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o CONFIDENTIAL December 1, I936 TREASURY FINANCING (This memorandum has "been p r e p a r e d a t Chairoan E c c l e s 1 r e q u e s t , and i n view of i t s i m p o r t a n t bearing on the B o a r d ' s problems, he haa asked ne t o f u r n i s h a copy t o each of the Governors. S . A. G.) c COITFIDMTIAL To: Board of Governors From: L. K. P i s e r December 1, Subject: Treasury financing Summary.— I t i s believed that about $400,000,000 of cash should be raised between December and March. Instead of including t h i s in the December financing, it-would be preferable to raise the cash by the sale of b i l l s , of which $200,000,000 would mature on March l 6 , .$100,000,000 on March 17, and $100,000,000 on March 18. These maturities would naintain greater s t a b i l i t y in the money market. They would also give more f l e x i b i l i t y to the financing, since the issues could e i t h e r be refunded or repaid, depending on the cash position of the Treasury on March 15. I t i s suggested that the amount of s e c u r i t i e s issued on December 15 •provide for refunding of the December and February note maturities and the December 15 h i l l n a t u r i t i e s , a t o t a l of $1,200,000,000. This could be handled e n t i r e l y by a new bond i s s u e . I t i s not recommended that holders of the maturing notes be given a choice of refunding into notes as well as i n t o the new bond issue, because the demand for notes would probably be n e g l i g i b l e ; t h i s i s indicated by the experience in the March and June financing and by the p r o b a b i l i t y that, since the market i s not expecting notes, holders of maturing issues may already have largely completed arrangements for exchanging them in the market for other notes or medium-term bonds already outstanding. I t i s suggested that the December financing consist of new 2 5/g percent Treasury bonds of 1957-1960. On the b a s i s of Monday's closing b i d prices t h i s issue would s e l l at a premium of about IS/32 p o i n t s . A 2 5/s percent bond i s preferred to a 2 3 / ^ percent bond, since even a 30-year bond with the l a t t e r coupon would probably s e l l a t over 102. I t i s -preferred to a 2 l / 2 percent bond, p a r t l y because n a t u r i t i e s are already f a i r l y large for the period where a 2 l / 2 percent bond might be sold. Furthermore, unless the market continues to advance, i t night l a t e r be necessary to issue a 2 5/8 percent bond. I t would seem more orderly to use the 2 5/s percent coupon before instead of a f t e r the 2 1/2 percent coupon. I t i s suggested that the remaining System Account maturities be replaced by new bonds. CONFIDENTIAL Page # 2 T re as ury re q uiremen t s.— The following table summarizes Treasury cash requirements from November 1, 193&. to June 30, 1937* (In millions of d o l l a r s ) Funds required: Cash expenditures, excluding statutory debt retirement and issuance of s e c u r i t i e s to veterans and to old age reserve account .• Redemption of matured debt obligations and veterans' bonds and reduction of checking accounts of Governmental agencies, l e s s sales of U. S. Savings bonds Public debt m a t u r i t i e s : December 15 - Treasury notes December 15 - Treasury b i l l s ,.. April 15 - Treasury notes June 15 - no m a t u r i t y November 1 to June 30 - r e g u l a r weekly Treasury b i l l s Total funds r e q u i r e d Proposed funds: Receipts, general and special accounts... New public debt issues: December 15 - new note or bond issue, or both March 15 - new note or bond issue to refund April 15 maturity June 15 - no new i ssues November 1 to June 30 - regular weekly Treasury b i l l s Working balance, October 31, 1936 Total proposed funds Working balance, June 30, 1937 l7 *... Refunding Cash Total -- ^>59O ^,590 — 320 320 790 l / H00 500 — — — — 790 ^-00 500 1,750 zz 1,750 3,^0 MlO — U,26O U,26o 1,190 — 1,190 500 — — 500 li75O — 1.750 — 1,290 1,290 3,^0 5,550 8,990 — 6U0 6U0 Including February 15,' 1937, maturity of $^0,000,000. ~ C0N7ID3ITTIAL Page #3 Prom the t a b l e i t would appear that i f the Treasury does not r a i s e any additional new cash before the end of the f i s c a l year the working balance at t h a t time w i l l be at a lower level than has r e c e n t l y been customary. In addition, there are a number of u n c e r t a i n t i e s as regards the accuracy of these f i g u r e s . Receipts include the expected revenues from a number of new taxes — the tax on u n d i s t r i b u t e d earnings, the tax on unjust enrichment, taxes on c a r r i e r s and t h e i r employees, and social security taxes — which aggregate nearly $900,000,000, In addition to the question of the accuracy of the estimates of y i e l d of new taxes, there i s the f u r t h e r p o s s i b i l i t y that c o l l e c t i o n of the taxes may be withheld by injunction and even that the taxes may be i n v a l i d a t e d by Supreme Court decision. There i s also the p o s s i b i l i t y t h a t r e l i e f expenditures may exceed the $500,000,000 a d d i t i o n a l amount mentioned in the September budget statement and included in the above figures. For these reasons i t would appear t h a t the Treasury should keep a r e l a t i v e l y strong cash p o s i t i o n u n t i l these u n c e r t a i n t i e s are removed. Or more importance i s t h e question of the timing of r e c e i p t s . Most of the large increase in r e c e i p t s for the current f i s c a l year w i l l occur on and a f t e r March 15. The d i s t r i b u t i o n of Treasury cash requirements by financing periods i s estimated as follows: (In millions of dollars) October 31 November 1 to December lU, December 15 to March l H . . , March 15 to June 30 , Casn requirements — Working balance at end of period 1,290 500 790 ^00 290 -350 6U0 CQHFIBBTFIAL Page fk The working balance will f a l l to about $800,000,000 on December lkt just prior to the quarterly income tax receipts, and to $300,000,000 on March 1*4-, even if collection of new taxes during this period reaches the expected amount. If none of the neu taxes should be collected the balance would be practically eliminated by March lU, In view of this situation, i t i s believed that some new cash should be raised between December and March. A figure of $U00,000,000 i s suggested. This would bring the total of cash raised during the fiscal year through public debt issues, including U. S. Savings bonds, to $1,220,000,000, as compared with the September estimate of $1,250,000,000, I t would leave the working balance at the end of the year at about $1,000,000,000, assuming the new taxes are accurately estimated. It would raise the March lh working balance to $700,000,000, which would probably be sufficient in view of the heavy tax receipts on March 15« If any additional cash should be needed before the end of the fiscal year because of an overestimate of receipts or an underestimate of expenditures i t could be raised by new issues between March and June, Instead of including the suggested $^00,000,000 in the December financing, i t would be preferable to raise the cash by the sale of b i l l s , of which $200,000,000 would mature on March l6, $100,000,000 on March 17, and $100,000,000 on March 18, These maturities would maintain greater stability in the noney market anc" would increase the flexibility of Treasury financing. At present there are no maturities on March 15, COHFIDMTIAL Page #5 I t i s estimated t h a t the unusually large tax c o l l e c t i o n s around t h a t date w i l l r e s u l t in the payment of about $500,000,000 to the Treasury. Unless there are m a t u r i t i e s around t h a t date, excess reserves would decline by $500,000,000. Should $4-00,000,000 of M i l s nature around March 15, however, t h i s decline i n excess reserves would be l a r g e l y eliminated. Another advantage of i s s u i n g "bills over i s s u i n g longer-tern s e c u r i t i e s i s t h a t the "bills could he refunded or repaid depending on the cash p o s i t i o n of the Treasury on March 15. I t i s suggested that the amount of s e c u r i t i e s issued on December 15 provide for refunding of the December and February note m a t u r i t i e s and the December 15 b i l l , m a t u r i t i e s , a t o t a l of $1,200,000,000. handled e n t i r e l y by a new bond i s s u e , This could be Such a program would be well within the magnitude of t r a n s a c t i o n s to which the market has been accustomed. I t i s not recommended t h a t holders of the maturing notes be given a choice of refunding i n t o n o t e s as well as i n t o the new bond i s s u e . The arguments i n favor of such an option are t h a t a large p o r t i o n of the maturing notes are held by banks and by the System Open Market Account. In view of the aversion of banks to increasing further t h e i r of long-term Government's and the d i f f i c u l t y portfolio of replacing m a t u r i t i e s by purchasing notes i n the market, there would be some advantage to giving holders of the maturing notes the option of refunding i n t o other n o t e s . This might be an additional i s s u e of the Juno 19Ul notes a t 101. The Page #b arguments in favor of such an issue appear to be overbalanced, however, by a probable negligible demand, based on experience in the March and June financing. The demand might be even smaller than was the case in these earlier periods, since the market i s not expecting notes, and holders of maturing issues may already have largely completed arrangements for exchanging then in the market for other notes or medium-tern bonds already outstanding. I t would not see^s desirable, therefore, to include an additional issue of notes in the new financing. The Government security market.— The Government security market has been exceptionally strong since the f i r s t of November, and the yields on Treasury securities have reached new low levels. As compared with the levels of early November the largest declines in yields have occurred in the medium-term bonds. The yields on Treasury bonds callable in 5 years are down on the average about 0*27 percent. down about 0.20 percent. t o 10 Treasury notes are Treasury bonds maturing and callable within 5 years and Treasury bonds callable in 10 to 15 years are down O.17 percent, and Treasury bonds callable in more than 15 years are down 0.11 percent. The buying has been fddely distributed and has included commercial banks both in and out of New York, savings banks, insurance companies, and individuals. Purchases have been largest for commercial banks. As is indicated by the iecluie in yields, the largest demand has been for medium-term bonds. Offerings have continued relatively small, particularly for medium-term CONFIDENTIAL Page # 7 bonds. Holdings of New York City banks have shown i r r e g u l a r movements i n connection w i t h switching o p e r a t i o n s . Government security dealers, after increasing their net position to about $220,000,000 at the ti?ne of the September financing, reduced their position early this nonth to $110,000,000, the lowest level since August, More recently the dealers' position has increased slightly as they have purchased the "rights*, but holdS% of "rights" are relatively small for a date as near the financing as the present In view of the strength of the Government security market, the continued purchases by banks and other investors, and the substantial amount of funds s t i l l available for investment, there i s no question as to the ability of the market to absorb a longi-t@rm Treasury bond, provided, of course, i t were attractively priced. Such an issue would aid the Treasury in i t s future refinancing by the greater spreading of maturities and the consequent lessening of the refunding problem. The market, although preferring a medium-term bond issue, is expecting a long-tern issue.. Financing recomendations.— I t i s suggested that the December financing consist of new 2 5/g percent Treasury bonds of 1957-i960. A 2 5/g percent bond is preferred to a 2 3/U percent bond, since even a 30-year bond with the l a t t e r coupon would probably sell at over 102. It is preferred to a 2 l/2 percent bond, partly because maturities are already fairly large for the period where a 2 l/2 percent bond might be sold. This would be about 19H9. There is a steady stream of issues COTIDESTI.AL Page #8 callable from I9U3 to 19U9 and a large amount of maturities from 19U5 to I9U9. Under such circumstances i t would seem desirable to leave this period open against a time in the future when i t ray "be desirable to sell a short-term issue. For example, i t nay not "be possible to refund .•'•'• a l l of the large maturities up to I9U9 into long-term securities as they come due and consequently i t may be of considerable help to the Treasury to have available an open period around 19^9 which could be used for refunding these maturities into short-term issues. Furthermore, if a 2 l/2 percent issue were floated on December 15 and the market reoained at present levels, i t might be necessary in subsequent financing to raise the coupon rate in filling the open periods of later before years. It would seem more orderly to use the 2 5/8 percent coupon/instead of after the 2 l/2 percent coupon, A call period of three years is suggested for the new issue, since that would be accordance with previous practice as regards an issue of this size. From the yields on outstanding securities based on Monday's closing bid prices, there i s calculated in the following table the estimated yield and price on the suggested issue and also on other possible issues. It will be noted that on the basis of the current market an issue callable in 1957 would sell to yield approximately 2.59 percent. If this issue were given a coupon rate of 2 5/g percent i t would sell at a premium of about IS/32 points. CONFIDENTIAL Page #9 Estimated yield Coupon rate Estimated price Notes maturing December 15, 19U1 1.05 1 lA 100 31/32 Bonds callable December 15, 191+9 2.U0 21/2 101 U/32 i?5^ 2.55 25/8 1013/32 1955 1956 2.57 2.58 2 5/8 2 5/g 100 26/32 100 22/32 1957 195s 1963 2.59 2.59 2.62 2 5/g 2 5/g 2 3/U 100 ig/32 10019/32 10216/32 In calculating the data in the preceding table the coupon rate was placed so as to £ive a premium of about 1/2 to 1 l/2 points. The lower limit is determined by the price on the "rights", 101 9/32 on the December and February issues. These quotations represent interest payable to December 15 in the amount of 3/32 and U/32 respectively, plus 1 6/32 and 1 5/32, an amount which represents the market valuation of the conversion price. Until the first of November these issues sold at only about 3/*+ °f a point above a no-yield basis, and the September 193^ notes just before the September financing was announced similarly sold at about that level. It is not necessary to place the price of a new issue at above 3/^ of a point, since some of the recent purchases are probably of a speculative nature. If a new issue should be put out which would sell at a price materially below the level of 3/U of a point it would unsettle the market. The lover CONFIDENTIAL Page #10 amount i n t h e range, l / 2 of a p o i n t , a l s o g i v e s t h e Treasury a margin of s a f e t y f o r changes i n the market between t h e time of t h e announcement and t h e time t h e "books are c l o s e d and gives d e a l e r s a r e a s o n a b l e p r o f i t f o r in effect underwriting the issue. If an issue were floated at above the upper level, 1 l/2 points, an exorbitant profit to the market would result. System Open Market Account.— There i s now held in the System Open Market Account approximately $7^1000,000 of the notes maturing in December and $85,000,000 of the notes maturing in February, which will be refunded in December. If the Treasury should offer a new bond issue in exchange for these notes, i t seems likely that the notes should be sold in the market and should be replaced by the new bonds, raising to $^95»OOO,OOO total holdings of bonds in the Account maturing in more than five years. This i s probably the maximum that should be held by the System Account in view of the possibility that the Account may to a considerable extent be liquidated over the next few years. As an Indication of the policy of commercial banks concerning the distribution of their holdings of Government securities, New York City banks hold about lk percent of their direct obligations in the form of bonds maturing before 19U9 and 17 percent after 19^9» These banks hold a smaller proportion of bonds than member banks in any other reserve classification, in view of the fact that they also hold the largest proportion of demand to total deposits, 95 percent. CONFIDENTIAL Page # 1 1 The System Account should p r o b a b l y h o l d a s m a l l e r p r o p o r t i o n of bonds than do How York City banks, s i n c e a rauch l a r g e r p r o p o r t i o n of t h e System portfolio is likely to be liquidated in the future. If a l l of the natTiring notes should be exchanged for a new long-ten bond, bonds maturing before December 31, 19U9, would represent 7 percent of total holdings in the Account and those maturing after 19^9 would represent 15 percent. The figure of $^95,000,000 suggested, above for bonds maturing in more than five years would leave a margin of $105,000,000 for possible purchases of Treasury bonds in the market in periods of temporary T?eakness. Consideration might also be given to the question of disposing of the System's holdings of some of the issues now selling on a low-yield basis in relation to their maturity and purchasing issues nor selling on a relatively high-yield basis. For example, part of the $85,000,000 of December 1939 notes, which yield 0.73 percent, might be exchanged for March 19^0 notes, which yield 0.89 percent, and the $631,000 of Treasury bonds of I9U7-I952, which yield 2.02 percent, night be exchanged for bonds of I9U6-I9U9, which yield 2.OS percent, or for bonds of I9H8-I951, which yield 2.2Q percent. A suggestion has been made by the manager of the System Open Market Account that a change should be made in the method of handling profits on sales of securities. Under the present method the System does not exchange i t s maturing issues directly with the Treasury for new issues, but sells CONFIDENTIAL Page #12 maturing i s s u e s and purchases new or o t h e r i s s u e s in the market. This method r e s u l t s i n a p r o f i t on maturing i s s u e s and the purchase of new i s s u e s at about a p o i n t premium, which g i v e s the System an i m e d i a t e and reduces the f u t u r e y i e l d . profit I t would appear to be sounder p r a c t i c e , as suggested by the manager of the Account, to u s e the r e a l i z e d p r o f i t s to w r i t e down the book value of new s e c u r i t i e s purchased. Such a procedure would give the sane r e s u l t s as would be r e a l i z e d by a d i r e c t exchange of maturing i s s u e s with the Treasury and the same r e s u l t s as o b t a i n e d p r i o r to enactment of the Banking Act of 1935. o FEB JAN o YIELDS ON GOVERNMENT OBLIGATIONS 1936 5 YEAR TREASURY NOTES TREASURY BONDS OF 1945-47 TREASURY BONpS OF 1955*60 MAR APR MAY JUNE JULY AUG SEPT NOV DEC o o o YIELDS ON TREASURY NOTES AND BONDS NOV. 30, 1936 PER CENT 2.5 2.0 1.5 XTRCASURV NOTES • TREASURY BONDS NUMBERS OPPOSITE ISSUES REPRESENT LENGTH OF CALL PERIOD BILLIONS OF DOLLARS 2.5 OUTSTANDING 0 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 I960 1961 1962 1963 o o U.S.TREASURY OBLIGATIONS OUTSTANDING BILLIONS OF DOLLARS OCT .31,1936 4 BILLIONS OF DOLLARS 4 AMOUNT MATURING BY CALENDAR YEAp 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 AMOUNT CALLABLE BY CALENDAR YEAR 1959 I960 1961 1962 1963 o UNITED STATES GOVERNMENT SECURITIES HELD BY FEDERAL RESERVE BANKS BILLIONS OF DOLLARS 0 Mar. Apr MATURITY DISTRIBUTION BY PERIODS-CUMULATED o o SYSTEM OPEN MARKET ACCOUNT MATURITY DISTRIBUTION OF UNITED STATES GOVERNMENT SECURITIES BY YEARS NOV. 25 ,1936 : . ; ' i ; [ = ; • • ' : ; -TTT :!::: • MILLIONS Of DOLLARS 600 i: i! Fm T-r;-r . . . : I !| '• 700 i i 1 • • * : 3ILLS : M0TF.J1 Bd 600 1 n [\\ .: : - i . : : : :;. . : : 100 : \ 77 7 7 / 77 / 7 ; 7 7 \\ i f $ ;• : ; •: —< H R+H t i ! y 1 • • . • : : • • • • i i f it i ; . I • : • i ^ ! ; j i y Y / VJ 1 1936 1937 1938 1939 1940 1941 • frrfj-1- t * / 77 77 77 / 1 --;- - : . j • i1 : 1 j/ 0 1ill] i \\ w • 1 • • • - • t j 200 • • ' :j. 400 300 30NDS • : 1 Ll ' ' 500 i : • 1 || 1942 1943 1944 1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 I960 1961 1962 1963 o o SYSTEM OPEN MARKET ACCOUNT MATURITY DISTRIBUTION OF UNITED STATES GOVERNMENT SECURITIES BY ISSUES MILLIONS OF OOLLARS Dec. Jan. NOV. 25,1936 Feb. Mar o
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