Presentation to the Treasury Borrowing Advisory U.S. Department of TreasuryOffice of Debt ManagementFebruary 1, 2011
Agenda

• Fiscal Developments• Auction Demand & Market Trends• Portfolio Metrics• Long-term Challenges

2
FISCAL DEVELOPMENTS

3
Steady Growth in Individual Tax Receipts 

4

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

0%

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

Mar-00

Jun-00

Sep-00

Dec-00

Mar-01

Jun-01

Sep-01

Dec-01

Mar-02

Jun-02

Sep-02

Dec-02

Mar-03

Jun-03

Sep-03

Dec-03

Mar-04

Jun-04

Sep-04

Dec-04

Mar-05

Jun-05

Sep-05

Dec-05

Mar-06

Jun-06

Sep-06

Dec-06

Mar-07

Jun-07

Sep-07

D07

Corporate Taxes Withheld Taxes Non

Note: Adjusted for 9/11/01 Corporate Tax Receipts disruptionSource: Monthly Treasury Statement

Quarterly Tax ReceiptsYear-over-Year Percentage Change

A closer look at Corporate: +6%Withheld: +8%Nonwithheld: +

Note: Data plotted is ye
TARP Repayments Increased with Citi and GM Stock 

-$125-$100

-$75-$50-$25

$0

$25$50$75

$100$125

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Repayments, Dividends, Interest (LHS) Cash Outflows (LHS) Cum

TARP Cash FlowsIn Billions $

The Automotive Industry Financing Program providedapproximately $80bn in loans and equity investment.

In June, over $68bn was repaid to the CapitalPurchase Program by JPMorgan, Morgan Stanley,Goldman, US Bancorp, AMEX, BONY, BB&T,Capital One, State Street, and Northern Trust.

In March, the Term Asset -BackedLending Facility , a joint venture with the Federal Reserve, was launched.

On October 14, 2008, the Capital Purchase Program was launched. By January 1, 2009, over $247bn in funds had been disbursed to U.S. banks.

In December, Bank of AmericaWells Fargo, and Citi repaid$90bn.

As of the to

5
Non-Marketable Redemptions Slowed in Q1 FY2011

6

-$30-$20-$10

$0

$10$20$30

Q1 

2005

Q2 Q3 Q4 Q1 

2006

Q2 Q3 Q4 Q1 

2007

Q2 Q3 Q4 Q1 

2008

Q2 Q3 Q4 Q1 

2009

Q2 

Savings Bond Foreign Series SLGS

Net Non-marketable IssuanceIn Billions $
Deficits Have Been Lower Year-over-Year through De

0

200400600800

1,0001,2001,4001,600

October November December January February March April May J

FY2009 FY2010 FY2011

Cumulative Budget Deficits by Fiscal YearIn Billions $

7

Source: OMB for end of Fiscal Yea
Primary Dealer and Government Deficit Estimates

FY 2011-2013 Deficit and Borrowing Estimates 

Primary

Dealers* 

FY 2011 Deficit Estimate 1,363 

FY 2012 Deficit Estimate 1,107 

FY 2013 Deficit Estimate 932 

FY 2011 Deficit Range 1,200-1,550FY 2012 Deficit Range 1,000-1,200FY 2013 Deficit Range 735-1,050FY 2011 Marketable Borrowing Range 1,050-2,116FY 2012 Marketable Borrowing Range 1,000-2,239Estimates as of: Jan 2011 Ja*Based on Primary Dealer feedback on January 24, 2011. Deficit estimat

8
Debt Outstanding is Approaching the Statutory Limit

9

468

10121416

1997 - Feb

1997 - Aug

1998 - Feb

1998 - Aug

1999 - Feb

1999 - Aug

2000 - Feb

2000 - Aug

2001 - Feb

2001 - Aug

2002 - Feb

2002 - Aug

2003 - Feb

2003 - Aug

2004 - Feb

2004 - Aug

2005 - Feb

2005 - Aug

2006 - Feb

2006 - Aug

Total Public Debt Outstanding Subject to the Statutory Debt In $ Trillions, as of January 31, 2011 

Current Current Headroo
AUCTION DEMAND & MARKET T

10
Coverage Ratios Have Remained Strong in FY2011

$0

$500

$1,000$1,500$2,000$2,500

FY2000 FY2001 FY2002 FY2003 FY2004 FY2005 FY2006 FY2007 FY2008 

Weighted Average Coverage Ratio on Notes and Bonds In Billions $, Coverage Ratio

Gross Private Issuance (LHS) Weighted Average Coverage 

Note: Excludes TIPS and Bills issuance. 

11

Sou
SOMA 3%

Primary Dealers

46%

Other Dealers

&Brokers

11%

Investment Funds

17%

Foreign&

International

22%

FY2011 YTD: Average Investor Class Allotments

Other Dealers&

Brokers 5%

Investment Funds

14%

Foreign&

International 

Five-Year Average o

Smaller Dealers Have Increased Nominal Coupon Au

12

*FY2006 through FY2010 Source: Treasu
Other Dealers&

Brokers 7%

Investment Fund

14%

F

Int

Five-Year Average o

SOMA 4% Individuals 2%

Primary Dealers

54%

Other Dealers&

Brokers 12%

Investment Funds

14%

Foreign&

International

14%

FY2011 YTD: Average Investor Class Allotments

Smaller Dealers Have Also Increased Bill Auction Pa

13

*FY2006 through FY2010 Source: Treasu
PORTFOLIO METRICS

14
Nominal Coupons and Bills as a Percentage of the P

15

69%

50%55%60%65%70%75%80%

Jan-00

Apr-00

Jul-00

Oct-00

Jan-01

Apr-01

Jul-01

Oct-01

Jan-02

Apr-02

Jul-02

Oct-02

Jan-03

Apr-03

Jul-03

Oct-03

Jan-04

Apr-04

Jul-04

Oct-04

Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jul-06

Oct-06

Jan-07

Apr-07

Jul-07

Oct-07

Nominal CouponsPercentage of Total Portfolio

Average 2000 - 2007

24%

20%25%30%35%40%

Jan-00

Apr-00

Jul-00

Oct-00

Jan-01

Apr-01

Jul-01

Oct-01

Jan-02

Apr-02

Jul-02

Oct-02

Jan-03

Apr-03

Jul-03

Oct-03

Jan-04

Apr-04

Jul-04

Oct-04

Jan-05

Apr-05

Jul-05

Oct-05

Jan-06

Apr-06

Jul-06

Oct-06

Jan-07

Apr-07

Jul-07

Ot07

BillsPercentage of Total Portfolio 

Average 2000 - 2007
Balances in the SFP Will Decline as the Debt Limit Ap

16

$0

$100$200$300$400$500$600$700$800

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

Sep-09

Oct-09

Nov-09

Dec-09

Jan-10

Feb-10

Mar-10

Apr-10

May-10

Jun-10

Treasury Supplementary Financing Program Cash BalanceIn Billions $

Max: $560B

Min: $5B 12/30/09
TIPS Issuance Will Continue to Increase

17

$0

$25$50$75

$100

1997 1999 2001 2003 2005 2007 

TIPSCalendar Year Issuance in Billions $, Percentage of Portfolio 

5‐Year (L) 10‐Year (L) 20‐Year (L) 30‐Year (L) 
The Ex-Post Cost of TIPS Issuance Continues to Dec

18

-5

05

101520253035

1/1/1997

7/1/1997

1/1/1998

7/1/1998

1/1/1999

7/1/1999

1/1/2000

7/1/2000

1/1/2001

7/1/2001

1/1/2002

7/1/2002

1/1/2003

7/1/2003

1/1/2004

7/1/2004

1/1/2005

7/1/2005

1/1/2006

7/1/2006

1/1/2007

Ex-Post TIPS Cost Since Program InceptionIn Billions $
Average Maturity of the Debt Continues to Lengthen

19

4045505560657075

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Average Maturity of Marketable DebtIn Months

Average Maturity Without Supplementary Financing Bills Average 

Current 58.9 as of 12/2010

Average 58.1

Min 42.4 in 4/1980

Max 70.9 in 5/2001

Statistics on Average Maturity since CY1980
Percentage of Debt Maturing in the Near-Term Remai

20

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

Jan-90

Jul-90

Jan-91

Jul-91

Jan-92

Jul-92

Jan-93

Jul-93

Jan-94

Jul-94

Jan-95

Jul-95

Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Jul-98

Jan-99

Jul-99

Jan-00

Jul-00

Jan-01

Jul-01

Jan-02

Jul-02

Jan-03

Jul-03

Jan-04

Jul-04

Percentage of Debt Maturing in Next 12 to 36 Months

Maturing in 12 Months Maturing in 24 Months Maturing i
LONG-TERM CHALLENGES

21
OMB FY2011 Mid-Session Review Projections

22

-$1,600-$1,400-$1,200-$1,000

-$800-$600-$400-$200

$0

$200$400

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Budget Surplus/DeficitIn Billions $, Percentage of GDP

Surplus/Deficit $ (LHS) Surplus/Deficit Percentage 
OMB Long-Term Debt Metrics

23

$0$5

$10$15$20$25$30

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Fiscal Year Outstanding DebtIn Trillions $, Percentage of GDP

Held by Public (LHS) Held by Government Accounts (LHS) Government Accounts As a % of GDP (RHS) Public A

$0

$100$200$300$400$500$600$700$800

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Fiscal Year Interest ExpenseIn Billions $, Percentage of GDP

Interest Expense (LHS) Interest Expense as a % of GDP (RHS) 

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

Average 1960-2010

2%
24 

What adjustments to debt issuance, if any, should Treaconsideration of its financing needs in the short-, medi
U.S. Treasury Borrow

Advisory Committe

Presentation to Treas

February 1, 2011
U.S. Treasury Financial Inno

Opportunities and Challen
3

Charge Question #2Debt Management Tools and Strategy Treasury continually seeks ways to minimize borrowing cosliability profile, enhance market liquidity, and expand the invTreasury securities. In light of these objectives, we would likcomment on the potential costs and benefits of new Treasuassist Treasury in achieving some or all of these objectivesany other debt management tools that Treasury should conthe question, please review the practices and products empmanagement authorities around the world. 
Part I
5

Overview• The U.S. is heavily reliant on foreign ownership of Treasu• Treasury may wish to diversify its investor base in a way t

cannibalize the current auction process by making sure neadditive to demand.

• Treasury could take advantage of structural changes in th

as well as regulatory developments.

• Treasury can benefit from the experience of other soverei• Treasury may wish to expand their current suite of debt in

other fixed-rate tenors, Floating Rate Notes (FRNs) and/oembedded options.

• These instruments, and their relative merits, are discusse

second part of this presentation. 
6

How has Treasury Ownership Evolved Over Tim• The foreign share has trended higher, crowding out the majo

• The acceleration of foreign ownership coincided with the 50% Ch

CNY/USD in early 1994. 

Holdings of Treasuries by Agent as % Treasury Debt Outsta

0%

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

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

Households Foreigners Banks Pensions + Insur
7

Foreign Ownership of Treasuries is Concentrate

Foreign Holdings by Selected Groups in % Total Foreign Hold

0%5%

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

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

China & HK Taiwan Oil Exporters 

• China and other Non-Japan Asia hold nearly 20% of total Treasury debt ou

held by foreigners. These ratios are up from 2% and 11%, respectively, in 

• Given the high concentration of foreign ownership, Treasury may wish to fo

sources of debt placement. 

• A more diversified debt holder base would prepare the Treasury for a pote

participation.
8

Treasury Could Benefit from Expanding the Curr

Foreign Ownership of Government Bonds

0%

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

US UK JP 

Treasury’s strategy to increase domestic sponsorship could • Learning lessons from the experience of other sovereigns.• Following a targeted approach by investor class (Banks, Pensions and Ins

• Taking advantage of structural changes in the U.S. debt market.• Taking advantage of legislative and regulatory reform, and• Introducing new products that are aligned with investor needs.
9

Cross Country ComparisonsIn addition to the evolution of Treasury ownership in the U.S., it is isome international metrics. We narrow our comparators to three c• Italy and Japan, as they are historically large borrowers.

• The U.K., because Treasury may wish to consider some tools tha

into their funding program (syndication, ultra-longs).

• U.S. total debt is still relatively low by international standards, but 

unique challenges.
10

A Tougher Competitive Environment for TreasurDebt Markets• In the U.S., Treasury 

debt accounts for a relatively small share of total domestic Debt.

• The Treasuries of two 

large borrowers, Italy and Japan, have a much larger slice of domestic debt pie.

• In Japan, Treasury Debt 

is the only game in town, Italy is a close second.

Treasury Debt as 

Total Debt Securitie
11

A Tougher Competitive Environment for TreasurDebt Markets

• The U.S., in contrast to our comparator countries, suffers f

competition from other Aaa asset classes. 

• Treasuries represent only 1/3 of the aggregate index, but n

index is Aaa.

• As a result, there is a great degree of competition from hig

products.

U.S. Barclays Aggregate Index Breakdown – Heavy Competition b
12

Taking Advantage of Market Changes (Adapt or Treasury may want to focus on areas where a product gap has developed in order to exp

Government Sponsored Enterprises (GSEs) successfully followed this strategy, when Tdramatically in the late 90’s, by introducing the Benchmark and Reference Note progra

The current environment offers comparable opportunities for Treasury because of disloc

as regulatory and legislative developments. 

• GSE debt issuance is expected to decline, as the Agencies are required to shrink the

toward Treasury securities.

• The roll off of bank debt issued under the Temporary Liquidity Guarantee Program (TL

generate demand for high quality assets. 

• Muni credit is coming into question, increasing demand for safe haven assets, like Tre

• Money Markets face a dearth of short-term paper because of the contraction of the C

boosting demand for short-term Treasury paper.

• Legislative and regulatory developments - Dodd-Frank, pension reform by the Finan

(FASB), the Liquidity Cover Ratio (LCR) under Basel III - have the potential to lead securities and liquid, high quality products.

The above market dynamics could generate demand in the following products: • Fixed rate vanilla term debt, especially in the long end.• FRNs and other short-dated products. • Callable and other yield-enhancement products. These products and opportunities will be reviewed in detail in the second half of the prese
13

Where can the incremental demand come from? 

• We will now focus on three key Treasury debt buyers:

─ Banks, ─ Pensions/Insurers and ─ Retail.

• These buyers could substantially increase their demand in light o

dislocations, as well as the regulatory and legislative changes me

• We think Treasury could tap into an additional $2.4 trn in dem

investor bases over the next 5 years, if the right products are 
14

Banks: Structural and regulatory forces should allocation to Treasuries

Bank demand for Treasuries is expected to be boosmarket developments:

• The gradual reduction in GSE balance sheets.

• The roll off of Government guaranteed bank debt iss

financial crisis (TLGP), and 

• Upcoming regulatory changes emanating from the B

We now turn to these developments.
15

Banks: GSE Balance Sheet reduction and TLGgenerate potential demand for Treasuries

The Debt Landscape for Aaa substitutes is changing, and this is supportive for TreGSEs -• Fannie and Freddie are currently required to shrink their retained portfolios by 10% each year.

• The resulting reduction of the GSEs balance sheet should reduce their issuance by around 120 bln per y

GSE paper will have to find alternative use for their funds.

TLGP -• The investment in government guaranteed bank debt (TLGP) will also need to shift to another asset as th

other programs have expired. There is almost $370 bln of this debt maturing by the end of 2012, a

Treasury could fill the gap left by the GSE size reduction and TLGP roll off. 

USD Guaranteed Bank Debt Maturity Profile (TLGP and Foreign B
16

Banks: Changes on the regulatory front should increase their demand for Treasuries• The key regulatory change emanates from Basel III.• The most important is the phasing in of the Liquidity Cove• Although the date of implementation has been pushed to 

seem to be trying to get there sooner to gain investor conf

• When the Fed eventually unwinds QE and drains cash, do

forced to replace it with liquid securities. 

• Barclays Capital estimates that banks can buy roughly $1 

(split between Treasuries and Agency/other alternatives). 

• If the current mix is maintained, we estimate $650-700 bln 

Treasuries.

• This projected flow into Treasuries is roughly twice that re

roll off.
17

Banks: U.S. banks are underinvested in Treasuother countries

• U.S. Bank holdings of Treasuries are relatively low due to crowd

quality asset classes (e.g. MBS, agency callables).

• Treasury can bridge the gap relative to other countries and maxi

forthcoming structural and regulatory changes by identifying prodneeds.

• These products (e.g., callables, Floating Rate Notes) are covered 

part of this presentation.
18

Pensions and Insurers: The impact of regulatioit has the potential to dramatically raise demand 

• Treasury penetration into these institutions is small relative to othe

• This is in large part the result of lenient regulatory and legislative 

respect to Asset-Liability matching by these institutions relative to 

• Two regulatory developments could increase Treasury demand fr

going forward:

─ The Implementation of Dodd-Frank, and 

─ The possible implementation of pension reform under FASB. 
19

Pensions and Insurers: Important legislative and are comingDodd – Frank• The implementation of Dodd Frank imposes higher costs to the 

instruments (e.g., posting of margins for exchange traded swaps

• As a result institutions may turn to the Treasury market for acquir

exposure, provided their demand can be met. 

FASB • After tackling the balance sheet side of Pension Reform under Ph

pursuing the more complex Phase II addressing the income state

• In order to align the U.S. regulatory framework to international sta

Phase II is now awaiting progress by the International Accounting 

• The final recommendations could and should generate additiona

fixed income assets in order to reduce the volatility of the plan sp

• FASB has consistently shied away from taking a U.K.-style appro

Their actions in the coming years has the potential for radically inTreasuries by the pension industry.
20

Pensions and Insurers: How can Treasury capitachanges?

In order to capitalize on these important developments, Trconsider the following strategies:

• Issuing longer duration instruments, currently in scarce su• Creating a syndicate desk similar to that of the U.K. Debt 

(DMO).
21

Pensions and insurers: The U.S. market is starved oduration securities

• Currently less than 10% of U.S. debt issuance has a maturity longer than • By comparison, nearly 30% of the U.K. issuance is in the long end.• The U.K., and to some extent Japan, have enjoyed a longer average mat

has provided considerable protection during periods of market disruption.

The second part of the presentation will discuss in more detail the issuance 

Maturity Distribution of 2010 Government Bond Issuance and Average Maturit
22

Pensions and Insurers: There should be demand bonds, and syndication may help their initial placem• If ultra-long products are contemplated, Treasury may con

syndicate desk, to aid in the pricing and distribution of thehas been very successful in employing the syndication-sty

─ Syndication has accounted for 15 % of issuance in the U.K. in the last 

─ This method has been used extensively for the placement of long date─ The syndication process allows the borrower to gauge more closely ma

size and tenor accordingly.

─ This would be especially critical during the early phase of the introduct

─ A syndication desk would also be able to address reverse inquiries by 

(e.g., institutional investors, corporate treasurers, etc).

• Under a scenario of concrete progress on the pension reg

expansion of long dated instruments issued by Treasury, assume that the U.S. could close at least half of the existiin terms of allocation to fixed income by insurers and (priv

• Such a move could expand Treasury demand by more tha
23

Retail Sector: There Appears to be Room for E• Treasury is less successful in selling U.S. Treasuries (UST) to ho

to the past and compared to other sovereigns. 

• Households’ investment in UST has waned considerably since th

hold roughly 3% of their assets in Treasuries, up from the 2007 lothe 5% level in ‘50s and ‘60s.

• Treasury used to place 30% of their debt to households; now the

• Savings Bonds used to be ubiquitous in retail portfolios, but they • Direct investment in Treasuries have failed to fill the gap left by th

disappearance.

Retail Holdings of UST as % of UST Debt Outstanding Retail Holdings of US
24

Retail Sector – There are substantial differences in ownership of Treasuries across countries 

Direct ownership of Treasury debt in the U.S. is roughly in line with our comparato

ownership falls short.

• This is at least in part due to lower bank holdings of Treasuries in the U.S. (they prefer 

agency callables and MBS), and much higher Government bond holdings by Japanese b• Here, “Indirect ownership” by retail is meant to capture Treasury debt holdings made as investments into other institutions, ie: through mutual funds, bank deposits, pension and 

•These entities then use the funds deposited by households and re-invest them into gove

•Indirect ownership is estimated by taking share ownership of Treasury debt of 3 categor

Funds, and Pensions and Insurers) and multiplying it by the share of these buyers in the 

Household Holdings of Government Bonds: Direct and Indirect Ownership as % Hou
25

Retail Sector: There are lessons to be learned sovereign borrowers 

• Italy and Japan have both pursued strategies to increase househo

government securities. While both countries have traditionally hathan the U.S., Italy was far more successful in translating that into government bonds. 

• Italy: The Italian Treasury followed the route of liquid, fungible ins

with individuals.

─ Retail investors used to invest almost exclusively in short term bills (BO─ The Italian Treasury was an innovator with the introduction of a Floating 

which allowed the transition toward longer term borrowing by retail witho

─ Once the retail community felt comfortable committing savings beyond t

more interested in long term fixed rate issuance (BTPs).

─ This was particularly important when rates fell, and ownership of BOTs 

ownership of CCTs and especially BTPs held up.

• Japan: MoF followed the route of dedicated (illiquid, non-fungible

were far less successful increasing direct investment by househol

• The lesson learned is: stick primarily to liquid products.
26

Retail Sector: In terms of Products and Marketiyield, liquidity, and safety

Products:• Yield enhancement products would likely be well received by the ret• Other structured notes (callable range accruals etc.) offer an even g

enhancement and are often purchased by more sophisticated retail 

• Floaters offer the benefits of being a liquid term instrument without s

could also offer some protection for individuals who have adjustable 

Marketing: • Treasury may consider employing a marketing campaign to increase 

debt as an asset class in individual portfolios.

• Treasury could take a page from earlier efforts to promote individual • Current Savings Bonds are the offspring of WW I Liberty Bonds and • Defense Bonds (renamed War Bonds after Pearl Harbor) benefited f

advertising donated during the first three years of the National Defen

• Through a combination of new attractive products, and aggressive m

at growing the household ownership share of Treasuries to the avera

• Such expansion would allow Treasury to place an additional $300-35

accounts.
27

• Over the course of the World War II, 85 million Americans 

$50 bln of Savings Bonds, tripling their ownership share oabout 18%. 

• It worked then....
28

• We now turn to the second part of our presentatio• There, we will address in more detail new securitie

management techniques which Treasury may wisdiversify its investor base.
Part II
30

Securities and Debt Management Techniqu

• Ultra-long bonds and associated strips: 40yr, 50yr, 1• Bonds with embedded options 

─Callables─ Puttables

• Money Market instruments• Bonds for individual retail investors• Floating rate bonds

─ Short floaters─CMT-style

• Other

─GDP-linked bonds─ A pure inflation security stripped from TIPS

• Debt management techniques: interest rate derivativ

tenders, debt exchanges
31

An Approach to Financial Innovation in the Market• Identify areas of excess net product demand and un

niches

• Pricing analytics• Limit rollover risk• Lower interest cost volatility• Expand investor base• Liquidity• Distribution Methods• Time to develop market• Ease of accounting and taxation mechanics for the U

investors
32

Net Demand: The market itself can be helpful in identifying opinnovation. Potential new securities and innovations should be 

demand testing.” Some underlying sources of demand are: durenhancement, protection, convexity, and market completeness

• Duration. Insurance companies and some pension plans typically have ve

predictable liabilities. They face a scarcity of high quality debt instruments liabilities. Ultra-long bonds and associated strips could be a source of supp

• Yield. Recently, financial turmoil and deleveraging has led to cut backs in 

traditional sources of high-quality spread products: GSEs, mortgage, assecorporations. Meanwhile, yields are near historic lows and credit spreads hcrisis levels. These factors combine to create demand for instruments such enhanced yield. 

• Protection. Many deposit-taking institutions have floating rate liabilities fun

They are exposed to losses in a rising rate environment. Individuals with flalso exposed to rising rates. 

• Volatility and convexity. Some entities such as mortgage servicers and i

have negatively convex earnings profiles. Such entities could offset this sooptions and positively convex securities to their portfolios. Puttable bonds be sources of convexity.

• Completeness. Investor demand is generally more evenly spread across 

supply, which is impacted by a combination of historical issuance patterns offers issuers an opportunity to fill in gaps in the existing yield curve, e.g. nmaturities and to smooth out rollover bulges with buybacks. 
33

Ultra-Long Bonds: Main Conclusions• Demand. There is significant demand for high-quality, long-d

entities with long-duration liabilities such as insurance compa

funds. 

• Strips. The arithmetic of the maturity-duration relationship (d

more slowly than maturity for ordinary coupon bonds) suggesbonds are issued, they be made strippable (the duration of stmaturity). 

• Pricing. Dealers can determine where they see demand for t

work backward to determine where to bid whole ultra-long co

• Distribution. P-strip demand will give dealers a solid basis fo

coupon auctions. Syndication methods have been successfucould further support the distribution process but normal reveprocess may also be sufficient. 

• Costs. Ultra-long bond yields are unlikely to be significantly h

30yr sector, keeping issuing costs down. Spreads in the U.Soverseas ultra-long bond markets are very tight to 30yr rates
34

Long-Duration Liabilities vs. Assets: the insurance companies and pension funds• Assets

─Duration of insurance company assets is typically: 6-10 years

• Liabilities

─Duration of liabilities is typically much longer than 6-10 years 

relatively stable, inviting cash-matching funding strategies.

• Sources of long-duration liabilities

─ Long term care (you pay up front and are covered in old age)─ Term life insurance: 20-year term is most popular and some c

term. 

─ Permanent life policies.─ Annuity products increasingly contain secondary guarantees s

minimum death benefits. 

─Defined benefit pension plans. 
35

Ultra-Long Analytics: Duration tapers off maturity. This effect is greater at higher cou

Duration vs. Maturity at Various Coupons
36

Make Ultra-Longs Strippable: STRIPS duration, hfunction of maturity, making STRIPS a good tool foduration and for liability cash-matching

Duration vs. Maturity 
37

Pricing Ultra-Longs: Dealers determine the demand investors at various yields and then decide where to bcoupon issue, e.g. a 5% P-strip on a 50 year bond shof around 4.60%
38

Ultra-Long Spreads to 30yr Maturities: Global 3cash (U.K.) curves show that ultra-longs typically trthan 30yr maturities. Dealers and Investors could umarket to help price new and existing ultra-long de
39

Convexity: Ultra-long bonds are potential sources Entities such as insurance companies and mortgagnegatively convex earnings profiles. 

Convexity vs. Maturity
40

Callable Bonds: Main Conclusions• Demand-supply gap. Callable Treasuries could fill an emerging gap betw

─ Demand for instruments offering enhanced yields is being driven by the absolute lo

compression, and regulatory changes. 

─ Net supply of high quality spread product, including callables is likely to continue to 

in the Agency, MBS, and structured product markets. 

─ The demand for volatility has decreased due to falling home mortgage issuance an

can fill this gap.

• Replacing GSE supply. Treasuries are relatively close substitutes for Age

─ The greatest opportunities for callable Treasury issuance may lie in the maturity ra

been previously mapped by the GSEs. Popular maturities are 2-5 years and the lo

• Corporate callable issuance. There may be demand for a regularly issue

Treasury. 

─ The bulk of the outstanding callable corporate bonds carry ratings of BBB or lower

between them and Treasuries. 

─ Corporate issuance is somewhat irregular. Corporate issuers generally tailor secur

terms of maturity and lockouts (project finance or cash outflow) rather than those o

• Cost. Pricing models suggest the incremental cost to Treasury of issuing c

18 bp for a 5yrNC1yr and 8 bp for a 2yrNC6mo. 

• Risk. Demand for callables tends to fall off if investors expect rates are he

generally expect (hope) to be called. Once a rate-rise cycle gets underway increases, Treasury may have to offer higher yield enhancement to maintaprogram or be willing to curtail the program.
41

Treasury Yields are Low and Corporate BoCompressed, Increasing Demand for Yield 

5Yr Treasuries vs. A Rated Corporate Bond Spreads

1.502.002.503.003.504.004.505.00

2001 2002 2003 2004 2005 2006 2007 2008 

Pct Yield

5yr Treasury Yield A Rated Corporate Bond Spreads
42

Net Supply of High Quality Assets: Trending lowQE2 removes $600bln in Treasuries through June 
43

ABS Has Also Seen Negative Net Issuance(2010 net -$97bln)

Net ABS Issuance

-150-100

-50

0

50

100150

2000 2001 2002 2003 2004 2005 2006 2007 

Includes Auto, Credit Card, Equipment, and Student Loan ABS.
44

Overall Net Callable Issuance Declined in 2

Net Callable Issuance

-600-400-200

0

200400600800

10001200

2001 2002 2003 2004 2005 2006 2007 

Agencies Agency MBS Non-Agency MBS Total
45

Agency Callables: A Closer Look at Inves• Domestic banks – larger banks buy short maturity, liquid, high c

enhance yield. Recent regulatory changes such as Dodd-Frank ademand significantly in Treasury-based liquidity portfolios. Some purchase short lockout callables with maturities of 15yr as a subs

• Foreign Banks – are opportunistic. Demand is strong when rate

fade when rates rise and calls go out of the money. 

• State and local governments – need securities with high liquidi

quality, and enhanced yields. They are often required by law to b

securities. Maturities favored are generally 3yrs and shorter; 6 mfavored but some entities will be opportunistic for yield pick up. 

• Fund Managers – will overweight callables in order to attempt to 

• Insurance Companies and Pension Funds – buy callable agen

a potential substitute for corporate bonds. 

• Foreign investors – many foreign investors have backed away f

due to uncertainty surrounding future status of GSEs. Callable Trwelcomed by many of these former GSE buyers.
46

Underlying Demand for Callable Agencies: In 20issuance of Agency callables was $829 bln; net issnegative. In 2010, a huge volume of Agencies were fell but the GSEs were able to replace most of them callable issues, indicating strong underlying investo
47

GSE Portfolio Changes Drive Net Issuance 

Note: FHLB is the combination of the advance and investment portfolios. Issuance includes discount no
48

... Including Net Callable Issuance

Note: FHLB is the combination of the advance and investment portfolios. Issuance includes discount notedecrease in net callable issuance in 2007/2008 was driven by an increase in FHLB discount note and floatdecreased. 
49

Structure: Short lockouts (6mo and 1yr) doAgency market
50

Callable Agency Market Liquidity• The difference between new issue spreads and sec

5-10 bp. 

• But liquidity has been improving. 

─Deal sizes have increased.─Rising number of underwriters. ─ European call structures ─ Shorter maturities
51

Pricing and Cost to Treasury: Incremental callables in the present Agency-range is esti8-22 bp according to fair value pricing modelevidence from the Agency market is consisteresults. 

Estimated Value of Embedded Call Op
52

Callable Yield vs. Bullets: Historical Spre• Yield difference between new issue agency callable yields 

averaged 11-24 bp in 2010 for 2-5yr maturities with Europ
53

Callable Corporates: The bulk of outstanding callaBBB or lower. Maturity peaks in the 5-10 year rangevenly distributed across the maturity spectrum. Thopportunities for regular Treasury issuance in the b
54

Money Market Instruments: Main Conclu• Regulatory changes are creating new demand for short-term instrume

and short callables. 

─ Estimates of the overall increase in demand for government debt 

requirements in order to comply with Basel III range from $400-80

─ Most of the increased demand is likely to be for short maturity, hig

whose risk weighting is zero. 

• Money market mutual funds: regulatory changes are requiring them t

maturity of their assets.

• Banks et al: at the same time, new regulations require banks and oth

maturity of their liabilities.

• The demand-supply gap will naturally widen further in a rising rate en

• Treasury has room to issue more bills if it desires to do so. Bills outst

total U.S. Treasury debt have returned to pre-crisis levels as has the debt. 

• Costs. More bill issuance may conflict with objective of further lengthe

debt and expose Treasury to rollover risk and higher funding costs in 
55

Room to Issue More Bills: T-bills as percmarketable debt have fallen back to around almost 35% of 2008/2009
56

Room to Issue More Bills: The average mTreasury debt held by the public is up to ~5
57

Regulatory Paradox: Regulations are creaniche for increased bill and callable issuancmoney market mutual funds• Money Market Mutual Funds (MMMFs)

─ SEC 2a-7 regulations requires the MMMFs to shorten the term 

bringing the weighted asset maturity to 60 days from 90 days their assets have to mature within 7 days.

─ This has increased the MMMFs demand for short-dated secu

• Banks and others

─ Basel III requires banks to lengthen their liabilities.

• The gap

─ There may be room for increased bill and callable issuance to 

between MMMFs and issuers that will be created by new regu

─ This gap will naturally widen (MMMFs will want more short pa

others will want to lengthen liabilities) if market participants exa rate hike cycle.

─ Puttable securities with puts exercisable every 60 days would 

MMMFs and offer a lower nominal initial interest rate for the U
58

Bonds for Individual Investors: Main Con• Increasing household ownership of Treasuries has t

broaden the investor base significantly. Each 1% incpercent of household assets = ~$535 bln. 

• Holdings of Treasuries by households are up sharpl

crisis and demographics favor further increases in th

• But household holdings of savings bonds has been 

the past few years at low levels ($190 bln).

• Households now have many, more liquid alternative

which are simpler and which do not face severe penredemption. 

• Treasury should focus on instruments that appeal to 

and institutional investors. 

• It should consider stepping up marketing initiatives, 

advertising geared toward retail investors, and it shotypes of issues.
59

Savings Bonds: Savings bonds outstandinlowest level in years, and an increasingly sTotal Public Debt
60

Household Holdings of Treasury Debt has Recently
61

Floating Rate Securities with Short Dated Rates: Main Conclusions

• A floating rate instrument, whose reset and reference rate are the same, eg a 6 

rate as its reference rate, would be a “convenience” product, allowing both indiv

the inconvenience of rolling bill positions or incurring transaction costs in the se

• Holders would not be exposed to the significant curve risks associated with CM

instruments where there is a mismatch between reference rate maturity and res

• Institutional demand for such instruments could be strong based on the likely in

term, high quality assets required by Basel III. And, there is a dearth of default-

• Demand will likely increase if rates are expected to rise. 

• From Treasury’s point of view, such instruments are attractive because they red• Treasury could set the maturity based on the distribution of its future redemptio

congestion. 5yr and 10yr maturities look promising from this point of view. 

• For Treasury, these floaters do not of mitigate against increased debt service co

environment, but neither do they increase them. 

• From a liability management perspective, floaters offer a counter-cyclical compo

rise in a stronger economy, and at the same time federal tax receipts will be incdebt-servicing costs.

• We assume that no fixed-margin discount or premium would be applied to the r

convenience for investors and the advantages to Treasury are about equal, but 

case.
62

CMT-Style Floaters: The reference rate is genethat is much longer than the reset period, eg a 5yand a 6 mo reset period. Japan and France have mixed success. Sample term sheet:• Maturity: 10yrs.• Reference rate: 5yr auction rates set in the period just prior to the reset da• Margin: A “margin” is set at auction, which is subtracted (or added to) from 

margin is fixed for the life of the bond. 

• The margin reflects investors’ demand for floating rate assets at a spread t

• Floor: Future coupon payments can not go below zero. Demand:• These securities may be demanded by deposit-taking entities, which have 

they fund at a spread using fixed rate assets. Such instruments give them protection from rising rates. 

• Individuals, especially those who expect rising rates or who have floating r

find these securities attractive. 
63

Analytics: CMT-style floaters are simple to relatively complex to price• Computing the “fair value” of a CMT-style floater: 

─ Extract the discount factors (zero coupon rates) associated with future coup

from the current yield curve.

─ Estimate the expected future coupon payments from the current forward cu

adjustment for convexity. 

─ In the case of a 10yr floater indexed to a 5yr reference rate with a 6mo rese

factors and associated expected forward 5yr rates. 

─ To value the zero-floor on coupon payments, we need to value an associate

index rate.

─ Volatility enters the valuation through its impact on the value of the floor and 

• Sensitivity to the slope of the yield curve: 

─ The fair value of CMT floaters is relatively sensitive to changes in the slope 

when the curve steepens and falling when it flattens. 

─ This is because an increase in a zero coupon rate has two opposite effects 

style floater:

 A negative effect operating via the higher discount factors  A positive effect operating via the implied higher coupons  For shorter maturities, the discount effect dominates the coupon effect, but as 

implied coupon effect dominates. 

─ One implication of this is to avoid exceptionally long maturities for both the f

rate because this exposes deposit-taking entities to large and likely unantici

end of the yield curve. This happened, for instance, in Japan.
64

GDP-Linked Bonds: Interesting but need to assess their potentialPremise: A GDP-linked bond pays a coupon based on a nation’s growtgrowth is 3%, and a nation regularly borrows at 7%, a GDP-linked bondthe GDP deviation from trend growth (3% in this example).Pros:• Dampens the relationship between the business cycle and interest ex• Reduces the pro-cyclicality of government spending by decreasing co

economic contractions, and vice-versa in economic expansions.

• Allows investors to express a view on the economy’s future growth an

from equity index investors.

Cons:• Complicated structure, difficult to price. Premium may be required du• Debate as to whether to adjust to the rate of growth of GDP, or the le• Economic data, which is the basis of the reference rate, is frequently • If GDP is strong, and coupons increase, investors may be concerned 

“call” the bond or enact buybacks.

• Demand for GDP-linked structures is unknown, extremely limited com
65

Stripping Out the Inflation Uplift from TIPS: To coverall demand for TIPSPros• As much as 60% of long-dated nominal Treasury issues are held 

significant demand for zero coupon securities.

• TIPS stripping, on the other hand, is very small partly because un

final cashflow includes both the face value (unadjusted principal) inflation. 

• Any type of increase to stripping activity will increase liquidity in t

• Separating the final cash flow into two components – an unadjus

inflation accrual or uplift (“pure” inflation) may increase the dema

• Demand for the pure inflation uplift could come from TIPS funds, 

insurance companies, corporations, and retail investors.

• Similar demand for pure inflation uplift has been seen in other cu

Cons• Dealers may be resistant to holding the residual strips, decreasin

• Demand for the non-pure inflation component may be less robus

inflation uplift. 

• Tax issues and fungibility issues with principal strips off conventio
66

Buybacks and Completeness: Treasury faces big ro-2015. There also may be room for a new maturity se20yr. Note the chart below is a snapshot and does not take into account future issuance.
67

Buybacks and Completeness: • Buybacks can be effective in reducing “peaks” in maturities and smoothing 

used these effectively over a multi-year period earlier in the decade to smo

• Currently, there is a sharp rollover peak in 2012, and the 2011 deficit, estim

relatively large.

• There is little time or room in the 2011 funding plan to implement a buybac

a significant impact on the 2012 rollover peak. Moving $100 bln from 2012 average maturity of the debt by approximately 1.2 months.

• As an example, with four quarters remaining in 2011, a $100 bln buy-back 

shift the debt profile, but might risk disrupting the market, leading to increa

• Post 2012, there may be more scope to introduce a buy-back program.• Treasury may find it difficult to purchase shorter maturity bonds held by rea
68

Interest Rate Derivatives As a Tool for LiabManagementPros• Treasury could use interest rates swaps to increase floating rate liabi

liabilities. 

• It could take advantage of aberrations in the USD swap curve, eg cu

maturities, swaps are trading around 30 bp below Treasuries of the sfixed and receiving floating at this maturity, Treasury could potentially savings. 

• Treasury could issue callable or puttable securities and hedge out the 

interest rate swaptions to create a straight, fixed rate liability, as is cucorporate sector.

• Treasury could issue foreign-currency denominated securities that co

U.S. dollars at possibly lower yields than those on its current USD-de

Cons• Treasury would be assuming counterparty risk, although this could be 

exchange-cleared, as proposed by Dodd-Frank legislation.

• Treasury may face collateral management issues if swaps are cleare

central clearing house.

• Lack of liquidity in certain segments of the swap market may limit sco
69

Summary and Conclusions• We found the following promising and deserving of further consid

─ Measures to expand retail investment in Treasury securities. These inc

and advertising along with the addition of new securities that appeal dias to institutions. 

─ Ultra-long bonds with maturities of 40 or 50 years. Such bonds should ─ Callable securities, especially those with relatively short maturities and 

regularly issued longer-maturity callable.

─ Instruments targeting the money markets and households, including FR

rate and reset periods are short-dated and synchronized. 

─ Changes in the structure of TIPS stripping program to enable investme

component of TIPS principal repayments in order to augment overall liq

─ Buybacks and similar measures to help Treasury smooth out the large 

in the coming decade. 

─ Interest rate derivatives to help manage liabilities and achieve cost-sa

• Measures we found less viable and requiring more study at this p

─ Longer-maturity CMT-style floaters, which are complex and expose inv

yield curve risk.

─ GDP-linked bonds, where demand is uncertain and the index is subjec

─ Puttable bonds, where demand for volatility and preferred structure are ─ Foreign currency denominated bonds.