost could lead to higher yields that 

monetary policy objective monetary policy objective.

4. Clever debt management strategy could potentially reduce debt service meaningfully, but still can’t completely substitute for prudent fiscal policy
Comparison of debt management strategies across the G7

Debt mana

g g ement strate

gies across the G7

Av g Maturity % Foreign Total Public Ratio of Ratio of debt Interest Pay ments Debt Ma

Country (y ears) Ow nership Debt (USD $bn) Debt to rev enue to GDP as share of rev enue MethodologUSA 4.25 49% 7551** 359% 53% 18% Cashflow matching. No ALM framUK 14.2 30% 1,347.1 118% 56% 3.30% Cashflow matching. No ALM fram

Optimizes mix of funding instrume

Germany 6.10 30%* 1522 151% 65.90% 6.10%

risk for the issuer. Deriv ativ e instrused

France 6.70 30%* 1689.7 137% 67.40% 5.70%

Cashflow management. Managemmade to ensure liquidity in issuesStrategic scenario analy sis and ris

Italy 6.87 30%* 2382.5 230% 105.80% 11.10% deriv ativ es products to minimize cJapan 7.00 6% 9875.1 2331% 190% 26.20% Cashflow matching. No ALM framAustralia 5.60 53% 92.87 19% 4.60% 2.60% Cost and risk optimization. Use of 

Driv en by set of principles to minihelp the DMO issue debt cost-effe

New Zealand 5.60 72% 35.8 49% 15.60% 6.00%

gov ernment balance sheet risk mmoral hazard, and limiting contingContingent liabilities are disclosed

national lev el w ith limited central g

Sou

rce:

JP Mo

rgan

* Estimated ow nership for Eurozone debt by non Eurozone members** Debt held by public

Sou ce: J o gan
Average maturity of outstanding treasuries is approximately 50 

which is near 25-year lows!

Average Maturity of Outstanding Treasuries, Months

7075

Treasury added a 20-year maturity point and increased sizes across the curve

30-year bonds were eliminated, issuance was reduced, and buybacks occurred, reducing the average maturity

65556050

Substantial unexpected funding needs prompted high amounts of bill issuance, further reducing average maturity

45

Dec-80 Sep-86 May-92 Feb-98 Oct-03 Jun-0

Sou

rce:

JP Mo

rgan

Sou ce: J o gan
Total federal government debt to GDP ratio was only higher du

Source: Bianco ResearchSource: Bianco Research
Debt to GDP about to go up significantly

Source: White House Office of Management and Budget Congressional Budget OfficeSource: White House Office of Management and Budget, Congressional Budget Office
Mandatory spending has increased 5x faster than discretionary s

Source: The Heritage Foundation 2009 Federal Revenue and Spending Book of Charts; and WhitM dB dManagement an

d

B

u

dget
Entitlement spending is confronting a demographic time bomb

Source: The heritage Foundation 2009 Federal Revenue and Spending Book of Charts; and CongOffi

ce
Plausible budget deficit outlook

2009 2010 2011 2012 2013 2014 2015 2016 

CBO August Baseline -1587 -1381 -921 -590 -538 -558 -558 -620 

Plausible Revenue ChangesEGTRRA & JGTRAA 0 -4 -121 -217 -247 -260 -271 -281 AMT 0 -7 -69 -31 -34 -37 -41 -46 Interaction 0 0 -13 -44 -49 -53 -58 -64 Making Work Pay etc Making Work Pay, etc. 0 -48 -141 -199 -203 -201 -199 -198 High Income 0 76 106 131 140 147 155 165 Debt Service 0 0 -4 -17 -42 -75 -109 -146 Subtotal Rev 0 17 -242 -377 -435 -479 -523 -570 Plausible Spending ChangesInflate Discretionary by GDP 0 -8 -33 -74 -120 -159 -194 -228 Iraq War Phaseout 0 1 7 29 59 83 97 104 Debt Service 0 0 -1 -1 -3 -8 -13 -19 Subtotal Disc. Spending 0 -7 -27 -46 -64 -84 -110 -143 Total Change 0 10 -269 -423 -499 -563 -633 -713 Resulting Surplus / Deficit -1587 -1371 -1190 -1013 -1037 -1121 -1191 -1333 GDP 14140 14439 14993 15754 16598 17319 18019 18760 D fi it % f GDP Deficits as % of GDP -11 2%. -9 5%. -7 9%. -6 4%. -6 2%. -6 5%. -6 6%. -7 1%. Debt Held by Public 7612 8984 10174 11186 12224 13345 14536 15869 Debt / GDP 54% 62% 68% 71% 74% 77% 81% 85% Interest 177 199 250 319 420 556 657 746 Interest Rate 2.3% 2.2% 2.5% 2.9% 3.4% 4.2% 4.5% 4.7% 

Source: Concord Coalition, CBO, JCT, The Lindsey Group 
The federal budget has benefited from the decline in rates, BUT approximatel

marketable Treasury securities now mature in less than 1 year

18%

Interest payments on federal debt

10%12%14%16%18%

4%6%8%

10%

0%2%

1979 1982 1985 1988 1991 1994 1997 2000 2003 

Net interest as % of federal budget Average interest paid

Source: Economic Report of the President 2009

Net interest as

% of federal budget Average interest paid

Source: Economic Report of the President 2009
Interest payments to rise substantially

Source: Heritage Special Report July 27, 2009; Office of Management and Budget, Budget of the United States Government, FY 2010, 

(July 15, 2009); Congressional Budget Office, A Preliminary Analysis of the President’s Budget and an Update of CBO’s Budget and Ec

2009, (July 15, 2009). Figures adjusted for inflation into 2009 dollars.
Large fiscal expansions coupled with debt monetization lead to 

Sou

rce: Deutsche Bank Global Ma

rkets Resea

rch

Sou ce: eutsche ank Global a kets esea ch
O f ptimal Maturity o

f Issuance
Definition of the problem

A f 15 i d dit i j t f di d 

Overview

- Across a range of 15 economic and credit scenarios, we project funding needs 10 years- Our goal is to find the optimal average maturity of debt issuance given differescenarios over the next 3 years scenarios over the next 3 years

Setup of problem: - Decision variable: % gross issuance of 2009-2011 to be issued in 3-months 

- Objective: Minimize the total cost of debt service from 2010-2020 (try to co

confidence crisis on sovereign credit by 2020)

- Constraints: 

-Maintain enough net issuance in bills and 10-years to meet investor need

-Additional Consideration

-Keep yields within a range to achieve monetary policy goals
Overview of the model

Contingent Real Growth 

Liabilities

Annual Issuance MAnnual Credit Spreads Shape of Yield Duration Supply Issuance

(Deficit)

Shape of Yield Curve p pp y

Cost of Debt Cost of Debt
Macro and credit scenarios

 The model considers 15 scenarios:

–

5 macro scenarios: n

arios: combinations m

binat

i

o

n

s

of 

growth 

and inflation

– 3 credit scenarios: optimistic, base case and disaster

Four focus scenarios

Credit L

Scenario Description Inflation

Real 

Growth

Fannie / 

Freddie FDIC

Ext

A

1 Base Case 2% 2% $300 $200 2 Low Growth, low inflation (Japan) 0% 0% $300 $200 

3 Moderate growth, high inflation 2% 5% $300 $200 4 High credit loss 2% 2% $600 $600 
Yield curve dynamics

♦The 10-year rate is the sum of:

- Real growth rate-Inflation

-Credit spread: based on amount of credit losses-Inflation risk premium: 50 bps + 20% of current inflation-An adjustment for duration supply: assume $1trn in net issuance leads to 1% incre

♦The 3-month point is largely determined by the Fed:

- Taylor rule: d(3-month Yield) = 1.5 * d(Inflation) + 0.5 * d(Real Growth)

- The 3-month credit spread is smaller than the 10-year spread and varies by credit 

- The impact of duration supply is small: $1trn in net issuance increases yields by 7 

The impact of duration supply is small: $1trn in net issuance increases yields by 7 

Rates in 2020 across focus scenarios 

S i G th I fl ti Credit Inflation Impact of Scenario Growth Inflation D 10 Yi ld 3 

C ed t Spread at o Risk Prem Durn Supply 10-yr Yield 3m 

Base 2.0% 2.0% 0.25% 0.9% 2.3% 7.5% 2.Japan 0.0% 0.0% 0.25% 0.5% 2.1% 2.8% 0.High Inflation 2 0% 5 0% 0 25% 1 5% 2 9% 11 7% 7 

* A recent study by JP Morgan concluded that net issuance of 10yrs in the amount of 1% of GDP causes yield to rThis would imply that yields would rise by 2% given $1 trn in issuance. We found this lead to yield curves that we

t b 2020 h l d th ff t W d f l th t th ff t d i d l i th ti id

High Inflation 2.0% 5.0% 0.25% 1.5% 2.9% 11.7% 7.High Credit 2.0% 2.0% 1.75% 0.9% 2.9% 9.6% 4.

steep by 2020 so we halved the effect. We do feel that the effect we used in our model is on the conservative side.
Budget outlook across scenarios

Federal budget in focus scenarios Federal budget in focus scenarios

2011 Yield Curve 2020 Yield Curve

% Bill in 

G 

Avg 

M t it f A M t it 

Deficit / 

GDP 

Scenario

Gross

Supply

Maturity of 

Issuance

Avg Maturity 

of Debt 2011 3m 10y 3m 10y

GDP 

(2015-2020)

Base 56% 55 74 2.2% 5.8% 2.9% 7.5% 9% Japan 81% 26 51 0.2% 2.8% 0.0% 2.8% 7% High Inflation 3% 116 96 4.4% 7.8% 7.4% 11.7% 11% 

High Credit 42% 70 83 2.6% 7.0% 4.3% 9.6% 9% 
Optimization across scenarios

♦In the low growth / low inflation scenario, we want to keep issuance as short as possib♦In the high inflation scenario, we should issue long now to lock in low rates

Average Debt Service / GDP: 2015-2020

8.00%9.00%

10.00%

4.00%5.00%6.00%7.00%

55 (74)

70(83)

2.00%3.00%

12 18 24 30 36 42 48 54 60 66 72 78 84 90 9

Maturity of Debt Issuance

26 (51)

Base Case Japan High Inflation High Credit Loss

Line shows optimal maturity of issuance to minimize total debt service cost for 2009-2020Number in parentheses is average maturity of total debt at the end of 2011Number in parentheses is average maturity of total debt at the end of 2011
Optimal issuance across macro and credit scenarios

Real I fl ti % of M t it 3 10 Deficit 

/ Debt 

/ Debt Service

Recent Issuance Yield Curve

Current macro environment

Growth Inflation Bills

Maturit

y 3m 10

y

/

GDP

/

GDP / GDP

-1% 1% 70% 26 0.08% 3.59% 14% 50% 1.3%

Optimal issuance for a given macro environment

Base Case Tax Rate 30% Hig

Real 

Growth Inflation

% Bills in 

Gross 

Supply

Debt 

Maturity 3m 10y

% Bills in 

Gross 

Supply

Debt 

Maturity 3m 1

0% 0% 80.6% 26 0.2% 2.8% 7.4% 149% 3.5% 83.6% 22 0.2% 2.

Base Case Tax Rate 30% Hig

Debt 

Service / 

GDP in 

2020

Optimal Issuance Yield Curve in 

Optimal Issuance Yield Curve in 2020 Deficit / 

GDP 

(2015-20)

Debt / 

GDP in 

2020

O

ptimal issuance for a 

given macro/credit environment

2% 2% 55.6% 55 2.2% 5.8% 8.9% 123% 6.6% 60.4% 49 2.2% 5.2% 5% 3.4% 116 4.4% 7.8% 11.1% 117% 9.3% 10.5% 108 4.4% 7.4% 0% 62.7% 47 1.2% 5.5% 7.0% 107% 5.4% 66.9% 42 1.2% 5.4% 5% 0.0% 120 4.9% 8.8% 10.6% 96% 8.8% 0.0% 120 4.9% 8.

p g

Real 

Growth Inflation Credit Losses (bn) % Bills in Gross Supply Debt Maturity 3m 10y % Bills in Gross Supply Debt Maturity (mos) 3m 

Deficit / GDP (2015-20) Debt / GDP in 2020

Base Case Tax Rate 30% 

Optimal Issuance Yield Curv

Debt 

Service / 

GDP in 

2020

Optimal Issuance Yield Curve in 2020

0% 0% $6 82.7% 23 0.1% 2.5% 7.4% 142% 2.9% 85.7% 20 0.1% 0% 0% $575 80.6% 26 0.2% 2.8% 7.4% 149% 3.5% 83.6% 22 0.2% 0% 0% $1,400 73.1% 34 0.6% 4.0% 7.9% 168% 5.9% 76.3% 31 0.6% 2% 5% $6 6.5% 112 4.4% 7.5% 11.1% 111% 8.6% 13.2% 105 4.4% 2% 5% $575 3.4% 116 4.4% 7.8% 11.1% 117% 9.3% 10.5% 108 4.4% 2% 5% $1,400 0.0% 120 4.8% 8.8% 11.7% 132% 12.0% 0.0% 120 4.8% 
Impact of duration supply

♦ Our choice of maturity is highly dependent on the impact of duration supply ♦All else eq g g gp , p 

ual if issuing more long debt has a larger impact on rates, the optim

will be shorter

Average Debt Service Across all Scenarios / GDP: 2015-2020

7.50%8.00%8.50%9.00%

56 months

5.50%6.00%6.50%7.00%

9

56 months

5.00%

12 18 24 30 36 42 48 54 60 66 72 78 84 90 9

Maturity of Debt Issuance

$1 trn in issuance -> 1% in yield $1 trn in issuance -> 2% in yield

79 months

y y
Implications of monetary policy constraints for debt issuance

♦ The lowest-cost issuance strategy may lead to yields that conflict with monegoals♦ If we restrict ourselves to strategies that limit near-term bond yields, the maissuance will be shorter

Issuance strategies across targeted yields

A M i 

Maximum Allowed 10-

Year Yield

Average Maturity

of Issuance 2009-

2011 Debt Maturity 2011

Debt Service 

2015-202

None 79 87 5.7%

5 5%. 74 84 5 7%.5.0% 56 75 5.8%4.5% 41 65 5.9%4.0% 28 53 6.2%

* Maximum across all scenarios** Average across scenarios

3.5% 16 41 6.7%3.0% 15 39 6.8%

** Average across scenarios
The choice of maturity matters, but without budgetary restraint 

debt could spiral

♦ In a high credit loss, high inflation scenario issuing long-dated debt from 20reduce debt service cost in 2020 by 13% of government revenues♦ But even with the optimal maturity debt service costs will be unbearable♦The dashed lines assume spending is cut by 30% by 2012

Debt Service as % of Federal Revenues: High Inflation, High Credit Scenario

90%40%50%60%70%80%

0%

10%20%30%40%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 20

Maturity of debt issued 2009-2011: 25 Months 54 Months 120 Month
Recap

Four Conclusions:1. Inflation, higher interest rate and roll over risk should be the primary cTreasury’s debt management strategies.2. In most scenarios, it is prudent to lengthen maturities significantly from average maturity of 50 months. Our base case is to extend to 74 months, extend to 96 months.3. The objective of lowest borrowing cost could lead to higher yields that monetary policy objective.4. Clever debt management strategy could potentially reduce debt service meaningfully, but still can’t completely substitute for prudent fiscal policy
Future Research

♦ We did not fully consider entitlement and state and local government as p

contingent liabilities Hence risk to the model is to the upside contingent liabilities. Hence risk to the model is to the upside.

♦ We can enhance the model on duration supply going forward. Current lit

on historical regression. Possible new variables to consider: oil, dollar de

change of foreign demand and US saving rate change of foreign demand, and US saving rate.

♦ We can attempt to model the rollover risk in a different context. We can t

credit spread to the amount of short term debt maturing within a certain ti