Debt Limit: Delays Create Debt Management Challenges and Increase Uncertainty in the Treasury Market
Published: 2011-02-22T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO has prepared this report to assist Congress in identifying and addressing debt management challenges. Since 1995, the statutory debt limit has been increased 12 times to its current level of $14.294 trillion. The Department of the Treasury (Treasury) recently notified Congress that the current debt limit could be reached as early as April 5, 2011, and the Congressional Budget Office (CBO) projects that under current law debt subject to the limit will exceed $25 trillion in 2021. This report (1) describes the actions that Treasury traditionally takes to manage debt near the limit, (2) analyzes the effects that approaching the debt limit has had on the market for Treasury securities, and (3) describes alternative mechanisms that would permit consideration of the link between policy decisions and the effect on debt when or before decisions are made. GAO analyzed Treasury and market data; interviewed Treasury officials, budget and legislative experts, and market participants; and reviewed practices in selected countries.
section_title: What GAO Found
paragraphs: The debt limit does not control or limit the ability of the federal government to run deficits or incur obligations. Rather, it is a limit on the ability to pay obligations already incurred. While debates surrounding the debt limit may raise awareness about the federal government's current debt trajectory and may also provide Congress with an opportunity to debate the fiscal policy decisions driving that trajectory, the ability to have an immediate effect on debt levels is limited. This is because the debt reflects previously enacted tax and spending policies. Delays in raising the debt limit create debt and cash management challenges for the Treasury, and these challenges have been exacerbated in recent years by a large growth in debt. In the past, Treasury has often used extraordinary actions, such as suspending investments or temporarily disinvesting securities held in federal employee retirement funds, to remain under the statutory limit. However, the extraordinary actions available to the Treasury have not kept pace with the growth in borrowing needs. For example, unlike the past, the amount potentially provided by the extraordinary actions for 1 month in fiscal year 2010 was less than the monthly increase in debt subject to the limit for most months of the year. As a result, once debt reaches the limit, Congress will likely have less time than in prior years to debate raising the debt limit before there are disruptions to government programs and services. This trend is likely to continue given the long-term fiscal outlook. Failure to raise the debt limit in a timely manner could have serious negative consequences for the Treasury market and increase borrowing costs. Also, some of the actions that Treasury has taken to manage the amount of debt near the limit add uncertainty to the Treasury market. In the past, Treasury has postponed auctions and dramatically reduced the amount of bills outstanding, which compromised the regularity of auctions and the certainty of supply on which Treasury relies to achieve the lowest borrowing cost over time. GAO's analysis suggests that borrowing costs modestly increased during debt limit debates in 2002, 2003, and most recently in 2010. In addition, managing debt near the debt limit diverts Treasury's limited resources away from other cash and debt management issues at a time when Treasury already faces challenges in lengthening the average maturity of its debt portfolio. Observers and participants suggested improving the link between the spending and revenue decisions that drive debt and changes in the debt limit. Better alignment could be possible if decisions about the debt level occur in conjunction with spending and revenue decisions as opposed to the after-the-fact approach now used. This practice, which is similar to practices used in some other countries, might facilitate efforts to change the fiscal path by highlighting the implications of tax and spending decisions on changes in debt. To avoid potential disruptions to Treasury markets and help inform fiscal policy decisions in a timely way, Congress should consider ways to better link decisions about the debt limit with decisions about spending and revenue. Treasury provided technical comments on a draft of this report, which GAO incorporated as appropriate.

section_title: Letter
paragraphs: Congress and the President have enacted laws to establish a limit on the  amount of federal debt that can be outstanding at one time. The debt limit  does not restrict Congress’ ability to enact spending and revenue  legislation that affect the level of debt or otherwise constrain fiscal policy;  it restricts the Department of the Treasury’s (Treasury) authority to  borrow to finance the decisions enacted by the Congress and the  President. As a result, as the government nears the debt limit, Treasury  often must deviate from its normal cash and debt management operations  and take a number of extraordinary actions such as temporarily  disinvesting securities held as part of federal employees’ retirement plans  to meet the government’s obligations as they come due without exceeding  the debt limit. Once the extraordinary actions are exhausted, Treasury is  not authorized to issue new debt and could be forced to delay payments  for government services or operations until funding is available and could  eventually be forced to default on legal debt obligations.
Since 1995, the statutory debt limit has been increased 12 times to its  current level of $14.294 trillion. Treasury recently notified Congress that  the current debt limit could be reached as early as April 5, 2011, and the  Congressional Budget Office (CBO) projects that, if current laws remain in  place, debt subject to the limit will exceed $25 trillion in 2021. Meanwhile,  GAO’s long-term simulations show that absent policy changes, federal debt  will increase continually over the next several decades. The medium- and  long-term outlook for the federal budget makes an understanding of the  operations and implications of the debt limit important.
GAO has prepared this report under the Comptroller General’s authority to  conduct evaluations on his own initiative as part of a continuing effort to  assist Congress in identifying and addressing debt management  challenges. This report examines the challenges associated with managing  cash and debt near the limit. Specifically, the objectives of this report are  to (1) describe the actions that Treasury has taken to manage debt near  the limit and challenges that arise, (2) analyze the effects that approaching  the debt limit has on the market for Treasury securities, including  Treasury’s borrowing costs, and (3) in light of the disconnect between the  debt limit and the policy decisions that have an effect on the size of federal  debt, describe alternative triggers or mechanisms that would permit  consideration of the link between policy decisions and their effect on debt  when or before decisions are made.
To answer our first objective, we analyzed publicly available data on  Treasury cash and debt transactions from the last 16 years (1995-2010) to  identify factors that could create challenges for Treasury in managing debt  near or at the limit. We reviewed documents provided by Treasury,  interviewed Treasury officials, and obtained estimates of the time and staff  involved in planning for when the debt limit will be reached and related  operations. We conducted a check for reasonableness of these estimates.
To determine what effect approaching the debt limit had on the Treasury  market, we analyzed changes in the size and timing of Treasury auctions  when debt was near or at the limit. Our review generally covered the last  16 years—or as many of those years for which data were readily  available—in order to include both a particularly disruptive debt limit  debate in 1995-1996 that required Treasury to take a number of  extraordinary actions and the most recent debt limit increase. We  interviewed several market participants and observers, including primary  dealers, money market fund managers, and credit rating agencies, to  obtain their views on how the debt limit and the actions Treasury takes to  manage the amount of debt when it is near the debt limit affect the  Treasury market. We analyzed changes in the yields for Treasury securities  before, during, and after five of the debt limit debates in the past 10 years,  including the most recent in 2009-2010, to determine how proximity to the  debt limit affected Treasury’s borrowing costs. See appendix II for more  details on how we estimated increased borrowing costs including  limitations to our analysis.
To identify alternative triggers or other mechanisms, we interviewed  budget and legislative experts including former congressional staff; former  CBO, Office of Management and Budget, and Treasury officials; and other  congressional observers from a range of policy research organizations. We  also reviewed information from select member countries of the  Organisation for Economic Co-operation and Development (OECD) and  received input from budget or debt office representatives from Canada,  Denmark, New Zealand, Sweden, Switzerland, and the United Kingdom  about mechanisms used in their countries to manage aggregate levels of  debt. We selected these countries based on a review of relevant reports  and other information published by the OECD and International Monetary  Fund (IMF). While selected countries offer illustrative examples, their  experiences are not always applicable to the United States given  differences in political systems and economies.
To assess the reliability of the data used in this report, including financial  markets data downloaded from Thomson Reuters’ proprietary statistical  database, Datastream, and IHS Global Insight and publicly available data  from Treasury and the Federal Reserve, we examined the data to look for  outliers and anomalies and, when possible, compared data from multiple  sources for consistency. In general, we chose databases that were  commonly used by Treasury and researchers to monitor changes in federal  debt and related transactions. On the basis of our assessment we believe  the data are sufficiently reliable for the purpose of this review.
We conducted our work from December 2009 to January 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
subsections: section_title: Background
paragraphs: Congress and the President first enacted a statutory limit on federal debt  during World War I to eliminate the need for Congress to approve each  new debt issuance and provide Treasury with greater discretion over how  it finances the government’s day-to-day borrowing needs. Federal debt  subject to the limit includes both debt held by the public and debt held by  government accounts (intragovernmental debt holdings). The majority of  debt held by the public consists of marketable Treasury securities, such as  bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS), that  are sold through auctions and can be resold by whoever owns them.  Treasury also issues a smaller amount of nonmarketable securities, such  as savings securities and special securities for state and local  governments. Debt held by the public primarily represents the amount the  federal government has borrowed to finance cumulative cash deficits.  Intragovernmental debt holdings represent balances of Treasury securities  held in government accounts such as the Social Security trust funds. It  increases when these accounts run a surplus or accrue interest on existing  securities. Debt subject to the limit increased from roughly $43 billion in  1940 to more than $13,000 billion (or $13 trillion) in 2010.
In the past, Congress has sought to link decisions about the level of debt to  those about the level of federal spending and revenue by integrating  changes to the debt limit into the larger budget process. For example, the  Congressional Budget Act of 1974 requires that Congress include the levels  of debt implied by the spending and revenue levels in the budget  resolution for the next 5 years and allows for specific estimates of the  increase in debt subject to the limit. Until recently, the House of  Representatives had a rule that automatically generated a joint resolution  considered to have been passed in the House changing the debt limit by  the amount recommended in the budget resolution for the next fiscal  year. The Congressional Budget Act as amended also established an  alternative procedure for changing the debt limit through reconciliation  legislation that is subject to expedited procedures. Despite these rules and  procedures, Congress usually votes on the debt limit after fiscal policy  decisions affecting federal borrowing have begun to take effect.
Debt limit increases frequently involve protracted debate, regardless of  prior votes on the budget resolution or other legislation that increases the  need to borrow. This debate often occurs when federal debt is near or at  the debt limit. Three pieces of legislation enacted to respond to the  financial market crisis and economic downturn are recent exceptions—in  each of these the debt limit was increased by roughly the amount the  legislation was expected to increase debt. For example, in addition to  spending and revenue provisions, the American Recovery and  Reinvestment Act of 2009 (Recovery Act) increased the debt limit by $789  billion from $11,315 billion to $12,104 billion. Federal debt at the time of  enactment was more than $600 billion below the limit.
Treasury’s normal cash management operations involve ensuring that  there is enough cash on hand to pay government obligations as they come  due. Treasury has two primary sources of funds to finance these  obligations: (1) revenue collections, such as federal tax revenues and  other fees the federal government imposes and (2) cash borrowed from  the public through auctions of marketable securities. One of Treasury’s  goals is to finance the government’s borrowing needs at the lowest cost  over time by, among other things, issuing a wide range of securities in a  regular and predictable pattern. Treasury currently issues bills that  mature in a year or less, notes with maturities of 2 to 10 years, and bonds  with maturities of greater than 10 years. Treasury also issues 5-year, 10- year, and 30-year TIPS, which offer inflation protection to investors who  are willing to pay a premium for this protection in the form of lower  interest rates. Treasury does not “time the market”—or seek to take  advantage of low interest rates—when it issues securities. Instead,  Treasury strives to lower its borrowing costs over time by relying on a  regular preannounced schedule of auctions.
Treasury holds cash in its operating cash balance in an account at the  Federal Reserve and in accounts at depository institutions across the  country. Treasury can draw down its operating cash balance as debt  approaches the limit, which allows Treasury to temporarily make  payments without increasing the amount of debt subject to the limit.
However, cash balances in its account at the Federal Reserve must be kept  at a sufficient level to avoid overdrawing this account since the Federal  Reserve System cannot legally lend directly to the Treasury.
The issuance of cash management bills (CM bills) provides another way  for Treasury to manage more closely the amount of additional debt subject  to the limit. CM bills are flexible securities that Treasury issues outside of  its regular preannounced auction schedule. Treasury sets the amount and  time to maturity to meet its immediate borrowing needs at the time.  Issuing CM bills allows Treasury to borrow cash for shorter periods than  regular bills to help manage the uncertainty around the timing of increases  to the debt limit. However, our past work showed that Treasury paid a  premium, in the form of higher yields, for CM bills relative to regular bills.
There are also a number of extraordinary actions currently available to  Treasury to avoid exceeding the debt limit. These actions reduce  uncertainty over future increases in debt subject to the limit or reduce the  amount of debt subject to the limit. Table 1 provides an overview of each  one. Two of these actions relate to the Civil Service Retirement and  Disability Fund (CSRDF), which is the trust fund for two federal  retirement plans that hold nonmarketable securities. To take these  actions, Treasury must declare in advance a debt issuance suspension  period (DISP)—a period in which Treasury determines that it cannot issue  debt without exceeding the debt limit. Another four actions can be taken  without first declaring a DISP.
Since 1995, the debt limit has been increased 12 times. Prior to 6 of these,  Treasury had to take one or more extraordinary actions to avoid  exceeding the debt limit. Figure 1 shows when the debt limit was  increased and the extraordinary actions that were used.
Prior to five of the six debt limit increases between 1996 and 2006,  Treasury took extraordinary actions, including declaring a DISP.
During the period immediately preceding the debt limit increase in August  1997, Treasury did not take any extraordinary actions.
The federal government ran budget surpluses in fiscal years 1998 through  2001. Debt subject to the limit increased by $293 billion during this period,  but no increases to the debt limit were required.
During the period immediately preceding the debt limit increase in  September 2007, Treasury suspended the issuance of SLGS but did not  take any other extraordinary actions or declare a DISP.  In 2008 and 2009, three laws that were expected to increase the amount of  debt held by the public included corresponding increases in the debt limit  at the time of enactment.  In December 2009 and February 2010, Treasury avoided taking  extraordinary actions as debt approached the limit in part by allowing the  Treasury securities it issued for the Supplementary Financing Program  (SFP)—a temporary program begun in 2008 at the request of the Federal  Reserve to drain reserves from the banking system and assist with its  emergency liquidity and lending initiatives—to mature without rolling  them over.
If debt is at the limit and the extraordinary actions are exhausted,  Treasury may not issue debt without further action from Congress and  could be forced to delay payments until sufficient funds become available.  In the past, Congress and the Secretary of the Treasury have taken  additional actions beyond those described above when necessary to  ensure that the government paid its obligations as they came due without  breaching the debt limit. For example, in 1996, Congress passed and the  President signed legislation allowing Treasury to issue securities  temporarily excluded from the debt limit in an amount equal to the March  1996 Social Security payments to ensure that benefit payments were made  on time.
Treasury has never been unable to pay interest or principal on debt held  by the public because of the debt limit. Treasury, credit rating agencies,  and others agree that failure to pay principal or interest on Treasury  securities because of the debt limit could have costly consequences for the  U.S. government and financial markets including higher future borrowing  costs for Treasury and the public; stress on the value of the dollar in  currency markets; and major disruptions in capital markets due to the  repricing of products, services, and transactions dependent on an  efficiently functioning Treasury market.
section_title: Increased Borrowing and Limited Borrowing Capacity Provided by Extraordinary Actions Create Debt Management Challenges
subsections: section_title: Extraordinary Actions Provide Less Borrowing Capacity Relative to Borrowing Needs Than They Did in the Past
paragraphs: The borrowing capacity provided by the extraordinary actions has grown  in size but has not kept pace with the growth in Treasury’s borrowing  needs. The amount potentially provided by the extraordinary actions for a  1-month DISP in fiscal year 2010 was less than the monthly increase in  debt subject to the limit for most months of the year. As of August 31,  2010, the extraordinary actions available to Treasury could provide about  $147.5 billion in additional borrowing capacity without a DISP and an  additional $7.7 billion per month based on the length of the DISP declared.  As table 2 shows, the amounts available from suspending G-Fund  investments, suspending ESF investments and the disinvestment of  CSRDF funds have all grown—with the bulk of the growth in the G-Fund.  G-Fund growth results from an increase in federal employee retirement  funds being invested in Treasury securities. However, the estimated total  borrowing capacity provided by extraordinary actions available without a  DISP is still $15 billion below Treasury’s average monthly borrowing needs  in fiscal year 2010, which was over $162 billion, and only 44 percent of the  largest single monthly increase in debt subject to the limit, which was over  $330 billion. Treasury officials stated that there are no additional  extraordinary actions within their legal authorities that could be prudently  used in the future to create additional borrowing capacity.
Some of the options used in the past are either more limited or no longer  available. FFB has the authority to issue up to $15 billion in securities that  are not subject to the debt limit that it can exchange for other Treasury  securities to reduce the amount of debt subject to the limit. However,  some or all of these FFB securities may be outstanding from previous  transactions, including those made to manage the amount of debt subject  to the limit in the past, and therefore unavailable. For example, as of  August 31, 2010, the exchange of FFB securities for other Treasury  securities could provide less than $5 billion in additional borrowing  capacity under the debt limit. In the past, FFB reversed these transactions  by redeeming FFB 9(a) obligations prior to maturity once the debt limit  was raised. However, Treasury officials said they no longer reverse these  transactions because of the potential costs FFB and its counterparties  could incur as a result. Also, until March 2004, Treasury kept  “compensating balances” in non-interest-bearing accounts at banks to  compensate them for collecting federal receipts for the Treasury. This  allowed Treasury to call back tens of billions of dollars when needed to  pay obligations and avoid breaching the debt limit. Since these  compensating balances were replaced in March 2004 by direct payment to  banks for services, this option is no longer available.
Assuming current borrowing trends, our estimates show that the  borrowing capacity provided by the extraordinary actions would be  sufficient to meet the government’s borrowing needs for as little as a few  days to a few weeks during certain times of the year. This means that once  debt approaches the debt limit, Treasury may not be able to manage the  amount of debt subject to the limit for as long a period of time as it had in  the past before the debt limit must be increased or payments must be  delayed. Figure 2 below shows the estimated borrowing capacity provided  by these actions for a 1-month DISP relative to the monthly change in debt  subject to the limit for fiscal year 2010 and 3 previous fiscal years in which  Treasury took extraordinary actions. The amount potentially provided by  the extraordinary actions for a 1-month DISP in fiscal year 2010 was less  than the monthly increase in debt subject to the limit in 8 of the 12 months.  In contrast, in earlier years, the potential borrowing capacity provided by  the extraordinary actions was greater than the monthly increase in debt  subject to the limit in almost all months.
The actions available without declaration of a DISP could potentially  provide $147.5 billion (as of Aug. 31, 2010), but the amount of time that  these actions provide before debt reaches the limit depends on a number  of factors. For instance, debt subject to the limit increases sharply certain  days of the year. Treasury makes semiannual interest payments on a large  amount of debt held in government accounts on the last day of June and  December. During the recent debt limit debate in early fiscal year 2010,  debt increased by more than $165 billion in a single day—December 31— because of $81 billion in net nonmarketable securities issuances, including  interest payments to government accounts, as well as $84 billion in net  marketable securities issuances.
Another factor that determines the amount of time that Treasury is able to  manage debt near the debt limit is the size of Treasury’s operating cash  balance. Treasury can draw down its operating cash balance to pay  obligations rather than increase borrowing. While the size of Treasury’s  operating cash balance routinely fluctuates throughout the year depending  on the timing of withdrawals and deposits, table 3 shows that Treasury’s  average operating cash balance was roughly twice as high in fiscal year  2009 and fiscal year 2010 as it was in the previous 6 fiscal years. From  December 15, 2009, to February 11, 2010, when debt was approaching the  debt limit, Treasury’s operating cash balance (excluding the SFP account  balance) rarely fell below $90 billion. Higher cash balances helped ensure  that Treasury had enough cash available to make large disbursements on  short notice. Treasury officials explained that higher cash balances were  not related to the debt limit but rather to regular and predictable financing  patterns coupled with large receipts and expenditures related to the  Troubled Asset Relief Program (TARP), Recovery Act, and other  legislation to address the financial crisis and the economic downturn.
The amount of additional borrowing capacity provided by disinvesting  CSRDF securities depends on the length of the DISP declared by the  Secretary. For past DISPs, the Secretary determined the amount of  disinvestments based on the length of the DISP and the estimated monthly  CSRDF benefit payments that would occur during this time. For example,  Treasury declared a DISP from May 16 to June 28, 2002, and disinvested  about $4 billion in Treasury securities held by the CSRDF. This amount  was roughly equal to the amount that would have been needed to make 1  month’s worth of Civil Service benefit payments. Similarly, Treasury  declared a 12-month DISP in November 1995 and disinvested $39.8 billion  in Treasury securities held by the CSRDF, roughly the equivalent of 12  months’ worth of benefit payments. The statute does not require that  disinvestments be made only for the purpose of making CSRDF benefit  payments. However, Treasury cannot disinvest additional securities later  to make those benefit payments. As a result, the amount provided by the  CSRDF declines over the period of the DISP. In the past 16 years, the  Secretary of the Treasury declared DISPs ranging from 14 days to 14  months. The period of time between the declaration of a DISP and the  debt limit increase ranged from 1 day to 4-½ months.
section_title: Treasury Diverts Resources from Other Priorities to Manage Debt near the Limit
paragraphs: Debt and cash management require more time and Treasury resources as  debt nears the debt limit. The size and timing of auctions must be adjusted  when nearing the debt limit; cash and borrowing needs must be forecasted  and monitored with increasing frequency and in increasing detail; and  contingency plans and alternative scenarios for the possible  implementation of extraordinary actions must be developed, reviewed,  and tested. These activities divert time and Treasury resources from other  cash and debt management issues. We reviewed estimates provided by the  Office of Debt Management (ODM), the Office of Fiscal Projections (OFP),  and the Bureau of the Public Debt (BPD) that overall indicated they  devoted as much as several hundred hours per week to managing debt  near the debt limit.
Treasury’s operational focus on the debt limit begins as early as 6 to 9  months before the debt limit is expected to be reached and increases as  debt nears the limit. Since this work involves contingency planning, it is  undertaken whether or not the debt limit is raised prior to the use of  extraordinary actions or the declaration of a DISP. For example, Treasury  staff develop projections under multiple scenarios of when debt might  reach the debt limit. As debt nears the debt limit, these projections and  scenarios are developed weekly, then daily, and finally as often as multiple  times a day. According to Treasury, these projections and scenarios may  take 3 of OFP’s 11 staff members between 2 to 4 hours per day to produce.
While Treasury needs accurate cash-flow forecasts to project changes in  the amount of debt subject to the limit, the precision and frequency  increases when debt is near or at the limit. While large regular and  predictable payments and receipts—such as Medicare and Social Security  payments and receipts from corporate taxes—cause predictable swings in  daily deposits and withdrawals, an official from OFP said that it was  uncertainty about other revenue and irregular payments that made  planning and forecasting more difficult as debt approached the debt limit  in fiscal year 2010. For example, as figure 3 shows, Treasury received an  influx of repayments of more than $90 billion from financial institutions  under TARP in December 2009. However, since Treasury did not know for  certain when these payments would be received, Treasury officials ran  multiple projections of when the debt limit would be reached.
Treasury uses the projections of debt subject to the limit not only for  operational scenarios but also in meetings to inform senior Treasury  officials—including the Secretary. These meetings also increase in  frequency from monthly to as often as daily as debt approaches the limit.  The meetings, which have included 10 or more executives and senior  career staff, are used to discuss strategies for managing debt near the debt  limit including the potential use of extraordinary actions. According to  Treasury, these meetings can require several hours of preparation. While  Treasury officials and staff can draw on previous experiences managing  debt near the debt limit, they told us that each debt limit event presents  new and different issues to be considered and addressed; in addition, there  are often senior officials who have not been through the experience and  must be fully briefed and prepared.
BPD—the bureau within Treasury that is responsible for implementing the  extraordinary actions and the accounting associated with those  transactions—also dedicates extensive resources on operations related to  the debt limit. BPD estimates that a 2-month DISP results in roughly 1,900  hours of work including the time spent before, during, and after the debt  limit increase. This includes more than 400 hours in the 6 weeks prior to  the implementation of any extraordinary actions spent on meetings to  prepare for when the debt limit is reached, preparation of parallel  accounts and spreadsheets in the event that extraordinary actions  involving the G-Fund and CSRDF are used, tests of the accounting system,  and a mock auction to practice and verify procedures for potential auction  postponements. BPD also estimates that it spends in excess of 140 hours  on debt limit–related activities each week once the first extraordinary  action is taken, and over 270 hours on activities such as unwinding past  transactions and preparing reports after the debt limit has been increased.  The increased workload could result in overtime hours for BPD  employees.
Treasury officials said that the increased focus on debt limit–related  operations in the months and weeks approaching the debt limit can divert  time and attention from other tasks that could improve Treasury  operations. For example, according to Treasury, OFP is able to spend less  time working to update or improve the models it uses in routine  forecasting of tax receipts, expenditures, and borrowing needs. Similarly,  Treasury officials said that ODM is able to spend less time analyzing short- term financing needs that could help inform auction amounts. Both of  these activities help Treasury more accurately project future borrowing  needs to avoid the following:  (1) Borrowing more than is needed to fund the government’s immediate  needs, which results in increased interest costs.  (2) Borrowing less than is sufficient to maintain Treasury’s operating cash  balance at a minimum level through regularly scheduled issuances of  marketable Treasury securities. This may require Treasury to issue CM  bills with little advance notice to the market, resulting in potentially higher  interest costs for the federal government.
section_title: Approaching the Debt Limit Can Add Uncertainty in the Treasury Market
subsections: section_title: Postponed Auctions and Other Disruptions May Lead to Increased Borrowing Costs
paragraphs: Some of the actions Treasury takes to manage the amount of debt as it  approaches the debt limit disrupt the regular and predictable auction  schedule that Treasury relies on to promote liquid markets and finance the  government’s borrowing needs at the lowest cost over time. Regular and  predictable auctions provide investors greater certainty and better  information with which to plan their investments. Meanwhile, a liquid  market allows investors to more easily buy and sell Treasury securities in  the secondary market. Market participants that we spoke with said that  any actions that Treasury takes to manage debt as it approaches the limit  that cause Treasury to deviate from its otherwise regular and predictable  schedule or reduce liquidity introduce uncertainty into the Treasury  market and have the potential to increase Treasury’s borrowing costs.
Since 1995, Treasury delayed the announcement of 17 regularly scheduled  auctions by 1-½ hours to 7 business days and postponed the auction date  for 11 auctions by as many as 8 business days (see table 4). Treasury also  reduced the offering size of a 13-week bill by $7 billion after the initial  auction announcement in October 1995 in order to stay under the debt  limit. These actions introduced uncertainty into the market for Treasury  securities, and in some circumstances may have increased borrowing  costs.
Treasury officials and market participants both stated that postponing the  announcement or auction of longer-dated securities such as notes and  bonds is more disruptive to the Treasury market than postponing shorter- dated securities such as bills. This is due in part to the fact that dealers  generally require additional time to work with customers and secure  financing for note and bond auctions. There is generally about a week  between the announcement of a note auction and the actual auction. The  announcement of a 2-year note auction was delayed 7 business days in  2002, reducing the time that dealers had to prepare bids from 5 business  days to less than 1. This auction had the lowest bid-to-cover ratio—the  ratio of dollar value of bids at auction to the amount accepted—for any 2- year note auction since these data began to be recorded in 1998. It is  difficult to say with certainty how much in additional interest Treasury  paid because of the postponement of this auction. Based on one estimate  that assumes that the rate on the note would have been roughly equal to  the constant maturity rate, or the closing rate on actively traded Treasury  securities maturing at the same time on the day that the auction actually  took place, Treasury paid an additional 7 basis points—or 0.07 percentage  points—on the $27 billion in 2-year notes issued that day. This equals  almost $19 million in additional interest costs each year. Based on an  alternative estimate that assumes that Treasury would have received the  prevailing interest rate on 2-year notes in the secondary market on the day  that the auction was originally scheduled to take place, the increased  interest costs would be even greater.
The level of disruption resulting from a postponed auction depends in part  on how early Treasury forewarns the market. Unlike the 2-year note  auction in 2002, Treasury discussed the prospect of postponing a 3-year  note and a 10-year note auction with members of the Treasury Borrowing  Committee at its regular committee meeting a week before the original  auction date and released the auction announcement a week before the  postponed auction took place. The yields at the subsequent auctions on  November 20 and 21, 1995 were roughly the same as the constant maturity  rate for each maturity on the day of the auction.
Auctions that are postponed beyond the maturity date of a previously  issued security can cause significant disruptions. Treasury generally  makes the actual exchange of Treasury securities for cash—the  settlement—a few days or more after the auction. Settlements frequently  occur around the same time that previously issued securities are maturing.  This allows Treasury to refund maturing securities—to use some or all of  the cash that it raised in the auction to redeem maturing securities. It also  allows investors to easily roll over, or reinvest, cash received from  maturing securities in newly issued securities. Treasury stated that when  the settlement date of a new security is moved past the maturity date of a  previously issued security, investors are unable to rollover their  investments in a timely way. As a result, they may choose to invest in a  financial instrument other than Treasury securities. This could affect  auction demand. Most of the postponed auctions in the past 16 years were  delayed by only 1 to 3 days and therefore did not affect the refunding of  maturing securities. However, in November 1995, the 3- and 10-year note  auctions intended to refund notes maturing on November 15, 1995, were  postponed past the maturity date. In this instance, Treasury bridged the  gap between the maturity and settlement date by auctioning a short-term  CM bill.
Overall, Treasury issued 20 CM bills totaling more than $300 billion during  DISPs in the past 16 years to manage the amount of debt near the limit. In  some cases, these were used to augment Treasury’s regular schedule of  bill auctions. For example, because of debt limit constraints, Treasury  delayed the 4-week bill auction scheduled for November 16, 2004.  Treasury then auctioned a 5-day CM bill for $7 billion on November 17,  2004. As mentioned previously, our prior work found that Treasury may  have paid a premium, in the form of higher interest, on these CM bills  compared to bills of a similar maturity.
section_title: Treasury Sharply Reduced the Supply of Bills during Recent Debt Limit Debate
paragraphs: While Treasury did not postpone any of its regularly scheduled auctions  during the most recent debt limit debate, it sharply reduced the total dollar  amount of bills outstanding primarily to manage the amount of debt as it  approached the limit. The total amount of Treasury bills outstanding  dropped by $350 billion (or about 17 percent) from September 23, 2009, to  February 12, 2010, (see fig. 4). Roughly $200 billion of this was related to  reductions to the SFP. The decline in Treasury bills outstanding was  accompanied by a decline in short-term rates paid by Treasury. However,  Treasury officials and market participants stated that a sharp and irregular  bill reduction in such a short period of time could affect liquidity in the  near term and add uncertainty in the market over the longer term. While  several different types of investors use bills to invest their funds in the  short term in a safe and highly liquid asset, market participants we spoke  with said that money market funds were likely most affected by the  reduction in bill supply. Market participants also noted that if Treasury  had to make similar reductions to its issuance of notes or bonds because  of proximity to the debt limit, the effect on the Treasury market would be  greater.
This sharp reduction in Treasury bills was unique to this most-recent debt  limit debate and largely related to the SFP, though large TARP repayments  in December, a reduction in Treasury’s operating cash balance, and the  transition to longer-dated securities were also factors. When Treasury  approached the debt limit earlier in the decade, the amount of Treasury  bills outstanding tended to fluctuate within a narrower range. To finance  the SFP program, Treasury auctions a series of CM bills, and places the  proceeds in a special account at the Federal Reserve Bank of New York.  These outstanding CM bills count against the debt limit. On September 16,  2009, Treasury announced it intended to reduce the SFP account from  $200 billion to $15 billion to preserve flexibility in debt management. This  amount dropped to as low as zero in December 2009. As late as February  2, 2010, Treasury announced that both the outlook for Treasury bills  issuance and the future of the SFP were uncertain. Shortly after the debt  limit was raised on February 12, 2010, Treasury returned the SFP account  to approximately $200 billion.
section_title: Evidence Suggests Borrowing Costs Increased during Some Debt Limit Event Periods
paragraphs: Our analysis suggests that the general uncertainty surrounding some debt  limit events including the most recent in 2009-2010 increased Treasury’s  borrowing costs in the months immediately prior to a debt limit increase.  To measure changes in Treasury’s borrowing costs, we examined the  spread between 13-week (i.e., 3-month) Treasury bill yields and 3-month  commercial paper yields around debt limit events since 2001. Rates for  Treasury bills, commercial paper, and other financial assets can fluctuate  from day to day in response to changes in the broader economy. By  focusing on a yield spread rather than changes in individual interest rates,  we are able to better measure changes in the relative risk of 3-month  Treasury bills and identify potential risk premiums. A narrowing of the  spread indicates that the market perceives the risk of Treasury bills to be  closer to that of commercial paper, while a widening of this spread means  that Treasury bills are perceived to be less risky relative to commercial  paper. We found that Treasury paid a premium on 3-month Treasury bills  issued during debt limit events in 2001–2002 and 2002–2003, but not in  2004–2005 and 2005–2006. For the most-recent debt limit event—which  lasted from August 7, 2009, to February 12, 2010—we found that Treasury  again paid a premium on 3-month Treasury bills. Figure 5 shows that the  average spread narrowed during the debt limit event in 2009–2010  compared to the average for the proceeding 3 months, implying that  Treasury paid a premium on 3-month Treasury bills issued during this time  period.
After controlling for other factors that could have affected the yield  spread, such as economic uncertainty and liquidity in the bill market, we  estimated that the debt limit added a premium of about 4 basis points  during the debt limit event period in 2009–2010. Applying this premium to  all 3-month Treasury bills issued during this period, we estimate that  Treasury paid $78 million in additional borrowing costs as a result of the  debt limit. We did not estimate the effects of nearing the debt limit on  yields of other Treasury securities, and therefore, do not know whether a  premium of the same size would apply to Treasury securities with longer  or shorter terms to maturity. However, even a smaller premium on the  large amount of Treasury securities issued during the debt limit event  period would result in a notable increase in borrowing costs. For instance,  for each additional basis point paid on bills issued during the 2009–2010  debt limit event period, Treasury’s borrowing cost would increase by  roughly $92 million. For more information on our statistical analysis,  including a discussion of the limitations, see appendix II.
Trends in U.S. credit default swap (CDS) premia, or “spreads” also suggest  that Treasury securities were perceived to be relatively more risky as debt  approached the limit in 2009-2010. While CDS are used in a variety of ways  other than to insure against a default, such as hedging against  counterparty risk, or the risk that another party will not fulfill its  contractual obligation, CDS spreads serve as an indicator of changes in the  market’s perception of risk in the Treasury market. U.S. CDS spreads  increase when risk in the Treasury market increases and therefore have an  inverse relationship to the yield spread. Not long after Treasury notified  Congress that the debt limit would need to be raised and Treasury began  reducing issuance of CM bills for the SFP, rates for 1-year U.S. CDS  spreads increased while the yield spread trend decreased (see fig. 6).  Similarly, in the weeks after the debt limit was raised, U.S. CDS spreads  decreased sharply. Some of the increase in U.S. CDS spreads likely reflects  general uncertainty about the global economy rather than the debt limit;  CDS spreads increased from late 2009 to early 2010 for other countries,  not just for the United States. However, 1-year U.S. CDS spreads tended to  increase more than comparable spreads for Germany, Japan, and the  United Kingdom during the event period.
Overall, the debt limit requires Treasury to deviate from its regular debt  management practices in ways that add uncertainty to the Treasury  market. While there are limitations to our analysis of changes to the  auction schedule and to Treasury yields around debt limit events,  collectively the analyses provide strong evidence that this uncertainty  does not come without a cost.
Beyond the immediate costs associated with the debt limit, some market  participants and others that we spoke with said that failing to raise the  debt limit in a timely manner added an additional level of risk to the  Treasury market. As noted above, the extraordinary actions provide less  borrowing capacity and therefore less time for debate about raising the  debt limit once debt reaches the limit than they have in the past. Analysts  and observers—including former congressional staff—expressed concern  that a miscalculation in when the debt limit needs to be increased by could  trigger a financial crisis in the Treasury market. Despite these concerns,  most of those whom we spoke with believe that Congress will raise the  debt limit before there is a significant market disruption and that Treasury  will continue to successfully manage debt near the debt limit as it has  done in the past. Treasury continues to consistently borrow at relatively  low interest rates, and demand for Treasury securities both in the United  States and abroad remains strong during periods of economic instability  because of their liquidity and low risk.
section_title: Experts and Practices of Other Countries Offer Insights for Better Linking Policy Decisions with Their Effect on Debt
subsections: section_title: Tying Debt Limit Increases to Annual Budget Decisions Is Similar to a Practice Used in Some Other Countries
paragraphs: We spoke with participants, observers, analysts, and other experts  representing a range of backgrounds and political perspectives—including  former congressional staff, former CBO Directors, former Treasury  officials, and representatives from credit rating agencies—about the role  of the debt limit in the U.S. budget process. Many cited the failure to link  fiscal policy decisions to changes in the debt limit as a weakness in the  process. Credit rating agencies, for example, consider a number of  different factors when assigning a credit rating to sovereign nations’ debt,  including the strength of the national economy, overall levels of  government debt, and monetary policy, as well as the budgetary  framework. While the debt limit has not compromised the United States’  AAA credit rating, credit rating agencies expressed concern about  separating the vote for spending increases and revenue decreases that  increase debt from the vote for additional borrowing authority. One credit  rating agency described this delinking as a weakness in the U.S. budgetary  framework. Another credit rating agency said that anything that has the  potential to delay the timely redemption of federal debt is viewed as a  negative. In 1996, Moody’s Investors Service (Moody’s) indicated a  possible downgrade for some Treasury securities with interest payments  coming due in part because Treasury had nearly exhausted its options for  managing debt near the debt limit. According to Moody’s this was the only  time that Moody’s has officially taken a negative rating action related to  U.S. Treasury securities. None of the experts that we spoke with said that  the existence of the debt limit served to restrain spending and tax  decisions prior to the debt limit debate, but some believe the debt limit has  served a useful purpose in highlighting the growth of federal debt.
Many of the experts that we spoke with identified possible changes to the  legislative process that would better link decisions about fiscal policy and  debt. Some suggested that since the budget resolution reflects aggregate  fiscal policy decisions, it should be used to consider the level of debt  implied by those decisions. The budget resolution generally sets out the  level for spending, revenues, and debt for the next fiscal year and the  following 4 fiscal years. Some favored a mechanism similar to what was  House Rule XXVIII in the 111th Congress. This rule provided for the  automatic engrossment and transmittal to the Senate of a joint resolution  changing the debt limit by the amount specified in the budget resolution.  This joint resolution was considered to have passed the House and was  then sent to the Senate. The Senate did not have a similar rule; it  sometimes, though not always, passed the joint resolution from the House,  albeit with a lag. In the last 16 years, this lag has ranged from 1 month to  more than 10 months. Others believed that this process still gave too little  visibility to the implications of spending and tax decisions on federal debt  and preferred separate votes on stand-alone legislation. They too believed  that the vote should be timed to go with the budget resolution—in part to  keep the link and in part to avoid reaching the debt limit later in the year  after the spending and tax decisions had been made.
Opinions varied on how to address increases in borrowing needs not  contemplated in budget resolutions. The actual amount of debt can differ  from the amount anticipated in the budget resolution because of newly  enacted legislation or because of the automatic stabilizers through which  changes in the economy affect government spending and revenue. Some  supported a formal or informal process whereby any legislation that would  increase debt beyond that envisioned in the resolution would contain a  separate title raising the debt limit by the appropriate amount. Congress  took this approach with three pieces of legislation enacted in 2008 and  2009 in response to the financial market crisis and economic downturn.  The Housing and Economic Recovery Act of 2008, the Emergency  Economic Stabilization Act of 2008, and the Recovery Act each included a  separate provision increasing the debt limit. Some congressional observers  pointed out that while this would tie spending and revenue decisions to  the debt-level effect of those decisions, it would not address increases in  debt arising from an economic downturn. Some of the ideas for dealing  with both the policy linkage and any increases in debt driven by economic  conditions were (1) considering further changes to the debt limit at the  time that the annual mid-session review is released; (2) setting aside a  reserve fund in the budget resolution for unanticipated borrowing needs;  and (3) delegating additional authority to Treasury to borrow for intrayear  financing needs that resulted from changes in the economy rather than  direct policy decisions.
The practice of approving borrowing authority in connection with  approval of the annual budget is used in other countries we examined. For  example, in Canada, the Ministry of Finance is provided with a fixed  amount that it is authorized to borrow for the fiscal year. When necessary,  the Ministry of Finance can request increased borrowing authority from  the executive branch of government to fund unforeseen borrowing needs.  In Sweden, the legislature approves borrowing authority annually;  however, it is limited to purpose—to finance current deficits, provide  loans, and redeem national debt, for example—rather than by amount.
section_title: Some Suggested Delegating Broader Authority to Treasury—a Practice Used in Some Other Countries
paragraphs: Some budget experts and a former Treasury official said that Congress  could delegate authority to Treasury to borrow as needed to fund  congressionally approved expenditures subject to a periodic review. They  suggested that Congress could vote to renew this authority at the start of a  new Congress or a new legislative session. This would preserve Congress’s  ability to have periodic debates over the current path of federal debt, they  argue, but change the trigger for debate from proximity to the debt limit to  another point in the legislative process to minimize disruptions to debt  management and the Treasury market.
Providing finance departments with broad authority to borrow is  consistent with practices in four of the countries we examined. In the  United Kingdom, for example, the Treasury is given broad authority to  raise money in a manner it “considers expedient for the purpose of  promoting sound monetary conditions.” In New Zealand, the Minister of  Finance is given similarly broad borrowing authority to borrow in the  public interest. However, when comparing borrowing authority across  countries, it is important to recognize that the division of power between  the legislative and executive branches varies among different political  systems. In parliamentary systems, the government is generally formed by  the political party that has the support of the majority of the parliament;  therefore, the interests of the legislative and executive branches are likely  more aligned, making the delegation of borrowing authority more of a  formality and not a subject of extensive deliberation. Of the countries that  we reviewed, only Denmark has a fixed nominal debt limit that is raised  through legislation outside the annual budget process comparable to the  U.S. debt limit. According to a Danish official, the limit is set high enough  that it does not impede debt managers’ ability to issue debt.
Some of those with whom we spoke said that tying delegation of  borrowing authority to a fixed nominal debt limit creates an action-forcing  event that draws attention to the growth in federal debt. They noted that  previous debt limit debates provided opportunities for the Congress and  the President to consider the implications of past fiscal policy decisions on  federal borrowing and sometimes played a role in the enactment of budget  process agreements intended to slow the growth of future federal  borrowing. For example, debt limit increases were passed jointly with  budget controls legislation five times between 1985 and 1997—and again  in February 2010 with the reenactment of a statutory pay-as-you-go, or  PAYGO, rule. Meanwhile, others said that the debate over debt limit  increases played a smaller role in fiscal policy discussions in recent years  than it had in the past and expected that the debt limit would not be  needed to trigger debate over federal borrowing in the future given the  already increasing attention to debt and deficits. In addition, some thought  that risks associated with the debates—such as the potential for Congress  to delay or to miscalculate the timing of a debt limit increase given the  small amount of borrowing capacity provided by the extraordinary  actions—outweighed the benefits.
section_title: Some Countries Have Mechanisms to Increase Attention to or Control over Fiscal Policy Decisions That Lead to an Increase in Debt
paragraphs: The United States is unusual among the countries we reviewed in using  the authorization of additional borrowing authority as an occasion to draw  attention to past fiscal policy decisions. Other countries that we reviewed  generally use fiscal rules or targets to increase attention to or control over  fiscal policy decisions that lead to an increase in debt. Fiscal rules  generally refer to permanent or multiyear constraints on fiscal policy  through simple numerical limits on budgetary aggregates. For example,  Switzerland has adopted a constitutional “debt brake” that places a limit  on expenditures that is equal to the expected revenue for the year adjusted  to reflect the country’s place in the current business cycle. Differences  between estimated and actual numbers are recorded in a separate account  that must by law be reduced if it reaches a certain level. Germany has  adopted a “golden rule” limiting net borrowing to the amount of  investment spending. Germany also approved a constitutional amendment  in 2009 requiring that structural deficits not exceed 0.35 percent of gross  domestic product (GDP)—or very close to balance.
Instead of budget constraints, some countries use debt targets to establish  an acceptable outcome for policymakers to work toward when making  fiscal policy decisions. These can be either statutory requirements or  political commitments by the current government. For example, in part to  keep debt at a sustainable level, Sweden targets a net surplus of 1 percent  of GDP over the course of the business cycle. In New Zealand, the  government is required to maintain debt at a “prudent level” and set  specific short-term and long-term targets for meeting this goal. If the  government deviates from these targets, the Minister of Finance must  explain the approach the government intends to take to return to prudent  levels. Members of the European Union agreed to target a ratio of gross  general government debt to GDP of 60 percent and budget deficits of not  more than 3 percent of GDP. Several nations have struggled to meet these  targets in recent years, raising concerns about the effectiveness of the  current enforcement mechanisms. In general, budget experts and other  observers have noted that the success of fiscal rules depends on effective  enforcement along with a sustained commitment by policymakers and the  public.
Specific fiscal rules and targets used in other countries may not be  appropriate for the United States given differences in the national  economies and political institutions. Nevertheless, some of the fiscal rules  and targets that we reviewed shared some common features that  distinguish them from the U.S. debt limit and offer insights for increasing  attention to or control over fiscal policy decisions that lead to an increase  in debt. These rules and targets  (1) measure debt in relation to the overall size of the economy (e.g., debt- to-GDP ratio),  (2) take into consideration whether the economy is in a period of  expansion or contraction,  (3) provide a near-term or medium-term debt target, as opposed to a  ceiling, for policymakers to work toward.
In recent years, several bipartisan and nonpartisan groups have suggested  the establishment of fiscal rules with one or more of these features in the  United States such as a debt-to-GDP target.
section_title: Conclusions
paragraphs: The debt limit does not control or limit the ability of the federal  government to run deficits or incur obligations. Rather, it is a limit on the  ability to pay bills incurred. The decisions that create the need to borrow  are made separately from—and generally earlier than—the decision about  the debt limit. Debates surrounding the debt limit may raise awareness  about the federal government’s current debt trajectory and also provide  Congress with an opportunity to debate the fiscal policy decisions driving  that trajectory. However, since this debate generally occurs after tax and  spending decisions have been enacted into law, Congress has a narrower  range of options to effect an immediate change to fiscal policy decisions  and hence to federal debt.
Failure to raise the debt limit could lead to serious negative consequences  in the Treasury market and for the ability of the United States to finance  federal debt at the lowest cost over time. Any delay in raising the debt  limit that affects Treasury’s regular and predictable schedule of auctions  can create uncertainty in the Treasury market. So too some of the actions  Treasury takes to manage the amount of debt near the debt limit, such as  reducing the size of auctions, can compromise the certainty of supply that  Treasury relies on to achieve the lowest borrowing cost over time. This  uncertainty can, in turn, raise the cost of financing the federal debt. In  addition, managing debt near the debt limit diverts Treasury’s limited  resources away from other cash and debt management issues at a time  when Treasury already faces significant challenges in lengthening the  average maturity of its debt portfolio, which reduces rollover risk and  uncertainty about future interest payments.
Recently—and for the foreseeable future—Treasury’s actions take place in  the context of rapidly growing federal debt. Treasury’s past success at  managing cash and debt when near or at the debt limit is no guarantee that  it can continue to manage successfully in the future and may be  misleading. Given the size of current and projected borrowing needs, the  extraordinary actions Treasury uses to manage debt near or at the debt  limit will be more limited in coming years. As a result, once debt is at the  debt limit, Congress will likely have less time to debate raising the debt  limit before there are disruptions to government programs and services  and to the Treasury market.
Observers and participants with whom we spoke suggested that improving  the link between the spending and revenue decisions that increase the  need to borrow and changes in the debt limit would improve the situation.  Better alignment could be possible if decisions about the debt level occur  in conjunction with spending and revenue decisions as opposed to the  after-the-fact approach now used. This would help avoid the uncertainty  and disruptions that occur during debates on the debt limit today. It might  also facilitate efforts to change the fiscal path by highlighting the  implications of these spending and revenue decisions on debt. This will be  particularly important in coming years as the federal government  addresses the challenge of unsustainable increases in federal debt.
section_title: Matter for Congressional Consideration
paragraphs: The projections of a growing debt burden have raised concerns both in  Congress and in the public. Well-designed budget processes and metrics  can help as Congress and the President seek to address the federal  government’s long-term fiscal challenge. The current design of the debt  limit does not engender or facilitate debate over specific tax or spending  proposals and their effect on debt. In addition, the uncertainty it creates  can lead to disruptions in the Treasury market and in turn to higher  borrowing costs. To avoid these potential disruptions to the Treasury  market and to help inform the fiscal policy debate in a timely way,  Congress should consider ways to better link decisions about the debt  limit with decisions about spending and revenue. Such a process would  build on the approach used in 2008 and 2009 when Congress passed and  the President signed three laws that were expected to increase borrowing  with a corresponding increase in the debt limit. This report presents a  number of approaches that could serve as a basis for better linking  decisions about spending and revenue with decisions about the debt limit.
section_title: Agency Comments
paragraphs: We requested comments on a draft of this report from the Secretary of the  Treasury. Treasury officials told us they appreciated the in-depth and  careful analysis contained in the report. They also provided technical  comments, which we incorporated as appropriate.
We will send copies of this report to interested congressional committees,  the Secretary of the Treasury, and other interested parties. We will also  make copies available at no charge on the GAO Web site at  http://www.gao.gov.
If you or your staff have any questions about this report, please contact  Susan J. Irving at (202) 512-6806 or irvings@gao.gov or Gary T. Engel at  (202) 512-3406 or engelg@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page   of this report. GAO staff who made major contributions to this report are  listed in appendix III.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to (1) describe the actions that the Department of the  Treasury (Treasury) has taken to manage debt near the debt limit and  challenges that arise, (2) analyze the effects that approaching the debt  limit had on the market for Treasury securities, including Treasury’s  borrowing costs, and (3) in light of the disconnect between the debt limit  and the policy decisions that have an effect on the size of federal debt,  describe alternative triggers or mechanisms that would permit  consideration of the link between policy decisions and the effect on debt  when or before decisions are made.
To answer our first objective, we reviewed Treasury documents and prior  GAO reports describing the actions that Treasury has taken during debt  limit debates since 1995. We used publicly available data including  Treasury’s Monthly Statement of Public Debt and federal investment  account statements to estimate the amount of potential borrowing  capacity these actions could provide in fiscal year 2010 in comparison to  previous years since 2002 in which debt approached the debt limit. To  identify challenges that might arise when managing debt near the debt  limit, we examined publicly available data from the Daily Treasury  Statement to identify trends in federal receipts and expenditures, issuance  and redemption of federal debt, and changes in Treasury’s operating cash  balance. To understand how managing debt near the debt limit affected  agency operations, we reviewed documents provided by Treasury,  interviewed Treasury officials involved in both the decision-making  process and implementation of extraordinary actions, and obtained  estimates when possible of the time and staff involved in planning for  when the debt limit will be reached and implementing the extraordinary  actions. To assess the reasonableness of Treasury estimates, we reviewed  calendar appointments and other supporting documents. However, we did  not obtain sufficient supporting documentation to independently verify  Treasury’s estimates. We were also unable to independently verify the  foregone opportunities that Treasury identified, such as less time to  analyze short-term financing needs, in part because it is difficult to prove  what would happen in the absence of the debt limit event.
To identify the potential effects of approaching the debt limit on the  market for Treasury securities, we reviewed publicly available Treasury  documents such as minutes from meetings of the Treasury Borrowing  Advisory Committee and academic literature, and interviewed Treasury  officials. Our review covered the last 16 years (1995–2010) in order to  include a particularly disruptive debt limit debate in 1995–1996 that  required Treasury to take a number of extraordinary actions, as well as the  most recent debt limit increase. In February 2010, we asked eight market  experts including six primary dealers for their general views on the effects  of delays in raising the debt limit on the market for Treasury securities and  Treasury operations.
On the basis of this initial analysis, we performed the following: (1) We  used press releases, auction announcements, and historical auction data  since 1995 to identify instances when auctions or auction announcements  or both, were delayed as a result of the debt limit. We compared the yields  at postponed auctions with yields on Treasury securities of the same  maturity being sold in the secondary market to estimate the effect of  delaying auctions or auction announcements on Treasury’s borrowing  costs. We discussed our methodology with Treasury officials and staff at  the Federal Reserve Bank of New York and incorporated their suggestions  and feedback when appropriate. (2) We used data provided by Treasury to  analyze changes in the amount of Treasury bills outstanding during debt  limit debates since 2002. (3) We performed a multivariate regression  analysis to estimate the effect of the debt limit on Treasury’s borrowing  costs. See appendix II for more details on our methodology used for  estimating these costs and limitations to our analysis. (4) In August 2010,  we received written or oral responses to a standard questionnaire from  four primary dealers and managers of a large mutual fund asking for their  views on postponed auctions, reductions in bills outstanding, Treasury’s  extraordinary actions, and the general uncertainty related to the timing of  debt limit increases. To obtain a broader perspective on the effects of  approaching the debt limit on financial markets, we also spoke with  representatives from two of the three major rating agencies, a major trade  organization representing securities firms and other financial institutions,  a research and consulting firm for the municipal bond market, and a State  and Local Government Series securities subscriber.
To examine the disconnect between the debt limit and the policy decisions  that have an effect on the size of federal debt, we conducted a literature  review and reviewed the legislative history of laws increasing the debt  limit. We began our review with the debt limit increase enacted on  December 12, 1985, because (1) this was the first in a series of debt limit  increases enacted in legislation containing budget process reforms, and  (2) after 1985, Congress provided Treasury with its current authorities  related to the G-Fund and Civil Service Retirement and Disability Fund  (CSRDF) thereby changing the way in which Treasury manages debt near  or at the debt limit.
To identify and describe alternative triggers or mechanisms that would  permit consideration of the link between policy decisions and the effect on  debt when or before decisions are made, we reviewed articles in academic  journals and reports and other information published by credit rating  agencies and policy research organizations. We conducted semistructured  interviews with budget and legislative experts. To ensure that we captured  a broad range of perspectives, we sought to include a minimum number of  representatives from the following categories: former congressional staff  with experience working for one or more of relevant committees (i.e., the  House Budget Committee, the House Committee on Ways and Means, the  Senate Budget Committee, and the Senate Finance Committee) or senior  party leadership in the House or Senate; former Congressional Budget  Office or Office of Management and Budget Directors; representatives  from a broad range of policy research organizations that focus on issues  related to the federal debt; and academics and other experts on the  legislative process. We interviewed a total of 17 budget and legislative  experts representing one or more of these different categories. Five of  those interviewed also had experience working at Treasury.
To put U.S. practices into perspective, we examined triggers and  mechanisms used by members of the Organisation for Economic Co- operation and Development (OECD)—an international organization  comprised of countries committed to democracy and market-based  economies. To identify countries for review, we analyzed countries’  responses to the 2007 OECD International Database of Budget Practices  and Procedures Survey, particularly questions asking about debt, deficit,  and other fiscal rules used when developing a budget. We selected  countries for further review based on their responses to the survey as well  as our review of reports by the OECD and the International Monetary  Fund. We sought to include countries that provided a range of different  mechanisms for (1) monitoring or controlling debt and (2) delegating  borrowing authority from their legislature to debt managers. Our selection  was limited to those countries with information on fiscal rules and  borrowing authority available in English. We chose seven countries for  further review: Canada, Denmark, Germany, New Zealand, Switzerland,  Sweden, and the United Kingdom. We contacted representatives from  budget offices, debt management offices, or supreme audit institutions in  each of these countries for additional information on their respective  country’s fiscal rules and borrowing authority. While selected countries  offer illustrative examples, their experiences are not always applicable to  the United States given differences in political systems and economies.
In order to assess the reliability of the data used in this report, including  proprietary data from Datastream and IHS Global Insight and publicly  available data from Treasury and the Federal Reserve, we examined the  data to look for outliers and anomalies and, when possible, compared data  from multiple sources for consistency. In general, we chose databases that  were commonly used by Treasury and researchers to monitor changes in  federal debt and related transactions. Where possible and appropriate, we  corroborated the results of our data analysis with other sources. On the  basis of our assessment, we believe the data are reliable for the purpose of  this review.
We conducted our work from December 2009 to January 2011 in  accordance with generally accepted government auditing standards. Those  standards require that we plan and perform the audit to obtain sufficient,  appropriate evidence to provide a reasonable basis for our findings and  conclusions based on our audit objectives. We believe that the evidence  obtained provides a reasonable basis for our findings and conclusions  based on our audit objectives.
section_title: Appendix II: Detailed Methodology and Findings of Statistical Analysis of Treasury Borrowing Costs near the Debt Limit
paragraphs: To measure changes in the Department of the Treasury’s (Treasury)  borrowing costs when debt is approaching the debt limit, we performed a  multivariate regression analysis of yields paid on 13-week (i.e., 3-month)  Treasury bills issued during the five debt limit events beginning in fiscal  year 2002. For our purposes, a debt limit event begins when the Secretary  notifies Congress that the debt limit needs to be raised and ends when  legislation increasing the debt limit is signed into law. The dependent  variable in our analysis is the spread, or difference, between yields on 3- month Treasury bills and yields on 3-month commercial paper. We used  yield spreads during the preevent period 3 months prior to the Secretary’s  letter as a benchmark against which yields during the event can be  compared. A narrowing of the spread indicates that the market perceives  the relative risk of Treasury bills to be closer to that of commercial paper,  increasing their cost to Treasury. Conversely, a widening of the spread  indicates that the market perceives the relative risk of Treasury bills to be  less than that of commercial paper, making them less costly to Treasury.  We regressed the yield spread on key variables affecting risk and liquidity  of the financial market. Our results suggest that Treasury paid a premium  ranging from 1 to 4 basis points on 3-month Treasury bills issued during  debt limit events in 2001–2002, 2002–2003, and most recently in 2009– 2010. However, we did not observe premiums in 2004–2005 and 2005– 2006.
subsections: section_title: Variables and Model Specifications
paragraphs: The existing literature on the effect of the debt limit on Treasury’s  borrowing costs is limited. Our analysis was based in part on a prior study  of the effect of debt limit events on Treasury interest rates by Liu, Shao,  and Yeager. Similar to the results of our analysis, Liu et al. (2009) found  that during debt limit events in 2001–2002 and 2002–2003, the spread  between 3-month Treasury bill yields and 3-month commercial paper  yields narrowed, implying that Treasury bills were relatively more costly  during this period; however, this relationship was not observed in either  the 2004–2005 or 2005–2006 debt limit events. The authors hypothesized  that, during these latter two debt limit events, investors may have assumed  based on past experience that members of Congress would resolve their  differences before there were any serious disruptions in the Treasury  market and therefore did not charge a premium on securities issued near  the debt limit. We also reviewed an earlier study by Nippani, Liu, and  Schulman which found that Treasury paid a premium on 3-month and 6- month Treasury bills issued during the debt limit event in 1995-1996.
On the basis of discussions with Treasury officials, staff at the Federal  Reserve Bank of New York, and market experts such as primary dealers  and larger investment funds, we determined that the model developed by  Liu et al. (2009) provided a reasonable starting point for our analysis. We  made modifications to reflect the Federal Reserve’s purchases of  commercial paper through its Commercial Paper Funding Facility (CPFF)  in 2008 to enhance the liquidity of the commercial paper market. We  included a variable to control for the volume of commercial paper held by  the Federal Reserve as a percentage of total commercial paper  outstanding. We also included the Chicago Board Options Exchange’s  Volatility Index (VIX) to control for volatility and uncertainty in financial  markets. The equation we used is  Yield Spread = B0 + B1*EVENT + B2*POST + B3*SPRET + B4*VIX +  B5*LOG(CPISSUE) + B6*LOG(TBILLTRANS) + B7*CPFFSHARE + Error  Table 5 below describes each of the variables in the equation and indicates  the expected sign of the coefficient. Treasury officials and market experts  said that our modifications to their equation were reasonable.
The regression results based on the variables listed above are presented in  table 6. Negative EVENT coefficients suggest that debt limit events  reduced the spread between commercial paper and Treasury yields  compared to the preevent period. Consistent with the Liu et al. (2009)  study, the EVENT coefficients for the debt limit events in 2001–2002 and  2002–2003 had the expected negative sign and were statistically  significant. In addition, the coefficient of the EVENT variable had the  expected negative sign and was statistically significant for the most recent  debt limit event in 2009–2010.
We explored a variety of alternative specifications to see whether our  model could be improved but found that no specification proved  particularly robust across all the events studied. On the basis of  discussions with Treasury staff and market experts, we added, replaced,  and removed variables and defined the event period differently. For  example, we explored several alternative controls for credit risk, including  the spread between London interbank offer rate (LIBOR) and the  Overnight Indexed Swap that measures risk and liquidity in the money  market, and the spread between Baa corporate bond yields and 10-year  Treasury note yields. We also redefined the event period to begin when  Treasury took its first extraordinary actions or, in the case of 2009–2010,  reduced the amount in the Supplementary Financing Program (SFP). None  of the alternative variables or specifications produced statistically  significant results. Using the Liu et al. (2009) specifications did not result  in statistically significant results for the most recent event in 2009–2010.
subsections: section_title: Effect of Debt Limit on Borrowing Costs
paragraphs: One the basis of our analysis, we estimate that Treasury paid $78 million in  additional interest costs for newly issued 3-month securities issued during  the 2009–2010 debt limit event period. We arrived at this estimate by  translating the coefficient of the EVENT in 2009–2010 (-.040) to basis  points (4) and multiplying by the amount of 3-month Treasury bills issued  during the event period. We selected 3-month bills for our analysis  because it is a commonly used benchmark in economic indicators such as  the TED spread—a key indicator of credit risk. We did not estimate the  effects of the debt limit on other Treasury securities with longer terms to  maturity in part because of a lack of reliable data on yields for private- sector fixed-income assets with maturity dates comparable to medium- term Treasury securities such as a 2-year note. Therefore, we do not know  whether the same 4-basis-point premium would apply to other Treasury  securities with longer or shorter terms to maturity issued during the debt  limit event period. Nippani et al. (2001) found that the effect of the debate  over the debt limit in 1995–1996 was greater on 3-month Treasury bills  than on 6-month Treasury bills, indicating the investors may have believed  that debate over the debt limit would be resolved over time and that  longer-dated securities would therefore be less affected. However, even a  smaller premium when applied to the large amount of Treasury securities  offered by Treasury would result in a notable increase in borrowing costs.  For instance, for each additional basis point paid on bills issued during the  2009–2010 debt limit event period, Treasury’s borrowing cost would  increase by roughly $92 million.
section_title: Limitations of the Analysis
paragraphs: There are a number of limitations to using a multivariate regression to  measure changes in Treasury’s borrowing costs. First, the results of our  analysis explain only a small portion of the variation in the yield spread, as  indicated by the relatively low R-squared statistics. Any equation  attempting to explain the yield spread would have limited explanatory  power given inherent randomness in daily time series data such as  Treasury bill and commercial paper yields. Furthermore, the estimates are  subject to omitted variable bias. Second, there was substantial variation in  the sign, size, and significance of the estimated coefficients across debt  limit events. However, the EVENT variable’s coefficient, which is the  central focus of our analysis, had the expected negative sign in four of the  five debt limit periods included in our analysis and was significant in three  of these periods. We discussed these and other limitations with Treasury  officials, staff at the Federal Reserve Bank of New York, and other market  experts such as primary dealers and incorporated their suggestions and  feedback when appropriate. Despite these limitations, the estimates do  suggest that a debt limit event may result in a premium.
section_title: Appendix III: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
paragraphs: Susan J. Irving, (202) 512-6806 or irvings@gao.gov  Gary T. Engel, (202) 512-3406 or engelg@gao.gov.
section_title: Staff Acknowledgments
paragraphs: In addition to the contacts named above, Melissa Wolf, Assistant Director;  Dawn Simpson, Assistant Director; Thomas J. McCabe, analyst-in-charge;  Richard Krashevski, Claire Li, Inna Livits, and Nicole McGuire made key  contributions to this report.