Debt Management: Treasury Has Improved Short-Term Investment Programs, but Should Broaden Investments to Reduce Risks and Increase Return
Published: 2007-09-20T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Growing debt and net interest costs are a result of persistent fiscal imbalances, which, if left unchecked, threaten to crowd out spending for other national priorities. The return on every federal dollar that the Department of the Treasury (Treasury) is able to invest represents an opportunity to reduce interest costs. This report (1) analyzes trends in Treasury's main receipts, expenditures, and cash balances, (2) describes Treasury's current investment strategy, and (3) identifies options for Treasury to consider for improving its return on short-term investments. GAO held interviews with Treasury officials and others and reviewed related documents.
section_title: What GAO Found
paragraphs: In managing the funds that flow through the federal government's account, Treasury frequently accumulates cash because of timing differences between when borrowing occurs, taxes are received, and agency payments are made. Treasury often receives large cash inflows in the middle of the month and makes large, regular payments in the beginning of the month. Treasury uses three short-term vehicles--Treasury Tax & Loan (TT&L) notes, Term Investment Option (TIO) offerings, and limited repurchase agreements (repo)--to invest operating cash. Before Treasury invests any portion of its operating cash balance, Treasury generally targets a $5 billion balance in its Treasury General Account (TGA) which is maintained across the 12 Federal Reserve Banks. The TT&L program provides Treasury with an effective system for collecting federal tax payments while assisting the Federal Reserve in executing monetary policy, but it subjects Treasury to concentration risk and earns a return well below the market rate. The TIO program earns a greater rate of return but it also subjects Treasury to concentration risk. Both programs also present capacity concerns. Treasury began testing repos through a pilot program in 2006. Repos have earned near market rates of return, but because of the pilot's scope and the current, limited legislative authority under which it operates, the repo participants, collateral, trading terms, and trading arrangements are restricted. A permanent, expanded repo program could permit Treasury to earn a higher rate of return, expand investment capacity, and reduce concentration risk. If given authority to design such a program, Treasury would need to tailor it to meet liquidity needs and to achieve a higher rate of return while minimizing risks that are associated with the selection of program participants, collateral types, terms of trade, and trading arrangements.

section_title: Letter
paragraphs: Growing debt and net interest costs are a result of persistent fiscal  imbalances. In July 2007, the Office of Management and Budget projected  that interest costs on debt held by the public will increase by almost 25  percent over the next 5 years to $290 billion. If left unchecked, interest  spending threatens to crowd out spending for other national priorities. The  Department of the Treasury (Treasury) is responsible for managing the  funds that flow through the federal government’s accounts, which are  maintained across the 12 Federal Reserve Banks and rolled into one  account, the Treasury General Account (TGA), at the end of each day.  Treasury frequently has funds available for short-term investment because  government collections and disbursements do not always align. In fiscal  year 2006, Treasury’s operating balance averaged $26.4 billion per day. The  return on every federal dollar that Treasury is able to invest represents an  opportunity for the U.S. government to reduce net interest costs.
Although there have been dramatic changes in financial markets that have  allowed investors to increase their rate of return while reducing risk,  Treasury’s investment authority has not changed over the past three  decades. Under current law Treasury is only permitted to invest in  depositary institutions and in obligations of the United States government.In addition to the TGA, Treasury invests in three collateralized instruments  with depositary institutions—Treasury Tax & Loan (TT&L) notes, Term  Investment Option (TIO) offerings, and limited repurchase agreements  (repo). The introduction of TIOs in 2002 and of repos in 2006 were part of  Treasury’s effort to update its cash management practices and improve  earnings and capacity without increasing unacceptable risks. In 2007, the  Administration asked Congress to update Treasury’s authority for selected  short-term investments.
This report is part of our ongoing work on Treasury’s cash and debt  management practices and was requested by the U.S. Senate Committee  on Finance. The objectives of this report are to (1) analyze trends in  Treasury’s main receipts, expenditures, and cash balances, (2) describe  Treasury’s current investment strategy, and (3) identify options for  Treasury to consider for improving its return on short-term cash  investments.
To describe Treasury’s cash management and short-term investment  practices we analyzed trends in cash available for short-term investment  with data collected from Treasury’s publicly available Daily Treasury  Statements. To evaluate Treasury’s current investment strategy and  identify options for improving Treasury’s return while mitigating risk, we  interviewed agency officials from Treasury, the Federal Reserve Board of  Governors, Federal Reserve Bank of New York, and Federal Reserve Bank  of St. Louis, and reviewed policies for managing short-term investments.  With data provided by Treasury, we analyzed participation in and returns  of Treasury’s short-term investment programs. We also interviewed  market analysts and officials from seven financial institutions, including  participants in Treasury’s short-term investment programs, to gain a  market perspective. In addition, we obtained documents from foreign and  state governments to learn about their short-term investment practices.  We performed our review from March 2006 through July 2007 in  accordance with generally accepted government auditing standards. See  appendix VI for more details on how we calculated rates and potential  return for Treasury’s short-term investments.
subsections: section_title: Background
paragraphs: In managing the funds that flow through the federal government’s account,  Treasury frequently accumulates cash due to timing differences in when  borrowing occurs, taxes are received, and agency payments are made.  Treasury often receives large cash inflows in the middle of the month and  makes large, regular payments in the beginning of the month. In general,  Treasury seeks to maintain low cash balances and repay debt whenever  possible, as the interest earned on short-term investments is generally  insufficient to cover additional borrowing costs.
As fiscal agents and depositaries for the federal government, the Federal  Reserve Banks provide services related to the federal debt, help Treasury  collect funds owed to the federal government, process electronic and  check payments for Treasury, invest excess Treasury balances and  maintain Treasury’s bank account, the TGA, through which most federal  receipts and disbursements flow. TGA funds are available for immediate  disbursement and are one of Treasury’s most liquid investments.
Over the past several decades, technological advances and global  expansion have led to significant changes in financial markets. Lending  institutions have developed greater capacity to increase returns and  manage risks, and increased regulatory freedom has helped to spur new  markets. Greater computer power and better telecommunications  networks have reduced barriers that once limited investment  opportunities. In particular, significant growth has occurred in the  segment of the money market that includes the use of repurchase  agreements, or repos. A repo is the transfer of cash for a specified amount  of time, typically overnight, in exchange for collateral. When the term of  the repo is over, the transaction unwinds, and the collateral and cash are  returned to their original owners, with a premium paid on the cash.
The repo market has become one of the largest segments of the U.S.  money market and is used by government and private institutional  investors to invest short-term excess cash. In the first quarter of 2007, the  average daily volume of outstanding total repos was $3.6 trillion,  according to information provided to the Federal Reserve by primary  dealers that engage in repo transactions.  Over $114.3 trillion in repo  trades involving U.S. Government Securities were reported in the first  quarter of 2007, with an average daily volume of approximately $1.8  trillion.  Repos were used by the Federal Reserve as early as 1917 and play  an important role in the conduct of monetary policy operations since the  Federal Reserve uses repos to dampen transient fluctuations in the supply  of reserves available to the banking system.  For the past 20 years, large  corporations have been shifting cash assets out of bank accounts into  instruments such as repos, which have enabled them to increase the  returns on their short-term cash assets with minimum risk to their funds.
Electronic systems have increased the speed of repo transactions and  expanded the range of investors that can participate. Innovative  arrangements for accepting collateral in the repo market, specifically  triparty arrangements, have reduced transactions costs, credit risks, and  operational risks. In a triparty repo an independent custodian bank acts as  an intermediary between the two parties in the transaction and is  responsible for clearing and settlement operations. The triparty structure  typically reduces costs, minimizes operational and credit risks, and has the  potential to increase returns. The Federal Reserve has been using triparty  arrangements for its repos since 1999.
section_title: Treasury’s Short-Term Cash Available for Investment Fluctuates According to a Predictable Pattern
paragraphs: Treasury’s operating cash balance fluctuates according to a predictable  pattern although the swings in daily cash balances have grown larger in  recent years. Before Treasury invests any portion of its operating cash  balance, Treasury generally targets a $5 billion balance in the TGA.  Treasury seeks to maintain a balance in the TGA large enough to protect  against overdraft and attempts to keep the balance stable to avoid  interfering with the Federal Reserve’s implementation of monetary policy.  Balances held in the TGA earn an implicit rate of return.
subsections: section_title: Treasury’s Cash Balances Available for Short-Term Investment Exhibit Predictable Cyclical Patterns
paragraphs: Patterns in receipts and disbursements cause frequent but predictable  swings in federal cash balances, which regularly provide Treasury with  cash available for short-term investment. Treasury’s daily operating cash  balance, the amount of cash remaining after receipts and disbursements  are accounted for, averaged $26.4 billion in fiscal year 2006.
The receipts Treasury uses to finance federal expenditures come primarily  from two sources: (1) tax revenues from sources such as personal and  corporate income taxes, payroll withholdings, or other fees the federal  government imposes; and (2) cash borrowed from the public through  Treasury’s regular auctions of debt securities. Treasury’s daily operating  cash balance is generally lower at the beginning of each month due to  mandatory expenditures and then rises in the middle of each month upon  the arrival of Treasury’s scheduled receipts. (See fig. 1.)  Treasury’s cash  balances also fluctuate depending on the time of year, with mid-month  increases that are particularly large in January, March, April, June,  September, and December. Treasury receives major corporate or  nonwithheld individual estimated tax payments, or both, in these months,  which significantly increases Treasury’s daily operating cash balance.  Increases are highest in April, when Treasury receives and processes the  prior year’s individual income tax liability settlements and the first  estimated payments of the current tax year from individuals and calendar  year corporations.
Large payments for programs such as Medicare, Social Security, federal  retirement, and veterans’ compensation frequently occur during the first 3  days of each month, significantly lowering Treasury’s daily operating cash  balance at the beginning of each month. One quarter of fiscal year 2006  outlays were paid in the first 3 days of the month. Like the tax deposit  schedule, the majority of the payment dates for these large benefit  programs are statutory, which limits Treasury’s flexibility in cash  management.
section_title: Treasury’s Cash Balances Available for Short-Term Investment Have Both Increased and Grown More Volatile over Time
paragraphs: In fiscal year 2006, Treasury’s average daily operating cash balance was  $26.4 billion, an $8.5 billion increase from fiscal year 2003. (See table 1.)  Swings in daily cash balances have also grown over time. Days with high  cash balances—and hence significant amounts of short-term cash for  investment—have more than quadrupled since 2003. (See fig. 2.) Cash  balances tend to be highest at the end of the month before large  mandatory payments are made. Over the past 3 years, cash balances have  generally increased in both dollar volume and volatility for most parts of  each month and for each business day of the week. Appendix I provides  more details on these trends.
section_title: The TGA Protects against Overdraft and a Stable Balance Assists with Monetary Policy
paragraphs: Before investing any portion of its operating balance, Treasury generally  seeks to maintain a stable $5 billion balance in the TGA to protect against  overdraft. An overdraft of the TGA could occur if the anticipated receipts  for the day fall short of expectation or if there are unanticipated  disbursements. Treasury cannot risk an overdraft because the Federal  Reserve is not authorized to lend directly to Treasury, in part to preserve  the Federal Reserve’s independence as the nation’s central bank. Before  1988, as federal payments became larger and the volatility of Treasury’s  operating cash balance increased, Treasury and the Federal Reserve  increased the TGA target balance. According to Federal Reserve officials,  improvements in the forecasting of receipts and expenditures have  permitted them to not make any permanent increases to the TGA since  1988 despite continued increases in operating balance volatility. See  appendix V for more detail on Treasury’s modifications to the TGA target  balance since 1988.
In the past, Treasury relied on compensating balances in depositary  institutions as a source of liquidity on rare occasions. For example, in the  week of September 11, 2001, Treasury pulled $12.6 billion from such  compensating balances to cover a financing gap caused by the  cancellation of a 4-week-bill auction. However, this source of liquidity has  not been available since 2004.
A stable TGA balance assists the Federal Reserve in its execution of  monetary policy. If Treasury’s TGA balance exceeds or falls short of its  target, the Federal Reserve must neutralize its effect on bank reserves  through open market operations. See appendix V for more details on how  the Federal Reserve injects or withdraws cash from the banking system in  response to changes in the TGA.  As shown in figure 3, in 2006 the TGA  balance deviated more than 20 percent from its $5 billion target 17 times.  In 9 of the 17 times, Treasury and the Federal Reserve had agreed in  advance to target a balance other than $5 billion. Treasury and the Federal  Reserve sometimes decide to target different balances for reasons that  include increased volatility on major tax due dates and the facilitation of  short-term reserve management.
section_title: TGA Balances Earn an Implicit Return
paragraphs: Although Treasury does not earn explicit interest on the TGA, it does earn  an implicit return as part of the Federal Reserve’s weekly remittance to  Treasury. However, the Federal Reserve told us that the amount cannot be  easily identified. The implicit return Treasury receives depends on  whether the purchases the Federal Reserve makes to offset the TGA  balance are permanent or temporary. In a stable TGA target environment,  such as exists today, the implicit return is roughly equivalent to the rate  earned by the Federal Reserve on its portfolio of Treasury securities. For  temporary increases in the TGA, the implicit return is roughly equal to the  rate the Federal Reserve earns on its overnight repos. According to the  Federal Reserve, the return cannot be isolated because it does not assign  specific portions of its investment portfolio to the TGA. The Federal  Reserve records the TGA on its balance sheet as a liability and offsets  increases in the TGA by purchasing additional assets.
While a higher TGA target balance would provide Treasury with increased  overdraft protection and earn market rates of return, it could increase  borrowing, which is costly whenever Treasury faces a negative funding  spread. A negative funding spread occurs when the interest earned on  cash balances is insufficient to cover the cost of the increased borrowing  necessary to maintain these balances. Conversely, if the Treasury were to  face a neutral or positive funding spread, increases would not be costly.  When Treasury’s cash balances are particularly low, it may have to raise  funds by issuing additional debt in order to maintain a stable and sufficient  TGA balance.
section_title: Treasury’s Short-Term Investment Strategies Have Evolved over Time, but Restrictions Still Subject Treasury to Several Risks and Lower Returns
paragraphs: In order to maintain a stable TGA balance, Treasury must place operating  cash above its $5 billion target in depositary institutions’ TT&L accounts  or into other short-term investments. The three short-term vehicles  currently used by Treasury subject Treasury to high concentration risks  and have limited capacity. TT&L provides Treasury with an effective  system for collecting taxes but subjects Treasury to concentration risk and  offers low rates of return. To improve returns, Treasury established the  TIO program in 2003, which provides near market rates of return but still  subjects Treasury to concentration risk and does not alleviate Treasury’s  capacity concerns. Treasury’s repo pilot, introduced in 2006, provides a  third limited investment option. Treasury earned near market rates of  return in the pilot, but because of its temporary status and limits in  Treasury’s current legislative authority, the pilot’s features—including  participants, collateral, trading terms, and clearing and settlement  arrangements—are restricted and prevent Treasury from accessing the  broader repo market. Table 2 shows the number of participants,  investment terms, relative performance, and concentration risk of these  three investment programs.
subsections: section_title: The TT&L Program Serves Key Functions but Has Significant Limitations
paragraphs: The TT&L program provides Treasury with an effective system for  collecting federal tax payments and helps Treasury meet its target balance  in the TGA, but it subjects Treasury to concentration risk and earns a  return well below market rate. In addition, the TT&L poses capacity  concerns. In 2006, Treasury invested about 30 percent of its operating cash  in TT&L deposits, with a daily average of $7.6 billion.
TT&L Benefits: The TT&L program represents a collaboration between  Treasury and over 9,000 commercial depositary institutions that collect tax  payments, about 1,000 of which also hold funds and pay interest to  Treasury. (See table 2.) There are three categories of participation:  collectors, retainers, and investors. The majority of TT&L participants are  collectors—they receive tax payments from customers and transfer the  payments to Treasury’s account at the Federal Reserve. Retainers perform  the same tax collection functions but may also retain specified amounts of  the cash in an interest-bearing account until the money is called by  Treasury. Investors not only collect and retain cash, but also may accept  funds from Treasury though different investment options. In one of these  options, the depositary institution agrees to accept automatic direct  deposits from Treasury made hourly throughout the day in the event that  Treasury cash receipts are greater than anticipated. These automatic  deposits—known as dynamic investments—are an important part of the  TT&L program because they are currently Treasury’s only option for  placing late-day cash and helping Treasury to meet its target TGA  balance.
TT&L Participant Concentration: TT&L deposits are highly  concentrated among a few large depositary institutions. For the past  couple of years, Treasury has invested almost half of TT&L deposits with  one depositary institution. Reasons for this concentration include  consolidation in the banking industry over the last two decades and the  lack of investment caps. In 2006, the five largest TT&L participants  accounted for 66 percent of the total funds invested in TT&L accounts, up  from 62 percent in 2005. (See tables 3 and 4.) This creates not only  concentration risk but also capacity concerns. If one or two of the largest  depositary institutions were to lower their TT&L balance limits or  withdraw from the program entirely, Treasury’s investment capacity  would fall far below that needed to accept the total amount of funds that  Treasury needs to invest during peak tax collection dates. In addition, the  number of depositary institutions participating in the TT&L program and  thus willing to accept Treasury cash has decreased over the past few  years. According to Treasury, at times it has been unable to place all of the  cash it wished to invest in part because of a reduction in the number of  TT&L participants.
TT&L Rates of Return: The interest rate earned on deposits in retainer  and investor accounts is fixed at the federal funds rate minus 25 basis  points. TT&L deposits are an inexpensive source of funding relative to  market alternatives for depositary institutions, but Treasury can withdraw  certain funds on short notice and funds are subject to strict collateral  requirements. See appendix II for a discussion of TT&L collateral  requirements.
When Treasury set the TT&L rate in 1978, it was a close approximation of  the overnight repo rate, which Treasury considered an economically  similar transaction. Treasury elected to use a proxy rate at the time  because information on the daily overnight repo rate was not widely  available. The repo market has grown considerably, and information about  repo rates is now readily available. Since 1978 the spread between the  federal funds rate and the repo rate has narrowed significantly from about  25 basis points to about 9 basis points in recent years. As a result, the  spread between the TT&L rate and the overnight repo rate has grown  larger, leaving Treasury earning a fixed rate on TT&L accounts that is well  below market rates. (See fig. 4.) In July 1999 Treasury proposed changing  the interest rate on TT&L deposits to align it with the overnight repo rate  since Treasury viewed TT&L deposits as overnight investments, similar to  repo transactions. However, financial institutions opposed the rate  change; in 2002 Treasury modified the proposal and began exploring the  short-term investment alternatives discussed later in this report,  specifically TIOs and repos.
section_title: TIO Program Earns a Better Rate of Return Than TT&L but Exposes Treasury to Similar Risks
paragraphs: Treasury’s TIO program, fully established in 2003, earns Treasury a higher  rate of return than the TT&L program but shares the TT&L program’s  concentration risk and Treasury’s capacity concerns in part because the  same depositary institutions participate in both programs. TIO  investments differ from TT&L deposits in two critical dimensions: (1) they  are auctioned rather than placed at a fixed rate and (2) they are placed for  a fixed number of days rather than being callable at will. Through the TIO  program, Treasury auctions off portions of its excess cash at a competitive  rate for a fixed number of days. The TIO program’s auction format allows  Treasury to receive a competitive, market-based interest rate for its  surplus cash.  Meanwhile, the participating depositary institutions benefit  from knowing in advance the exact amount and timing of the investment.
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While depositary institutions have no control over when funds are  deposited or withdrawn from the TT&L accounts, they know exactly how  long TIO funds will be deposited, and through competitive bidding have  more direct influence over the amount of funds that they receive. By 2006,  approximately 60 percent of Treasury’s short-term investments were  shifted into TIOs. In fiscal year 2006 Treasury invested $500 billion through  TIO auctions. As of February 2007, 60 TT&L depositaries participated in  the TIO program, up from 43 in 2004. The textbox provides additional  details on how Treasury conducts TIO auctions.
TIO Rates: TIOs earn a higher rate of return than TT&L deposits. In fiscal  year 2006, TIO auction rates were on average 17 basis points higher than  TT&L rates over the same terms, increasing Treasury’s gross return by  approximately $20 million. The TIO rates were also about 3 basis points  below Treasury’s benchmark for a market rate, which is based on repo  rates of similar terms and collateral. There are variations among TIO  auctions regarding the length of the term and the amount of cash offered  that affect rates. According to a Federal Reserve study, TIO rates are most  competitive for TIO term lengths of 5 days or greater, and the larger the  auction size, the lower the TIO rate.
TIO Participant Concentration: Although the TIO program has  increased Treasury’s rate of return, it has not lessened its concentration  risk, in part because TIO investors must be TT&L depositaries and they  can receive up to 50 percent of funds offered by Treasury per auction. TIO  investment concentration has increased in recent years. In fiscal year 2006,  50 percent of TIO funds were awarded to two depositary institutions, up  from about 40 percent in fiscal year 2004. (See table 5.)
TIO Collateral and Capacity: TIO collateral restrictions are similar to  those in the TT&L program, and because depositary institutions  participate in both programs, participants’ total capacity is divided  between the two programs. Depositary institutions transfer collateral  between the TIO and TT&L programs in order to participate in upcoming  TIO auctions, which depletes the amount of collateral and capacity in  TT&L accounts.  According to Treasury, TT&L account capacity declined  between 2001 and 2006, but capacity has shifted from TT&L accounts to  the TIO program such that total investment capacity remained in line with  the average capacity from 2001 to 2006. This shift of capacity from TT&L  accounts to the TIO program presents challenges to using all of the  capacity when there is a sudden and significant increase in Treasury’s cash  balance (e.g., if the balance spikes up for only 1 or 2 days). There have  been a few instances in the last few years in which Treasury has raised or  considered raising the target Federal Reserve balance because TT&L  accounts were close to capacity. Appendix II provides additional  information on the types of collateral pledged in TIO auctions and how  they are valued.
section_title: Treasury’s Repo Pilot Has Continued to Improve Overall Returns, but Is Currently Limited in Scope
paragraphs: Like the TIO program, the repo pilot provides Treasury with higher rates  of return than TT&L deposits, but current legal restrictions and the pilot’s  limited scope prevent Treasury from accessing a broader repo market. At  $4 billion per day, Treasury’s repo pilot is small relative to the $1.8 trillion  per day repo market.
In March 2006 as part of its initiative to modernize its cash management  program, Treasury began operating a 1-year pilot program to invest excess  cash into repos, consistent with GAO recommendations. The objectives  of the pilot were to (1) assess the effect of this type of investment  operation on both Treasury and Federal Reserve operations, internal  systems, and processes, and (2) explore the benefits of using repos to  expand Treasury’s investment capacity and increase the return on invested  funds. Initially there was only one participant; a second participant was  added in August 2006. In the first 12 months of the repo pilot program,  Treasury conducted 235 repo transactions, and invested $645 billion  altogether. Treasury’s repo investments in the second half of fiscal year  2006 made up 11 percent of its total short-term investment balance. In that  first year of the repo pilot, rates were on average 21 basis points higher  than TT&L rates and earned close to Federal Reserve repo rates. In its  evaluation of the pilot, Treasury found that it can effectively conduct repo  transactions with a limited number of counterparties without adverse  effect on its or the Federal Reserve’s operations, internal systems, and  processes.
Repo Participants: Under current law, Treasury is limited to investing its  excess cash in depositaries maintaining TT&L accounts and in obligations  of the United States. As a result, it cannot invest with securities dealers  who play a prominent role in the repo market. The Federal Reserve  conducts all of its repos with 21 securities dealers, who are selected based  on their ability to make good markets, participate meaningfully in  Treasury auctions, and provide market intelligence that is useful to the  Federal Reserve in the formulation and implementation of monetary  policy. In 2006, the Federal Reserve had an average daily balance of $25.3  billion in repos with selected securities dealers.
Repo Term and Frequency: The repo pilot program offers only repos  that have a term of 1 business day. Although this term comprises the  largest share of the repo market, some participants invest in repos with  longer terms. In addition, the repo pilot program conducts only a single  daily auction at 9 a.m. Other repo participants conduct transactions  throughout the day in the broader repo market, allowing them to place  cash late in the day.
Repo Bids: Bidding for Treasury’s repo pilot program is conducted by  telephone, which is consistent with market convention for repos with a  limited number of participants. Industry experts view telephone trading as  an efficient way to conduct trades for offerings with a few counterparties.  A greater number of counterparties may require an electronic trading  system in order to prevent delays between the time rate quotes are made  and accepted. Electronic trading systems also reduce trading costs and the  risk of clearing errors. In 2006 the Federal Reserve upgraded to a new  electronic trading system, FedTrade, to manage its repo trades with  primary dealers. Treasury officials told us that they were exploring the  capabilities of an electronic system similar to that used by the Federal  Reserve and its application to an expanded repo program.
Repo Collateral: Because of its current investment authority, Treasury  only accepts Treasury securities as collateral in its repo pilot program.  Participants in the larger repo market, including the Federal Reserve,  accept a wider range of collateral types including mortgage-backed  securities and U.S. government agency securities. Although repos backed  by Treasury securities constitute the largest share of the repo market,  there are some important limitations to demand for such repos.  Most  importantly for Treasury, the demand for repos backed by Treasury  securities is lowest during times when Treasury has the most cash to  invest. This happens in April and May, when, in response to high tax  receipts, Treasury reduces the number of Treasury bills available in the  market. Additionally, the rates received on repos backed by mortgage- backed securities and U.S. agency securities are typically higher than the  rates for Treasury securities.
Repo Clearing and Settlement: Clearing is the process of calculating  the obligations of the counterparties to make deliveries of securities or  payments of cash. Settlement is the transfer of cash and securities  between the party and counterparty. For repo transactions, clearing and  settlement are typically done through either a delivery-versus-payment  (DVP) or triparty arrangement. In a DVP arrangement, as is used in the  repo pilot program, the party and counterparty complete the clearing and  settlement processes. In a triparty agreement, an independent custodial  bank manages the clearing and settlement process.
As illustrated in figure 5 below, in a DVP transaction, cash is transferred to  the party, and the securities are delivered to the counterparty or its fiscal  agent. The delivery of securities is done over a secure transfer system  operated by the Federal Reserve Banks, which allows the transfer of  certain types of securities such as U.S. Treasury and U.S. government  agency securities. In triparty repos, both counterparties maintain accounts  at a third-party custodian bank that facilitates the transfer of cash and  securities between accounts. A broader range of securities can be used as  collateral because the securities are already in accounts at the  independent custodial bank.
section_title: Options Exist to Increase Treasury’s Rate of Return and Reduce Risk on Short- Term Investments
subsections: section_title: Treasury Should Minimize TT&L Investments and Expand the Repo Program to Increase Returns and Reduce the Risks of Concentration and Constrained Capacity
paragraphs: Treasury could increase its return on investment by continuing to reduce  funds in TT&L accounts and reallocate those funds to a mix of TIOs and  repos. In 2006, Treasury invested an average of $7.64 billion per day in the  TT&L program. Treasury generally maintains at least $2 billion in the  TT&L program as a means of maintaining active participation in the  program. Retaining some TT&L banks to take direct investments as part of  a broadened array of investment options would likely be advantageous for  Treasury, by helping to provide Treasury with a more diversified set of  investment options and by presumably increasing overall investment  capacity. As illustrated in figure 6, during certain times of the year,  Treasury has large balances in TT&L accounts earning a below-market rate  that could instead be invested in an expanded repo program. If Treasury  had invested TT&L funds in excess of the $2 billion floor in repo  investments and earned the Federal Reserve’s overnight repo rate, we  estimate that Treasury could have earned an additional $12.6 million in  2006. Investing in repos could also reduce the high levels of  concentration and alleviate the limited capacity in the TT&L and TIO  programs by accessing the almost $2 trillion broker-dealer repo market.
section_title: Treasury Will Need to Consider Primary Investment Objectives If Given Authority to Design a Permanent, Expanded Repo Program
paragraphs: In designing the operational elements of a permanent, expanded repo  program, Treasury would need to consider industry investment practices  in designing the program’s operational elements and managing risks that  are associated with the selection of participants, collateral types, terms of  trade, and trading arrangements. Since the repo pilot was conducted under  current limited authority, Treasury did not have the opportunity to  consider design decisions, such as we discuss in this section.
subsections: section_title: Primary Investment Objectives
paragraphs: In establishing a permanent, expanded repo program, Treasury would  benefit from the insights gained in its repo pilot program and from  examining recommended investment practices and federal regulations of  other repo operations. Three sources of recommended short-term  investment practices are the Government Finance Officers Association  (GFOA), an organization that advises state and local governments’ finance  officials, the Federal Reserve Policy on Payments System Risk, and the  federal repo regulations issued by the Federal Deposit Insurance  Corporation. Guidance for recommended short-term investment  practices cite three primary objectives, in order of priority: (1) risk  management, (2) liquidity, and (3) yield.
Risk Management: According to the GFOA, the preservation and safety  of principal is the foremost objective of short-term investments, which is  accomplished by minimizing certain risks that are present in repo  investments:   (a) Credit Risk: The risk that a repo party will not fulfill its  obligations to Treasury.   (b) Concentration of Credit Risk: The risk of loss attributable to  the magnitude of Treasury’s investment in a single party.  (c) Custodial Risk: The risk that, in the event of a failure of a repo,  Treasury will not be able to recover the full value of collateral  securities that are in possession of outside parties.   (d) Interest Rate Risk: The risk that changes in interest rates will  adversely affect the fair value of Treasury’s investment.
In a permanent repo program, Treasury will need to establish criteria to  select counterparties to minimize exposure to credit risk, consider its  overall exposure to each party and any of its related parent companies,  and to monitor its exposure to interest rate risk. In determining with  whom Treasury would be willing to conduct repos, Treasury would need  to monitor the possibility of losses due to the high concentration of  investments with a few participants. Specifically, Treasury would need to  consider its overall exposure to each counterparty and any of its related  parent companies and subsidiaries in its investments. To reduce interest  rate risk, Treasury already requires TT&L participants to provide a greater  amount of collateral than the amount of cash received. In a permanent  repo program, Treasury will also need to monitor its exposure to  market/interest rate risk that would arise from accepting a wider variety of  collateral and investing at times for terms longer than overnight.
Liquidity: Recommended investment practices related to liquidity are  designed to ensure availability of funds when needed. The GFOA identifies  two elements: (1) setting the term of some repo investments to mature  when cash needs are highest and (2) having some repo investments that  allow the investor to obtain cash on short notice without penalty. For  Treasury, cash needs are greatest on or near the beginning of each month.  The ability to obtain cash on short notice might be accomplished by  engaging in overnight repos that can be rolled over every day. Treasury’s  optimal mix of overnight and longer-term repos would depend on the  patterns of Treasury receipts and cash available for short-term  investments and on the timing and size of expected cash needs.
Yield: An expanded repo program has the potential to improve Treasury’s  return on investments relative to TT&L rates while maintaining current  minimal risk investment policies. Treasury has already incorporated a  recommended practice in its repo pilot program related to assessing the  yield performance of a repo investment program. Specifically, Treasury  compared the return on its repo pilot investments to an appropriate  market benchmark.
section_title: Design and Operating Decisions
paragraphs: In designing a permanent, expanded repo program, Treasury should  consider the investment principles cited above in its selection of  participants, collateral types, trading processes, and clearing and  settlement arrangements.
Repo Participants: Expanding the repo program to include securities  dealers, with whom Treasury does not currently invest, would increase  Treasury’s investment capacity and could reduce the concentration risk  found in the TT&L and TIO programs. In its evaluation of the repo pilot  program, Treasury raised the possibility of expanding the range of parties  to include the 21 securities dealers selected by the Federal Reserve to  conduct its monetary policy operations. Whether Treasury uses the same  criteria used by the Federal Reserve or develops its own criteria to select  an acceptable set of counterparties, expanding to securities dealers would  give Treasury greater access to the repo market and expand its investment  capacity.
Repo Collateral: Expanding the type of collateral acceptable in a  permanent repo program could also increase Treasury’s return and  investment capacity. Treasury would benefit from adopting the practice of  other participants in the repo market, including the Federal Reserve,  which accepts a wider range of collateral types, such as mortgage-backed  securities and U.S. government agency securities. For example, the  Federal Reserve selects from participant’s propositions across three  different types of collateral. The rates it accepts depend on the  attractiveness of participant bids relative to current rates in the financing  market for each particular class of collateral.
Repo Trading: Treasury should consider adopting an electronic trading  system if it expands beyond a small number of participants to ensure  transparency and fairness. Trading in Treasury’s repo pilot program is  conducted by telephone, which is consistent with market convention for  repos with a limited number of participants. However, a greater number of  counterparties may require an electronic trading system in order to  prevent time delays, lower the risk of operational errors, and reduce  trading costs. According to Treasury, it is exploring the capabilities of an  electronic system similar to that used by the Federal Reserve that would  allow it to conduct repo operations with a large number of parties in a  transparent and fair manner.  The exact costs of such a system are  currently unknown.
Clearing and Settlement: Treasury should consider the advantages and  disadvantages of adopting a triparty clearing and settlement arrangement  for an expanded repo program. A triparty arrangement would reduce  clearing and settlement costs, facilitate the expansion of collateral, and  increase investment flexibility. According to an industry expert, the  primary benefit of triparty arrangements is that the securities are held by a  commercial clearing bank, which reduces risk and administrative work for  both repo counterparties.  For Treasury, triparty arrangements would  reduce the expenses of monitoring, clearing, and settlement. Triparty  arrangements would also facilitate the use of a broader range of securities  for collateral because custodian banks can hold classes of securities that  cannot be transferred over Fedwire. In addition, triparty arrangements  would expand Treasury’s processing capacity, and allow Treasury to make  additional repo investments later in the day to accommodate  unanticipated excess cash.
Although there are certain disadvantages to triparty arrangements, there  may be options that Treasury could explore to reduce them. Unsecured  intraday exposure may exist because there is a time lag between when  cash from a repo transaction is transferred from the counterparty’s  account and when the counterparty receives the collateral associated with  the transaction. In addition, with a triparty arrangement, Treasury would  not take possession of the pledged securities as its fiscal agent, the  Federal Reserve, does in a DVP arrangement. According to Treasury, there  may be a number of ways to mitigate these risks. See table 6 for a  summary of triparty advantages and disadvantages.
section_title: Conclusions
paragraphs: In the face of persistent federal deficits accompanied by growing net  interest costs, and given the opportunities created by significant  innovations in financial markets, further progress in Treasury’s short-term  investment practices is possible. Treasury is to be commended for its  efforts to modernize cash management that have resulted in higher returns  on short-term investments while maintaining current minimal risk  investment policies, but it is possible to do more. Our analysis shows that  a permanent, expanded repo program could increase earnings while  maintaining current minimal risk investment policies.
section_title: Matter for Congressional Consideration
paragraphs: Congress should consider providing the Secretary of the Treasury with  broader authority in the design of an expanded program of repurchase  agreements. Congress could note that it expects that in the selection of  participants, decisions about acceptable collateral, and choice of other  design features the Secretary will follow a process designed to mitigate  various types of risks including concentration risk, credit risk, and  market/interest rate risk. The decision not to legislate in detail how  Treasury invests cash does not remove Congress’s oversight authority or  responsibility. To assist Congress with oversight, the legislation could  require the Secretary to report annually on the Treasury investment  program.
section_title: Recommendation for Executive Action
paragraphs: We recommend that the Secretary of the Treasury explore the reallocation  of its short-term investments as discussed in this report and, if provided  the authority to do so, implement a permanent, expanded repo program  that would help Treasury meet its short-term investment objectives while  maintaining current minimal risk investment policies. If provided the  authority for a permanent, expanded repo program, Treasury should  consider allowing broker dealers as counterparties and expanding  acceptable collateral types to alleviate capacity concerns and increase  rates of return. The effects on rates of return and operational efficiencies  of an electronic trading platform and a triparty clearing and settlement  system should also be considered. When making decisions about short- term investment programs, Treasury should follow a systematic process to  identify and mitigate various types of risks including concentration risk,  credit risk, and market/interest rate risk. Treasury should consider the  costs and benefits of each alternative and determine whether the benefits  to the federal government outweigh any costs. Treasury should also  consider how its investment programs might be combined to produce  outcomes that are more beneficial, and should consider the effect of its  investments on similar Federal Reserve open market operations.
section_title: Agency Comments and Our Evaluation
paragraphs: We requested comments on a draft of this report from the Secretary of the  Treasury. Treasury agreed with our findings, conclusions, and  recommendations. The Fiscal Assistant Secretary’s letter is reprinted in  appendix VII. Treasury also provided technical comments, which we have  incorporated as appropriate. We also received technical comments from  the Federal Reserve, which we have incorporated as appropriate.
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If you or your staff have any questions about this report, please contact  Susan J. Irving at (202) 512-9142 or irvings@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 making key contributions to this  report are listed in appendix VIII.
section_title: Appendix I: Trends in Treasury’s Operating Cash Balance and Allocation of Short-Term Investments
subsections: section_title: Trends in Treasury’s Operating Cash Balance
paragraphs: We used publicly available Daily Treasury Statements to analyze the  Department of the Treasury’s (Treasury) availability of cash during times  of the month and days of the week during fiscal years 2003–2006. Our  analysis shows that cash balances tend to be highest at the end of the  month before large mandatory payments are made. Over the past 3 years,  cash balances have increased in both dollar volume and volatility for most  parts of each month and for each business day of the week. (See tables 7  and 8.)
section_title: Trends in Treasury’s Investment Allocation
paragraphs: Treasury’s trend over the past 5 years has been to move cash available for  investment out of the Treasury Tax & Loan (TT&L) Main Account and into  Term Investment Option (TIO) offerings and recently into repurchase  agreements (repo).  Treasury piloted the TIO program in 2002, and the  program became a permanent program in October 2003.  The addition of  the repo pilot program in March 2006 provided Treasury with an additional  option for investment.  (See table 9.)
With the development of the TIO program and the repo pilot, Treasury’s  investments in TT&L accounts have declined as it began placing more and  more of its operating balance in these programs, particularly TIO since the  repo pilot did not begin until March 2006. Specifically, the share of  Treasury’s three investments (not including the balance in the Treasury  General Account ) in TT&L accounts declined from 96 percent in  fiscal year 2002 to only 36 percent in 2006.  In contrast, the share of  Treasury’s investments in the TIO program grew to over 60 percent by  2005 and remained the largest program by share of volume in 2006 at  almost 60 percent. (See table 10.)
In the repo pilot’s first 6 months, Treasury allocated about 11 percent of its  total investments to the repo pilot on average. (See table 11.)  It appears  that Treasury primarily allocated funds away from TT&L and into the repo  pilot rather than from TIO.  TIOs as a percentage of total investments were  down only slightly from 62 percent for 2005 to 60 percent for the first 6  months of the repo pilot, while TT&L deposits decreased from 38 percent  to 30 percent over the same periods.
section_title: Appendix II: Acceptable Collateral in Treasury’s Short-Term Investment Programs
paragraphs: This appendix provides additional information on acceptable collateral for  the Department of the Treasury’s (Treasury) short-term investment  programs.  The first section discusses acceptable collateral in the Treasury  Tax and Loan (TT&L) and Term Investment Option (TIO) programs. The  second section discusses collateral distribution among Treasury’s short- term investment programs. In the third section, we describe Treasury’s  Special Direct Investment (SDI) program, which provides additional  capacity for Treasury in times when its operating cash balance is very  high. Finally, in the fourth section we provide a table of “haircuts” that  Treasury places on collateral depositary institutions pledged in exchange  for Treasury funds. A haircut is the percentage that is subtracted from the  market value of the collateral. The size of the haircut reflects the  perceived risk associated with the pledged assets. See figure 8.
subsections: section_title: Collateral in the TT&L and TIO Programs
paragraphs: Traditionally, Treasury has accepted a wide range of collateral in the  TT&L program to ensure sufficient capacity and mitigate risk. To reduce  risk, Treasury requires that a greater amount of collateral be pledged than  the amount of cash received. Known as a “haircut,” the excess amount  pledged may increase depending on the maturity, quality, scarcity, and  price volatility of the underlying collateral. In the late 1990s, faced with  budget surpluses and a lack of sufficient capacity in the TT&L program,  Treasury expanded the range of TT&L collateral to include asset-backed  securities and also agreed to accept commercial loans in less restrictive  arrangements in its SDI program. Depositary institutions pay a uniform  interest rate on all deposits regardless of collateral type for both regular  TT&L investments and SDI investments.
Treasury restricts assets pledged in the TT&L and TIO programs to nine  collateral categories. (See table 12.) While any of the nine categories of  collateral may be pledged to secure TT&L funds, collateral pledged in the  TIO program is restricted to collateral types specified in the TIO auction  announcement. Certain assets are not acceptable in any of Treasury’s  short-term investment programs, such as mutual funds and obligations of  foreign countries. (See table 13.) As discussed earlier in this report,  collateral acceptable in the repo pilot program is restricted to Treasury  securities.
section_title: Collateral Allocation in Treasury’s Short- Term Investment Programs
paragraphs: Table 14 shows Federal Reserve data on the relative use of different  collateral types pledged for the TT&L and TIO programs.  The repo pilot  only accepts Treasury securities.  According to the Federal Reserve,  mortgage-backed securities make up 60 percent of the collateral  depositary institutions pledged for TT&L funds. In the TIO program,  commercial loans make up half of the collateral depositary institutions  pledged to secure Treasury funds. (See table 14.) Forty percent or less of  the collateral pledged in the TT&L and TIO programs is made up of  acceptable collateral types other than mortgage-backed securities and  commercial loans.
section_title: Special Direct Investments
paragraphs: To address capacity limits in its operating cash balance, Treasury added  the SDI program in 1982. This provides Treasury additional TT&L capacity  when operating cash balances are unusually high. While collateral used to  secure Treasury’s cash in regular TT&L accounts must be held by a  Federal Reserve Bank (FRB) or a Treasury-authorized FRB-designated  custodian, in an SDI, the depositary institution may use collateral retained  on its premises in what is called an off-premises collateral arrangement.  Acceptable collateral in the SDI program includes student loans,  commercial loans, and one-to-four family mortgages, the last of which is  only accepted in the SDI program. SDI balances earn the same rate of  return as TT&L balances and may be withdrawn at any time by Treasury.
Since 2002, the number and dollar amount of SDIs have decreased, in part  because of the establishment of the TIO program in 2003. (See fig. 7.)
Collateral Value  for Securities or  (% of Market Value)
Deposited /7 (%  of Market Value)
Balance)
Balance)
U.S. Government Guaranteed Agencies:  U.S. Government Sponsored Enterprises: Collateralized Mortgage Obligations  (AAA)
U.S. Government Agency Guaranteed Loans  Commercial and Agricultural Loans: 1-4 Family Residential Mortgages /6 * This document is for informational purposes only and subject to change without notice.
It is not binding on either the Treasury or the Federal Reserve System (FRS) in any particular transaction.
All pledged collateral must be transferable and owned by the depositary free and clear  of all liens, charges, or claims.  A detailed list of acceptable collateral for the TT&L Program  can be obtained from Treasury's Bureau of the Public Debt website (www.treasurydirect.gov).
section_title: Appendix III: The TGA Was Treasury’s Only Investment between 1974 and 1978
paragraphs: Although the Department of the Treasury (Treasury) receives an implicit  return on Treasury General Account (TGA) balances from the Federal  Reserve, the TGA is not considered an official short-term investment  vehicle. However, between 1974 and 1978 a number of circumstances  forced Treasury to hold the bulk of its total operating cash balance in the  TGA.
Prior to 1977, Treasury Tax & Loan (TT&L) depositaries were not  authorized to pay interest on Treasury’s deposits. At the time, Treasury  placed cash in these depositaries, which provided a number of services,  such as handling subscriptions to U.S. securities, issuing savings bonds,  and processing Treasury checks. However, a number of developments  between 1964 and 1974 brought an end to this practice. Tax receipts grew  significantly, increasing the size of TT&L accounts. Interest rates had risen  considerably, providing significantly greater earnings potential on TT&L  balances. There was a decline in the number of Treasury-related services  that banks performed. In addition, there was no correlation between the  level of service a bank provided and amount of funds it received.  As a  result, it was possible for banks that provided only a few services to  receive large TT&L deposits for which they paid no interest while other  banks that provided numerous Treasury-related services received too little  interest on TT&L deposits to offset their costs.
In 1974 Treasury concluded that the benefits depositary institutions  received from holding TT&L funds substantially outweighed the aggregate  value of the services that these institutions provided. In order to recoup  some of its lost earnings, Treasury pursued what it described as a “stop- gap” policy. Treasury moved all of the funds it reasonably could from its  non-interest-bearing TT&L accounts to its Federal Reserve account, the  TGA.  In turn, the Federal Reserve acted to offset the drain on reserves  caused by increasing the size of its securities portfolio. This then led to  larger weekly remittances to Treasury. In 1976 Treasury estimated that it  received $365 million in indirect earnings from the Federal Reserve in this  way.
This shift of placing almost all excess cash in the TGA created problems  for the conduct of monetary policy by increasing the volatility of the TGA.  The average weekly swings in the TGA balance more than doubled from  $533 million to $1,388 million between 1974 and 1975. As a result, the  Federal Reserve had to make frequent large purchases of securities in  order to reinvest the funds that the TGA was absorbing from the banking  system. On some occasions the Federal Reserve was unable to offset the  large swings in the TGA balance through temporary open market  operations, and it had to request that Treasury redeposit funds in the  TT&L accounts to avoid having to make outright purchases of securities in  the secondary market. In 1977 legislation was enacted authorizing  Treasury to earn interest on its short-term investments. Treasury began  investing a greater share of its operating cash balance in interest-bearing  accounts at commercial banks in 1978, leaving a smaller stable amount  invested in the TGA.
section_title: Appendix IV: Timeline of Key Treasury Actions for the Treasury Tax and Loan and Term Investment Option Programs
paragraphs: ppendix IV: Timeline of Key Treasury   for the Treasury Tax and Loan and vestment Option Programs  Deprtment of the Treasury (Treasury) receive report on Federl Reerve Bnk ctual trsaction from the previousy,  nd Treasury’s  for  Regionl  Finncil  Center  report  on  the  Atomted  Clering  House  pyment  tht  will  ettled ot of the Treasury ccont tht dy.
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Gray boxes indicate events that do not happen on a daily basis.
section_title: Appendix V: Changes in the TGA Target Balance and the Federal Reserve’s Open Market Operations
paragraphs: While the Department of the Treasury (Treasury) has not made permanent  changes to the Treasury General Account (TGA) balance since 1988,  Treasury continues to adjust the TGA balance and modify its target  balance to accommodate major corporate and tax due dates. (See table  15.)
subsections: section_title: The TGA and the Federal Reserve’s Execution of Monetary Policy
paragraphs: Treasury also seeks to keep the target balance stable to assist the Federal  Reserve in executing monetary policy. If Treasury’s TGA balance exceeds  or falls short of its target, the Federal Reserve must neutralize the change  in overall reserves through market interventions.  If Treasury has greater  amounts of short-term cash than can be invested through other investment  programs, the cash would have to be deposited into the TGA. If the TGA  exceeded its $5 billion target, the Federal Reserve would have to inject  large amounts of reserves into the market. On the other hand, insufficient  funds in the Treasury’s total operating cash balance could cause the TGA  to fall below its target, and the Federal Reserve would have to take  reserves out of the system. (See fig. 9.)
All depositary institutions in the United States are required to maintain a  certain percentage of their customers’ checking account balances as  reserves. A depositary institution with a temporary shortfall in reserves  can borrow funds from an institution with a surplus of reserves on a short- term basis. The interest rate that banks charge one another for this short- term lending is known as the federal funds rate. By adding or draining the  level of reserves in the banking system, the Federal Reserve is able to  influence the supply of reserves and thus the federal funds rate, which in  turn has a significant effect on a wide range of short-term interest rates  and, ultimately, the economy as whole.
The two most common operations the Federal Reserve uses to intervene  in the market are outright securities purchases and repurchase agreements  (repo). To address a permanent increase in the demand for reserve  balances, the Federal Reserve purchases securities outright in the  secondary market. When the Federal Reserve purchases securities, it  credits the account of the security dealer’s depositary institution, thereby  increasing the aggregate level of reserves in the banking system. Securities  purchased in these operations are kept in the System Open Market  Account, or SOMA, portfolio.  Currently, the SOMA portfolio contains only  U.S. Treasury debt.
To make more frequent seasonal or daily adjustments to aggregate reserve  levels, the Federal Reserve uses repos. To temporarily add (drain) reserve  balances to (from) the banking system, the Federal Reserve makes a  collateralized loan (borrows against collateral) for a period typically  ranging from 1 to 14 days. For repo transactions, the Federal Reserve  primarily accepts Treasury securities for collateral, but also accepts a  small amount of federal agency securities.
section_title: Appendix VI: Detailed Methodology of Calculations
subsections: section_title: Value of Spread between TIO and TT&L Rates in 2006
paragraphs: In fiscal year 2006, the Department of the Treasury (Treasury) invested a  daily average of $12.4 billion in Term Investment Option (TIO) offerings,  or almost 60 percent of its short-term investment balance. The rates  earned through TIO investments were on average 17 basis points higher  than the rates earned on Treasury Tax and Loan (TT&L) deposits over the  same periods. We calculate that the value of this spread over the course of  2006 was about $20 million.
To determine the value of this spread between TT&L and TIO rates, we  compiled publicly available data on TIO auction award amounts, TIO  auction rates, and average TT&L rates earned over the period of each TIO  auction. Treasury conducted 103 TIO auctions in fiscal year 2006. To  calculate the value of the spread between the TIO rate and average TT&L  rate per auction, we first calculated the spread between the two rates for  each auction. We then calculated the value of that spread in dollars by  adjusting the rate for length of term, and multiplying it by the auction  award amount. We then added up the spread value in dollars for each of  the 103 auctions to obtain a total. (See table 16 below.)
section_title: Estimated Return Treasury Could Earn by Reallocating Funds from TT&L to Repos
paragraphs: We estimate that if Treasury had earned an overnight repo rate on most of  the funds that it invested in TT&L deposits in fiscal year 2006 instead of  the TT&L rate, Treasury could have potentially earned an additional $12.6  million. Treasury generally maintains at least $2 billion in the TT&L  program as a means of maintaining active participation in the program. We  calculated that Treasury’s balance in TT&L accounts exceeded this  minimum balance threshold in fiscal year 2006 on 276 calendar days by an  average of $7 billion. Altogether, the amount of available operating cash in  excess of this threshold totaled $1.9 trillion in fiscal year 2006, about three  times the amount necessary to meet the minimum balance.
When it set the current TT&L rate to 25 basis points below the federal  funds rate in 1978, Treasury considered overnight repos to be an  acceptable market-based comparison to TT&L deposits. The Federal  Reserve conducts overnight repos with its primary broker-dealers. We  estimate that if Treasury had invested this $1.9 trillion in a higher yielding  investment earning the same rate as Federal Reserve repos, Treasury  could have earned an additional $12.6 million in fiscal year 2006, or 5.4  percent of its return on available TT&L deposits. (See table 17.)
To calculate this potential increase in gross return on Treasury’s short- term investments, we compiled publicly available data on short-term  investments in fiscal year 2006 from Daily Treasury Statements (DTS) and  the Federal Reserve.  We calculated the daily balance invested in TT&L  accounts, including Special Direct Investments (SDI), from DTS data as  well as the effective TT&L rate. We also calculated the effective rate  earned by the Federal Reserve on overnight repos for each available  calendar day in 2006.  On days where rate data were not available because  an overnight repo was not in effect, we assumed a rate by averaging the  first available rates before and after the missing rate. There were 276  calendar days in fiscal year 2006 where the daily TT&L Main Account  balance exceeded $2 billion. For each day, we determined (1) what  Treasury actually earned from the residual balance over $2 billion by  multiplying the balance amount by the effective TT&L rate for that day,  and (2) what Treasury could have earned from the residual balance by  multiplying the balance amount by the actual or estimated Federal Reserve  overnight repo rate.  We then calculated the total dollar spread between  these two returns for all 276 days.
section_title: Appendix VII: Comments from the Department of the Treasury
section_title: Appendix VIII: GAO Contact and Staff Acknowledgments
subsections: section_title: Acknowledgments
paragraphs: In addition to the contact named above, Jose Oyola (Assistant Director),  Jessica Berkholtz, Amy Bowser, Tara Carter (Analyst-in-Charge), Richard  Krashevski, Thomas McCabe, Matthew Mohning, Nicolus Paskiewicz, and  Albert Sim made contributions to the report. Melissa Wolf, James  McDermott, Dawn Simpson, and Dean Carpenter also provided key  assistance.
section_title: Glossary
subsections: section_title: Delivery-Versus-Payment (DVP) Arrangement
paragraphs: The repo trading arrangement in which the party and counterparty  complete the clearing and settlement processes.
section_title: Dynamic Investment
paragraphs: Automatic deposits that occur when depositary institutions agree to  accept direct deposits from the Department of the Treasury (Treasury)  when Treasury cash receipts are greater than anticipated. Dynamic  investments are made hourly throughout the day and are Treasury’s only  option for placing late-day cash.
section_title: Haircut
paragraphs: The percentage that is subtracted from the market value of the collateral.  The size of the haircut reflects the perceived risk associated with the  pledged assets.
section_title: Repurchase Agreement (repo)
paragraphs: The transfer of cash for a specified amount of time, typically overnight, in  exchange for collateral. When the term of the repo is over, the transaction  unwinds, and the collateral and cash are returned to their original owners,  with a premium paid on the cash.
section_title: Special Direct Investment (SDI)
paragraphs: An investment vehicle that provides Treasury additional Treasury Tax and  Loan (TT&L) capacity when operating cash balances are unusually high. In  an SDI, the depositary institution may use collateral retained on its  premises in what is called an off-premises collateral arrangement.  Acceptable collateral in the SDI program includes student loans,  commercial loans, and one-to-four family mortgages, the last of which is  only accepted in the SDI program. SDI balances earn the same rate of  return as TT&L balances and may be withdrawn at any time by Treasury.
section_title: Term Investment Option (TIO)
paragraphs: Deposits in depositary institutions that allow Treasury to auction off  portions of its excess cash at a competitive rate for a fixed number of  days.
section_title: Treasury General Account (TGA)
paragraphs: Treasury’s bank account, through which most federal receipts and  disbursements flow.  It is maintained across the 12 Federal Reserve Banks  and rolled into one account at the end of each business day.
section_title: Treasury Tax & Loan (TT&L)
paragraphs: A collaboration between Treasury and over 9,000 commercial depositary  institutions that collect tax payments. About 1,000 of these depositary  institutions also hold funds and pay interest to Treasury.
section_title: Triparty Arrangement
paragraphs: The repo trading arrangement in which an independent custodian bank  acts as an intermediary between the two parties in the transaction and is  responsible for clearing and settlement operations.