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PROBLEMS ASSOCIATED WITH FEDERAL DEBT
MANAGEMENT

HEARINGS
BEFORE THE

SUBCOMMITTEE ON
DOMESTIC MONETARY POLICY
OF THE

COMMITTEE ON
BANKING, FINANCE AND URBAN AFFAIRS
HOUSE OF REPRESENTATIVES
NINETY-SEVENTH

CONGRESS

SECOND SESSION

M A R C H 23 A N D 24, 1982

Serial No. 97-68
Printed for the use of the
Committee on Banking, Finance and Urban Affairs

U.S. GOVERNMENT PRINTING OFFICE
95-448 O




WASHINGTON: 1982

HOUSE COMMITTEE ON

BANKING,

FINANCE AND URBAN

AFFAIRS

FERNAND J. ST GERMAIN, Rhode Island, Chairman
HENRY S. REUSS, Wisconsin
J. WILLIAM STANTON, Ohio
HENRY B. GONZALEZ, Texas
CHALMERS P. WYLIE, Ohio
JOSEPH G. MINISH, New Jersey
STEWART B. McKINNEY, Connecticut
FRANK ANNUNZIO, Illinois
GEORGE HANSEN, Idaho
PARREN J. MITCHELL, Maryland
JIM LEACH, Iowa
WALTER E. FAUNTROY, District of
THOMAS B. EVANS, JR., Delaware
Columbia
RON PAUL, Texas
ED BETHUNE, Arkansas
STEPHEN L. NEAL, North Carolina
NORMAN D. SHUMWAY, California
JERRY M. PATTERSON, California
STAN PARRIS, Virginia
JAMES J. BLANCHARD, Michigan
ED WEBER, Ohio
CARROLL HUBBARD, JR., Kentucky
BILL McCOLLUM, Florida
JOHN J. LAFALCE, New York
GREGORY W. CARMAN, New York
DAVID W. EVANS, Indiana
GEORGE C. WORTLEY, New York
NORMAN E. D'AMOURS, New Hampshire
MARGE ROUKEMA, New Jersey
STANLEY N. LUNDINE, New York
BILL LOWERY, California
MARY ROSE OAKAR, Ohio
JAMES K. COYNE, Pennsylvania
JIM MATTOX, Texas
DOUGLAS K. BEREUTER, Nebraska
BRUCE F. VENTO, Minnesota
DAVID DREIER, California
DOUG BARNARD, JR., Georgia
ROBERT GARCIA, New York
MIKE LOWRY, Washington
CHARLES E. SCHUMER, New York
BARNEY FRANK, Massachusetts
BILL PATMAN, Texas
WILLIAM J. COYNE, Pennsylvania
STENY H. HOYER, Maryland

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY

WALTER E. FAUNTROY, District of Columbia, Chairman
PARREN J. MITCHELL, Maryland
GEORGE HANSEN, Idaho
STEPHEN L. NEAL, North Carolina
RON PAUL, Texas
BILL McCOLLUM, Florida
DOUG BARNARD, JR., Georgia
BILL LOWERY, California
HENRY S. REUSS, Wisconsin
JAMES J. BLANCHARD, Michigan
ED WEBER, Ohio
CARROLL HUBBARD, JR., Kentucky
JAMES K. COYNE, Pennsylvania
BILL PATMAN, Texas




HOWARD LEE, Staff Director
(II)

CONTENTS
Page
1
45

Hearings held on:
March 23, 1982
March 24, 1982
STATEMENTS
Axilrod, Stephen H., Staff Director for Monetary and Financial Policy, Board
of Governors of the Federal Reserve System
Bunting, David, Managing Director, First Boston Corp., and president of the
Association of Primary Dealers in U.S. Government Securities
Napoli, Daniel, vice president/manager, government securities trading, Merrill Lynch
Taylor, David G., executive vice president, Continental Illinois National Bank
and chairman of the Government and Federal Agencies Securities Committee of the Public Securities Association; accompanied by Frank Smeal,
partner of Goldman Sachs and Co., and immediate past chairman of the
above committee
Stalnecker, Hon. Mark E., Deputy Assistant Secretary of the Treasury for
Federal Finance
Sternlight, Peter D., Senior Vice President, Federal Reserve Bank of New
York

31
107
Ill

46
4
34

ADDITIONAL MATERIAL SUBMITTED FOR INCLUSION IN T H E RECORD
Stalnecker, Hon. Mark E.:
Charts submitted to accompany oral testimony
Response to request for additional information from:
Chairman Walter E. Fauntroy
Congressman Bill Patman
Taylor, David G., letter submitted:
Dated March 31, 1982, responding to Chairman Fauntroy's request for
additional information
Dated April 6, 1982, to Chairman Fauntroy, responding to Mr. Taylor's
request for certain recent Treasury Department reports

9
19
28
54
77

APPENDIXES
Appendix A:
Letter to hearing witnesses from Chairman Fauntroy containing eight
questions to which they should respond
132
Response of David G. Bunting, First Boston Corp
134
Response of Maria Fiorini Ramirez, Merrill Lynch
136
Response of David G. Taylor, Continental Illinois National Bank &
Trust Co., Chicago, 111
140
Additional correspondence
141,142
Appendix B: Statement of Treasury Assistant Secretary Roger W . Mehle
145
Appendix C: Debt financing: Graphics
160
Appendix D: Notice of subcommittee hearing
197
Appendix E: Miscellaneous material:
"Federal Deficits: A Faulty Gauge of Government's Impact on Federal
Markets," report of the Federal Reserve Bank of Philadelphia
217
"Financing the Deficit," report of the Federal Reserve Bank of San
Francisco
231




(in)

IV
Appendix E—Continued
Letter from Bank of America Executive Vice President John R. Vella,
dated September 2, 1982, in response to Chairman Fauntroy's request
for comment on certain issues
"The Dealer Market for U.S. Government Securities," report of the Federal Reserve Bank of New York




Pa®e

234
203

PROBLEMS ASSOCIATED WITH FEDERAL DEBT
MANAGEMENT
TUESDAY, MARCH 23, 1982
HOUSE OF REPRESENTATIVES,
COMMITTEE ON B A N K I N G , FINANCE AND U R B A N AFFAIRS,
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY,

Washington, D.C.
The subcommittee met, pursuant to notice, at 10:20 a.m., in room
2222, Rayburn House Office Building; Hon. Walter E. Fauntroy
(chairman of the subcommittee) presiding.
Present: Representatives Barnard, Patman, Hansen, and James
K. Coyne.
Chairman FAUNTROY. The subcommittee will come to order.
Today, we begin 2 days of hearings on the management of the
national debt by the Treasury of the United States. As each of us is
aware, the outstanding national debt of the United States stood at
$1,046 trillion on March 9, 1982. By the end of the year, it is expected to increase by at least an additional $120 billion and by
1985, the debt may easily increase by an additional $554 billion.
That potential growth is more than the total accumulated debt of
the United States in 1975. At that time, the national debt stood at
$534.53 billion. From then until 1981, the national debt grew an additional $442.40 billion for the total of $976 billion in 1981.
Aside from the obvious impact that such an addition to the national debt may have on various credit-sensitive industries and interest rates, there is the added impact that can arise from the daily
management of the sale of new and the refinancing of old debt.
The maturities offered, the interest rates contemplated, the size of
the offerings, and the parties to whom the debt may be sold can
have as profound an impact on interest rates as anything which
the Federal Reserve may do to influence the money supply. Yet,
this is a subject to which we have given little consideration and
thought.
These hearings are intended to focus attention on the mechanisms which are used to finance the debt, the objectives which the
Treasury considers when financing the debt, how these objectives
are viewed by the Federal Reserve and the marketplace, the weaknesses and strengths of the Government securities market, and the
impact of these factors on the costs to the Government of the debt.
The U.S. Government securities market is the focus of the most
powerful money decisions in this country and possibly throughout
the world. Large market participants are relatively few in number.
Yet, they affect an item of the national budget which exceeds $100




(l)

2
billion for interest payments and which composed 2.34 percent of
the GNP in fiscal year 1981 and is increasing. The size of the dollars about which we are speaking are so large that they defy conceptualization. Yet, they are very real and have a very real impact
on everything that any of us buy or sell. They have a very real
impact on the safety and soundness of our financial institutions
and on our national security. While these hearings do not encompass the inflationary impact of the debt, per se, we must recognize
that the debt of the Government has an enormous potential to
drive inflation to very high levels. I will not dwell on the debate
that can ensue from this comment, but I did not want it to go completely unnoticed.
Neither do I want to permit to go unnoticed the impact on Treasury financing of new and innovative forms of financial instruments
which have been a concern for so many of us recently. I am speaking particularly of Government guaranteed tax-exempt instruments issued by hospital authorities, some industrial development
authorities, and most recently, by financial institutions in the form
of all saver certificates. All of these instruments, of course, have a
desirable public purpose. They do, however, have a public cost of
which we ought to be knowledgeable. Those costs are ultimately reflected in the yields on Treasury securities and later in the costs of
money that you and I must pay for the mortgage on our house, the
loan on our car, and the credit card in our pocket.
I think it is fair to note that the Treasury, with the help of the
Federal Reserve, has made a conscious effort to limit shocks inflicted upon the capital markets. Whether the impact of Treasury borrowings can be further limited and how the impact will be minimized with the potential forthcoming deficits and refinancings is
another matter. As a part of these hearings, we will explore how
the Treasury proposes to finance this substantial addition to our
national debt, how the markets are likely to react to the debt increases, and the estimates of the administration of future debt, the
impact on interest rates, and the role which various advisory
groups and dealers have on the decisions of the Treasury.
These first 2 days of hearings are just the beginning of the inquiry by this subcommittee into one of the most important components which influence the price of credit, the supply of money, and
the operations of the Federal Reserve System. Today, we will first
hear from the Honorable Mark E. Stalnecker, Deputy Assistant
Secretary for Federal Finance of the Treasury. Next we will hear
from Stephen Axilrod, Staff Director of the Office of Monetary and
Financial Policy of the Board of Governors of the Federal Reserve,
and Peter Sternlight, Managing Director of the Federal Open
Market Committee and senior vice president of the New York Federal Reserve Bank.
Before we hear from Secretary Stalnecker I would like to yield to
my friend and distinguished ranking member of the subcommittee
at today's hearing, Mr. James Coyne.
Mr. COYNE. Thank you, Mr. Chairman.
Of course I am not a ranking member of the subcommittee
except for the moment, but I am very happy to fill in for some of
my colleagues.




3
I want to thank you for your introductory remarks. They focus
on the need to consider very closely the policies that the Treasury
and the Federal Government are pursuing with regard to the management of the Federal debt. Perhaps now more than any time in
our country's history we should focus on these questions because
obviously we have a very broad spectrum or difference of opinion
on the causes of the high interest rates afflicting our country
today.
The high interest rates paid by our Government to finance the
Federal debt, and what under President Reagan, has become a
much lower rate of inflation, has produced a spread between interest rates and inflation rates which is perhaps broader now than at
almost any time in our country's history.
The burden of financing that debt is, in real terms, greater than
at any time in our history. We seek alternatives to make that
burden less significant on the American taxpayer and also to see
what administrative tasks can be undertaken to encourage our
economy to bring interest rates down in step with the falling inflation rates.
Perhaps the greatest achievement of the Reagan Presidency has
been the success we have had in fighting inflation. In case you
have not heard, this morning at 9 o'clock the Labor Department
released figures showing the Consumer Price Index rose last month
by an annual rate of only 2.4 percent. Yet we are financing our
debt at rates of five, six and seven times as high.
We hope that our witnesses today can give us some insight into
what can be done to bring the debt cost down.
I have spoken with Assistant Secretaries Mehle, Sprinkel and
Secretary Regan on these issues and have proposed for their consideration a new innovative approach, the constant dollar debt instruments or purchasing power bonds, similar to those proposed by
Milton Friedman. Similar, also to those that have been introduced
in Great Britain in recent years. These bonds shift the risk of inflation off the shoulder of the American purchaser of debt instruments and deposit it fairly on the shoulders of the Federal Government.
If the Federal Government is serious about licking inflation, if
we are serious about assuring the American public that inflation is
going to stay down at 2 or 3 percent, then isn't it foolish for us to
be selling once-a-year, long-term bonds that are noncallable at a
constant interest rate of 14 percent or higher?
Does that not seem to be saying to the American public that inflation may be down now, but we are not sure it is going to stay
down? I hope we can persuade the powers that be in the Treasury
to consider the option of putting the burden of inflation on the
shoulders of the Government so that the Government keeps the
risk of losses from inflation. As long as the Government is a
winner from inflation in its debt management policy I am not sure
the Government will take the steps needed to insure that inflation
stays low.
Thank you, Mr. Chairman, for the opportunity to make some remarks. I look forward to the testimony we are about to hear.
Chairman FAUNTROY. As do we all. Thank you, Mr. Coyne.




4

Mr. Stalnecker, we are very pleased to have you before our subcommittee. We have your prepared testimony. You may proceed in
whatever manner you choose.
STATEMENT OF HON. MARK E. STALNECKER, DEPUTY ASSISTANT
SECRETARY OF THE TREASURY FOR FEDERAL FINANCE

Mr. STALNECKER. Thank you, Mr. Chairman. It is a pleasure to
be here this morning to discuss the objectives of public debt management and the financing techniques employed by the Treasury. I
also want to discuss our concerns regarding certain limitations imposed by the Second Liberty Bond Act, the governing statute for
Treasury debt management.
The public debt includes both marketable and nonmarketable securities issued by the Treasury. The tables attached to my statement present data on public debt securities and ownership over the
last decade. The Treasury issues these securities to finance both
budget deficits and off-budget deficits, including the borrowing
needs of the Federal Financing Bank, and to refund maturing debt.
My statement will deal primarily with Treasury marketable
issues, but I will also comment on the savings bond program and I
will be happy to answer any questions you may have regarding
other nonmarketable Treasury debt issues.
Treasury marketable securities include: First, Treasury bills,
which are sold at a discount and have maturities of less than 1
year; second, Treasury notes, which have semiannual interest coupons and maturities from 2 to 10 years; and third, Treasury bonds,
which have semiannual coupons and maturities in excess of 10
years.
The Treasury currently sells all of its marketable bills and
coupon securities in competitive auctions.
Announcements and sales of regular 13-, 26-, and 52-week bills
are on a well-known schedule that varies only on holidays or when
interrupted by congressional inaction on debt limit legislation.
With regard to coupon securities (notes and bonds), market participants are generally cognizant of the schedule of Treasury issues,
because of the regularity of the new issue and maturity cycles.
When the Treasury announces a sale of marketable securities, it
makes its announcement of the amount and other terms of the sale
available to the financial press and news wire services simultaneously, so that no news organization or market participant has
the advantage of advance information. The Treasury announces its
offerings far enough ahead of the sale dates to permit information
to be disseminated to all interested parties.
The Treasury does not purchase advertising for its marketable
securities, nor does it pay commissions to dealers who make markets in Treasury securities. Dealers and investors submit subscriptions to Treasury offerings directly to the Treasury or to Federal
Reserve banks and branches which act as the Treasury's fiscal
agency.
Dealers in U.S. Government securities often are awarded the
major share of issues in competitive auctions, and dealers subsequently distribute the securities to their customers. Dealer profits
or losses on the transactions are determined by the difference be-




5
tween the price the dealer pays to the Treasury and the price the
dealer receives from the customer. The dealer's capital is at risk in
each transaction, since the dealership is in effect trading for its
own account.
The Treasury accepts noncompetitive tenders in Treasury bill
and coupon auctions up to preannounced limits for each investor at
the average price of accepted competitive tenders. Allotments on
noncompetitive tenders are made prior to awards on competitive
bids. The purpose of accepting tenders on a noncompetitive basis is
to achieve a wider distribution of the securities by attracting
tenders from small banks and other investors who are generally
thought to have limited access to up-to-date information on market
conditions and would therefore be unwilling to bid on a competitive
basis for the securities.
REGULARIZATION OF ISSUES

Treasury debt management operations are directed to meeting
the U.S. Government's daily cash needs in order to assure that sufficient funds are available to pay obligations when and as due,
while providing a prudent cash balance. Our operations in the
market are conducted so as to minimize disruption and thereby
reduce the cost of our debt operations. Disruptive financing operations increase market uncertainty and hence the risk of purchasing securities, raising the rates paid on Treasury obligations. Treasury feels that the most important element in reducing market uncertainty about debt financing is the maintenance of a regular, predictable cycle of security issuance. Regularity of debt management
removes a major source of market uncertainty, and assures that
Treasury debt can be sold at the lowest possible interest rate consistent with market conditions at the time of the sale.
Predictabiity of debt management is important for another
reason, as well. Because Treasury securities are the benchmark for
the Nation's fixed income market, Treasury mismanagement of the
debt can destabilize the entire financial system.
Treasury has raised large amounts in the market over the past
few years. In fiscal year 1979, net market borrowing amounted to
$27.4 billion. This total rose to $83.6 billion in fiscal year 1980, and
to $90.5 billion last year. Although market interest rates were
historically high during this period, Treasury financing operations,
per se, did not disrupt the market. Leaving aside the issue of
whether a given level of deficit financing raises interest rates, the
conduct of debt management during this period prevented major
market dislocations. If these massive borrowing requirements had
been met in a haphazard manner, significant damage to the financial markets would have occurred. Unpredictable shifts of Treasury
financing out of one sector of the market to another based on interest rate forecasts or other "opportunistic" rationales could have seriously damaged market confidence and driven rates significantly
higher. This potential for damage to the market is yet another
reason to pursue prudent, predictable debt management operations.
The current regular issue cycles for Treasury financing through
sales of bills, notes, and bonds began in the early 1970's and are
still evolving. Treasury sells securities in all maturity ranges to




6
meet the needs of the broadest possible array of investors. Establishment of this regular pattern has contributed to a positive
market climate in several ways:
First, by creating a schedule of Treasury security auctions, different investors, as well as dealers, can plan portfolio strategies in advance.
Second, by establishing the potential Treasury new issue calendar in advance, other issuers, including federally sponsored agencies and private borrowers, can plan their financing operations
with more certainty.
Third, by spreading Treasury maturities evenly over time,
market disruptions are lessened and future refunding and borrowing operations can be facilitated.
Not all Treasury borrowing can be done on this regular schedule,
because there are seasonal flows in U. S. Government budget receipts and outlays. Receipts, for instance, tend to be concentrated
in the April-June quarter while outlays are generally constant
throughout the year. Seasonal borrowing to adjust for this mismatch in cash flows has been accomplished by selling cash management bills in the deficit period to mature in the cash surplus
period. These bills are also used to bridge cash shortfalls resulting
from an unanticipated drop in receipts or bulge in outlays. Nevertheless, regularity is a keystone of Treasury debt operations.
LONG-TERM BONDS

I would especially like to address the role of long bond issuance
in the overall scheme of Treasury debt management and regularization. Long bond issuance is an integral part of Treasury's regularization of debt operations. Two bond sales are normally conducted each quarter, with a 20-year bond auction in the last month of
the quarter and a 30-year bond sale as part of the mid-quarter refunding operation. The Treasury bond market is deep and liquid,
with cash market trading aided by a well-developed futures
market.
I would like to digress and talk about the futures market because
we do believe that the financial futures market does on balance facilitate the management of the public debt by shifting risk to those
able to bear it, by price discovery and dissemination, and by increasing the liquidity of the underlying cash market. This increase
in the underlying liquidity of the cash market for Treasury securities is in the Treasury's and Government's interest because it increases the attractiveness of its offerings, thus reducing the cost of
servicing the public debt.
In addition to meeting the investment needs of long-term portfolio managers, sale of long-term obligations extends the average life
of Treasury debt, which reduces the disruptive effects of frequent
Treasury operations to refund maturing issues. Almost one-half of
outstanding marketable debt matures within one year—I have included several charts which depict some of these points. This refunding need must be added to Treasury's new cash borrowing requirement to determine gross Treasury issuance in the market. Because of the short average maturity of outstanding Treasury debt—




7
see chart 2—long bond issuance must remain an integral part of
Treasury's debt management policy.
Some observers have suggested that Treasury should avoid the
sale of long-term securities when interest rates are high—and I
would like to put quotations around this high—in order to avoid
locking in high interest costs. However, any definition of high interest rates is extremely subjective and carries with it an implicit
forecast of future interest rates. If Treasury temporarily withdrew
from the bond market because it felt rates were high, market reaction to reentry in the long market could well be that rates were
low. Thus, reentry could be interpreted as a Government forecast
of higher rates in the future. Management of the debt based on interest rate forecasts would create tremendous uncertainty as to
Treasury's financing schedule and, over the long run, would result
in higher costs to the Government by reducing the market's willingness to bid in auctions. Therefore, a consistent policy of debt issuance across the maturity spectrum must be maintained without
regard to expected interest rate developments.
I would also note that, because of the large volume of maturing
obligations refinanced each year, interest expense on the public
debt is extremely sensitive to interest rate movements. This adds
volatility to the interest expense component of Federal outlays. As
interest rates move up and down, Treasury's interest expense also
rises or falls. As long as the debt outstanding retains this shortterm character, debt extension must be a part of our debt operations.
As interest rates decline in the next few years, as we expect they
will, because of the refinancing of our outstanding debt obligations
the Treasury will see a significant decline in interest expense due
to the interest rate declines in the marketplace. That raises a question as to how many of Treasury's eggs should be placed in the one
basket of declining interest rates— which would be the case if we
avoided the sale of long-term obligations at this time.
At this point I would like to mention that market uncertainty
has recently arisen because of congressional inaction on Treasury's
request to repeal the 4Vi-percent ceiling on long bonds. The face
amount of Treasury bonds held by the public with interest rates in
excess of 4V4 percent may not exceed $70 billion. Treasury has exhausted this authority—see chart 3. Unless Congress repeals the
4V4-percent ceiling, or grants additional issuing authority, no more
bonds may be sold. In fact, Treasury would normally announce its
regular auction of 20-year bonds today. It cannot do so because of
congressional inaction. Unless authority is granted in the next few
weeks the usual sale of 30-year bonds as part of our May refunding
is also in jeopardy. Inability to sell these securities has created dislocations in the market and raised questions about the Treasury's
ability to carry out predictable, prudent debt management policies.
I urge Congress to expedite the long bond authority legislation so
that this uncertainty can be resolved.
U.S. S A V I N G S

BONDS

I would like to turn now to our current proposal for the savings
bond program. The Treasury has sent a request for expedited




8
action on new savings bond legislation to the chairman of the
House Ways and Means Committee. Savings bond legislation is urgently needed to give savings bond investors a fair rate of return
and to stem the cash outflow from savings bonds that the Treasury
has sustained since late 1978—chart 4.
Under existing law the Treasury is not permitted to offer an interest rate in savings bonds that will keep up with the interest
rates available from other investments. The legislation Treasury
submitted to Congress in January will remove the statutory interest rate ceiling on savings bonds and thus will enable Treasury to
guarantee the small, long-term savings bond investor that the interest rate will always be reasonably in line with current market
rates available to larger investors. This is the only way that we can
revitalize the savings bond program.
A healthy savings bond program is not only good for small
savers, it is good for the Treasury too. Even at the higher marketrelated rates we propose to pay to savings bond holders the costs to
the Treasury will be somewhat less than the alternative cost of financing this debt in the open market. Thus, the longer we delay
the introduction of the new variable rate savings bond, the greater
the cost of financing the debt.
SUMMARY

A capsule summary of Treasury debt management policy is that
it is most effective when it is least obtrusive. Debt extension, regularization of new issues and maturities, the use of auctions to sell
new Treasury securities at prevailing market yields, the communication of Treasury financing needs to the public, and the maintenance of a viable savings bond program all help to minimize the
potential disruptive effects of the Treasury's large refunding and
new financing tasks, and to minimize the cost of financing the
public debt.
Mr. Chairman, that concludes my testimony on debt management matters of primary concern to the Treasury, but I will be
happy to answer any questions at this time.
[The charts to accompany Mr. Stalnecker's testimony follow:]




Table II
Changes i n I n t e r e s t - B e a r i n g P u b l i c Debt S e c u r i t i e s Held b y P r i v a t e
(Calendar y e a r s , in b i l l i o n s of d o l l a r s )

Investors

1971
T o t a l Debt Held by P u b l i c *
Marketable
Bills
Coupons
Maturing i n :
under 1 y e a r
1-5 years
5-10 years
10-20 years
20 y e a r s and o v e r
Nonmarketable
Savings bonds & n o t e s
Foreign s e r i e s
S t a t e and l o c a l
Other
Memo:
Holdings Federal Reserve
Banks
O f f i c e o f the Secretary
o f the Treasury

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

$246.0

$260.5

$259.7

$269.9

$348.4

$408.4

$459.2

$502.8

$539.4

$615, .1

$693.1

173.4

180.2

170.7

181.0

255.8

307.8

344.3

365.2

402.2

492,.3

580.7

65.9

73.4

70.4

82.2

119.3

122.3

119.0

119.3

127.3

172,.1

195.3

107.5

106.8

100.5

98.8

136.7

185.6

225. 3

245.9

274.9

320,. 2

385.4

15.9
60.7
16.9
6.6
7.3

17,6
57.6
17.5
9.6
4.4

22.9
50.9
13.2
9.1
4.3

18.1
54.2
13.5
8.7
4.3

30.8
74.7
16.7
8.5
5.9

35.2
103.8
31.0
7.4
8.2

53.0
119.5
32.8
8.3
11.7

54.9
128.3
33.6
13.8
15.3

63.1
133.2
36.6
19.8
22.3

67,.5
159,.6
41,. 2
27,.3
24,.6

80.0
188.4
50.9
34.1
32.0

72.7

80.2

88.9

88.8

92.5

100.6

114.9

137.5

137.1

122,.8

112.4

54.9
16.8

58.1
20.6

1.1

1.1

60.9
26.0
0.4
1.6

63.8
22.8
0.6
1.6

67.9
21.6
1.2
1.8

72.3
22.3
4.5
1.5

77.0
22.0
13.9
1.8

80.9
29.6
24.3
2.7

79.9
28.8
24.6
3.8

72,.5
24,.0
23,.8
2,.5

68.1
19.0
23.0
2.3

62.1

70.2

69.9

78.5

80.5

97.0

101.2

109.6

117.5

121,.3

130.9

""

'

*Excludes U.S. Government accounts and Federal Reserve Banks' holdings of public debt securities.




March 1 7 ,

1982




Table II
Changes in Interest-Bearing Public Debt Securities Held by Private Investors
(Calendar years, in billions of dollars)
1972

Total Debt Held by Public*
Marketable
Bills
Coupons
Maturing in:
under 1 year
1 - 5 years
5 - 1 0 years
10-20 years
20 years and over
Nonmarketable
Savings bonds & notes
Foreign series
State and local
Other
Memo:
Holdings Federal Reserve
Banks
O f f i c e of the Secretary
of the Treasury

1973

1974

1975

1976

1977

1978

1979

1980

1981

$14.5

$ - 0 , .8

$10.2

$78 .5

$60.0

$50.8

$43.6

$ 3 6 ,.6

$75 .7

$78.0

52.0

36.5

20.9

3 7 ,. 0

90 . 1

88.4

6.9

- 9 .• 5

10.3

74.9

7.6

- 3 ,.2

11.9

37.1

3.0

-3.2

0.3

8 ,. 0

44 . 8

23.2

39.7

20.6

2 9 ,. 0

45 . 3

65.2

-0.7

- 6 ,.3

-1.7

37.8

49.0

1.8
-3.1
0.6
2.9
-2.9

5 ,. 3
- 6 , .7
- 4 ..3
- 0 ,,5

-4.8
3.3
0.3
-0.4

— - -

12.7
20.5
3.2
-0.2
1.6

4.4
29.5
14.3
-1.1
2.3

17.8
15.7
1.8
0.9
3.5

1.8
8.8
0.8
5.5
3.6

8 ,. 2
4 ,. 9
3 ,. 0
6 ,. 0
7 ,. 0

4 .4
26 . 4
4 .6
7 .5
2 .3

12.5
28.8
9.7
6.8
7.4

7.6

8 ,. 7

3.7

8.0

14.3

22.6

-0,4
.

- 1 4 .3

-10.4

3.3
3.9

3.0
-3.2
0.2

0.4

2,. 7
5 ,. 4
.
0,4
0, 2
.

4.1
-1.2
0.6
0.2

4.4
0.7
3.2
-0.3

4.7
-0.1
9.4
0.2

3.9
7.4
10.4
0.9

- 1 ,. 1
- 0 ,.7
0,3
.
1 ,. 1

-0.3

8 ,. 6

2.0

7.4

9.0

4.2

8.4

7 ,. 8

-7
-4
-0
-1

.4
.8
.8
.3

3 .8
March

17,

-4
-5
-0
-0

.4
.0
.8
.2

9.6
1982

*Excludes U.S. Government accounts and Federal Reserve Banks' holdings of public debt securities.




Table III
Ownership of Publ ic Debt Securities by Private Investors*

End of
Calendar
Year
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981

Total
Privately
Held

Commercial
Banks

$229,.1
247.
.1
.7
261,
260,
.9
271,
.0
349,
.4
.5
409,
461. 3
.
508,
.6
540.
.5
.4
616,
694,
.5

$62,
.7
65,
.3
67,
.7
60,
.3
55,
.6
85,
.1
103,
.8
101 .4
93 .2
96,
.4
116,
.0
109,
.4

Individuals
Savings Other
Bonds
Securities
$52,
.1
54,
.4
57,
.7
60,
.3
63,
.4
67,
.3
72,
.0
76
.7
80,
79,
.9
72,
.5
.1
68,

.1
$29,
.8
18,
16,
.2
16,
.9
20,
.8
21,
.3
29 .6
.1
31.
33,
.3
36,
.2
56,
.7
75,
.6

Billions of Dollars
Mutual
Savings
Banks
Corporations

Insurance
Companies
.4
$7.
7,
.0
.6
6,
.4
6,
.2
6,
9,
.5
.7
12,
15,
.5
15,
.7
16,
.7
.1
20,
19,
.1

.1
$3,
.1
3,
.4
3,
2,
.9
2,
.5
4,
.5
.9
5,
5,
.9
.0
5,
4,
.7
.4
5,
5,
.2

.3
$7.
11,
.4
9,
.8
10,
.9
.4
12,
21,
.3
.1
26,
20,
.5
19,
.6
22,
.9
.7
25,
37,
.8

State and
Local
Governments
$27,
.8
25,
.4
28,
.9
.2
29,
.2
29,
34,
.2
.6
41,
50 .8
.4
64,
69,
.9
78,
.8
85,
.6

Foreign and
International

Other
Investc

$19,
.8
.1
46,
54,
.5
54,
.7
.8
58,
.5
66,
78,
.1
109,
.6
137,
.8
.7
123,
134,
.3
141,
.5

$19.9
15.6
17.0
19.3
22.1
37.4
39.7
49.7
58.9
90.1
106.9
152.2

Percentage Distribution
End of
Calendar
Year
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981

Total
Privately
Held

Commercial
Banks

100%
100
100
100
100
100
100
100
100
100
100
100

.4%
27,
.4
26,
25,
.9
.1
23,
20,
.5
24,
.4
25,
.3
22,
.0
18,
.3
17,
.8
.8
18,
15,
.8

Individuals
Savings Other
Bonds
Securities
.7%
22,
22,
.0
22,
.0
23.
.1
23,
.4
19,
.3
17,
.6
16,
.6
.9
15,
14,
.8
11,
.8
9,
.8

12,
.7%
7,
.6
.2
6,
6,
.5
7,
.7
6,
.1
7,
.2
6,
.7
.5
6,
6,
.7
.2
9,
10,
.9

Insurance
Companies
.2%
3,
2,
.8
.5
2,
.5
2,
2,
.3
.7
2.
.1
3,
.4
3,
.1
3,
3,
.1
.2
3,
.8
2,

Mutual
Savings
Banks
Corporations

1,.4%
1..3
1,
.3

1..1

.9
0,
1,.3
.4
1,
1..3
1,.0
0,.9
0,.9
0,.7

Office of the Secretary
of the Treasury
* Includes small amounts of matured debt on which interest has ceased.

.2%
3,
4,
.6
3,
.7
4,
.2
4 .6
.1
6,
.4
6,
4,
.4
3 .9
4,
.2
.2
4,
.4
5,

State and
Local
Governments

Foreign and
International

Other
Investors

.1%
12,
10.
.3
11,
.0
11,
.2
10,
.8
9.
.8
.2
10,
11,
.0
.7
12,
12,
.9
.7
12,
12,
.3

.6%
8,
18.
,1
20,
.8
21,
.0
21,
.7
19,
.0
.1
19,
.8
23,
27,
.1
22,
.9
21,
.8
.4
20,

.7%
8,
6.
.3
6,
.5
7,
.4
.2
8,
10,
.7
.7
9,
10,
.8
11 .6
16,
.7
17,
.3
21,
.9

March 17, 1982




Chart 1

PRIVATE H O L D I N G S O F T R E A S U R Y M A R K E T A B L E DEBT
BY MATURITY
COUPONS
]Over 10 years
L . !2-10 years
years
\\ year & under
BILLS

1971

1972

1973

1974

1975
1976
1977
As of December 31

1978

1979

1980

1981
January 26,1982 1




Chart 1

A V E R A G E L E N G T H O F T H E M A R K E T A B L E DEBT
Privately Held

OJJce o* the Secretary of the Treasury




Chart 3

USE O F A U T H O R I T Y T O ISSUE T R E A S U R Y B O N D S
W I T H I N T E R E S T R A T E O V E R AVA P E R C E N T

As of December 31

J / l s s u e d or announced through D e c e m b e r 3 1 , 1 9 8 1




Chart 4

CUMULATIVE NET C A S H F L O W IN S A V I N G S BONDS 1 7

onice c the secretary o the Treasury
<
<
Office of Government F,na-K.ng

1 / Cash sales less redemptions
e January 1 982 partly estimated

January 26. 1982 5

16

Chairman FAUNTROY. We thank you, Mr. Stalnecker.
Can you tell the subcommittee the extent to which the United
States relies on non-Americans to finance its debt? To what extent
do foreign nations, foreign governments, foreign central banks or
foreign financing institutions hold U.S. debt? Additionally, could
you tell the subcommittee the extent to which this has increased or
decreased in recent years, say over the past decade. Finally, can
you tell us the extent to which you expect to rely on foreign purchasers to finance the new debt and any refinancing.
Mr. STALNECKER. As of the end of calendar year 1 9 8 1 , private investors held about $ 6 9 5 billion in outstanding debt. Foreign and international investors—this is, by the way, table 3 of my prepared
testimony which includes these figures—foreign and international
investors held a little over $141 billion of that amount which represented 20.4 percent of the debt held by private investors. While the
amount held by foreigners is the highest that it has been in recent
years, as a percentage of the total privately owned debt outstanding, the amount held by foreign and international investors has declined from 27.1 percent in 1978 to the recent level of 20.4 percent.
The amount of foreign participation in the Treasury market is
dependent on several factors. Attractiveness of the U.S. dollar as a
currency is one aspect. Intervention by foreign governments in the
currency markets to support their currencies or to support the
dollar is another factor. Normally the foreign dollar holdings used
for intervention are placed in short Treasury obligations, so when
dollars are sold on the foreign exchange markets, foreign Treasury
holdings also decline. Of course, the large exporting nations that
have a balance of trade surplus, for example, oil exporting nations,
often invest their dollar holdings in Treasury securities. So, the
amount of investment in Treasury securities by these foreign and
international investors is a complex matter and there is really no
way ahead of time that we can judge how much in a given fiscal
year the foreign sector will take of our securities.
Our view is that as long as the dollar retains its character as a
strong currency, which it has for the last several years, there will
be continued investor interest, not just on the part of foreign official governments, but also private investors in Treasury securities.
Also I note to the extent foreign investors purchase Treasury securities there is less Treasury supply that has to be purchased by
domestic investors. Therefore, our belief is that by having no barriers to foreign capital we can facilitate not just the financing of
Treasury obligations, but also the financing of corporate and other
obligations in this country. We feel it has been a positive development in financing the debt in the past few years.
Chairman FAUNTROY. IS there any way of tracking the extent to
which proceeds from the sale of Government securities get reinvested in new plant and equipment in this country?
Mr. STALNECKER. The proceeds of U . S . Government securities
sales are basically used to finance the operations of the Federal
Government. Certain of the budget programs which involve guaranteed loans or foreign military sales are also financed through the
sale of Federal Treasury obligations. Most of the proceeds of U.S.
Government sales are used for building of infrastructure of the




17

U.S. Government, whether buildings, highways, or general operations.
Chairman FAUNTROY. Let me correct myself, what I really meant
was the interest payments.
Mr. STALNECKER. You are asking whether the proceeds of U . S .
Government interest payments are used to make plant and equipment expenditures by the private sector?
Chairman FAUNTROY. Yes. Is there any way of tracking that?
Mr. STALNECKER. I don't believe there is. I think as a rough approximation of who receives interest payments we can use this
same ownership table and assume to the same extent foreign ownership has 20 percent of the debt, they receive 20 percent of the
interest.
To the extent corporations have 5 percent of the debt, they receive 5 percent of the interest. Commercial banks also own large
amounts. Once these interest payments are made to the holders of
the debt they can obviously do whatever they want to with them.
Some of the proceeds are presumably reinvested in Treasury securities or corporate assets to maintain the investment portfolios of
the holders. Commercial banks can use the interest income they receive from their holdings of Treasury securities to make loans to
corporations. I presume that could be used for plants and equipment. I don't believe there is any way to quantify how much of the
interest payments on the Government debt is used to invest in
plant and equipment.
Chairman FAUNTROY. I raise that question because, as one who
in the past was not as concerned about the Federal deficit, I have
found that my lack of concern was in the assurance that those who
received the interest were reinvesting in American plant and
equipment and productivity. I have become increasingly concerned
in recent years that rather than going to Chrysler and Ford and
GM and RCA, that this money may be going to Toyota, Panasonic,
and many other foreign corporations or individuals. We are thus
looking at a window of vulnerability.
Even if the deficit is reduced by the final quarter of, say, 1983,
much of the short-term debt issued now will be maturing. Thus
while the net cash needs then may be only slightly above what is
necessary this quarter, the volume of outstanding debt will jump
substantially. What action can you take now to lessen the impact
that will surely be felt by the end of 1983 and beyond to accommodate the increased refinancing?
Mr. STALNECKER. The single most effective way of reducing the
refinancing burden of Treasury debt is to pursue a policy of debt
extension. I refer you to the chart in my testimony, chart No. 2,
which shows what has happened to the average length of Treasury
marketable debt over the broad scope of years since the end of
World War II.
The average length of the debt is really a proxy for the Treasury's refunding task. In other words, if the average maturity of the
debt is long, and at the end of World War II it exceeded 10 years,
that means a greater proportion of Treasury debt is going to
mature in future years than it is tomorrow or the next year.
Since late 1976 when the average maturity was less than 2XA>
years, Treasury has tried to extend the average maturity by sale of




18

long-term instruments and thereby reduce this refunding operation
you just alluded to.
At the end of 1981 the average maturity was still 4 years which
was an improvement from the low point of December 1975, but still
is not up to the levels that Treasury debt attained at the end of
World War II or even in the fifties or sixties.
The single most important element to reducing this refunding
and churning effect that results in short-term markets when Treasury has to roll over the debt is to maintain a policy of extension of
long-term debt.
As of the end of February over $290 billion of our privately held
marketable securities will mature within a year. That represented
nearly one-half of total privately held marketable Treasury debt
outstanding. Again, this is yet another reason to continue to rely
on longer term security issues as well as short-term securities.
Chairman FAUNTROY. It has been suggested that I ask you
whether or not the most recent financing is going to come within
this year?
Mr. STALNECKER. You are talking about the quarterly refunding
that is coming up?
Chairman FAUNTROY. I am asking about the huge deficit about
which we are all concerned.
Mr. STALNECKER. The new deficit will be financed in a combination of bills, notes, and bonds. Over the past year we have tried to
raise as much new cash as we possibly could in the longer term
market, the note and bond market. But within the last year, even
with our emphasis on coupons, we have had to resort to a lot of bill
financing.
The amount of privately held marketable debt maturing within a
year has risen from the end of 1980 to the end of 1981 from $240 to
$275 billion. So that shows that the amount of debt maturing
within 1 year rose last year despite our efforts to extend the debt.
In the refundings that come up in the next few months we would
normally try to maintain a balance between intermediate and
short-term maturities. The actual amounts, of course, are dependent on what our cash needs are at that time.
Chairman FAUNTROY. Let me ask one more question before yielding to my colleagues. As you know, there has developed in the private market substantial numbers of new and different kinds of instruments which are variously pegged to Treasury instruments.
Some of these are even tax exempt and others are tax exempt and
guaranteed by the United States. Additionally, some are backed by
real property while others are merely guaranteed. I would like to
know the impact that these instruments have on the ability of the
Treasury to sell its debt.
I further would like to know the effectiveness of these kinds of
instruments in furthering public policy. For example, how effective
is the use of tax-exempt federally guaranteed hospital bonds as opposed to the use of direct appropriations, and what are the revenue
and cash consequences of such a development?
Mr. STALNECKER. The Treasury as a general policy matter feels
that tax-exempt financing is an inefficient means of providing
funds for projects. Studies have shown that the interest saving to
the borrowers who use tax-exempt financing is less than the loss of




19

revenues to the Treasury through the inability to collect taxes on
the interest income. Therefore, the Treasury is very strongly opposed to the use of guaranteed tax-exempt financing.
Certainly the tax-exempt market has a place and to the extent
State and local governments need to issue securities for operating
funds and capital investments, the Treasury wouldn't want to infringe upon that right or close the market to them. But the issue of
industrial development bonds and other uses of tax-exempt financing for what do not appear to be public investment projects is of
great concern to the Treasury. We have been working with Congress to come up with some new proposals to decrease the amount
of tax-exempt securities that are used to finance private-purpose
projects. In terms of the competing nature of these securities with
Treasury securities, I would like to say that first of all the Treasury represents the triple A or quadruple A credit risk in the country. Therefore, even the use of asset financing, whether it is real
property or some kind of variable rate innovation, does not remove
the underlying credit risk involved in investing in a non-Treasury
obligation.
In addition to credit risk there is also liquidity risk. The Treasury has more liquidity in terms of the holder being able to sell a
position if he wants to.
Generally speaking, these innovations have not impacted the
ability of the Treasury to raise credit because we are first in line.
However, the use of Government-guaranteed tax-exempt financing
is a different matter. In addition to having the full faith and credit
obligation of the U. S. Government it also carries tax-exemption
privileges which U. S. Treasury obligations do not. That represents
a direct competition with Treasury financing and for the reasons I
mentioned before, that is, the Treasury loses more in tax revenues
than the borrower gains in terms of lower interest cost as well as
the impact on Treasury's interest expense, the Treasury is against
the issuance of Government-guaranteed tax-exempt financing. We
try to limit it as much as we can.
Chairman FAUNTROY. You indicated that there is a loss when the
Government goes the tax-exempt route. What is the loss per dollar
of benefit in your view?
Mr. STALNECKER. I haven't seen a recent study, but my memory
tells me that for every $3 of borrowing benefit or interest expense
benefit that the borrower receives, approximately $4 are lost in tax
revenues. I can check on that to see if we have any up-to-date numbers. I think the $3 versus $4 tradeoff is approximately what it
costs the Government.
Chairman FAUNTROY. I would like to have an updated figure on
that.
[At the request of Chairman Fauntroy, the following additional
information was submitted by Mr. Stalnecker for inclusion in the
record:]
RESPONSE RECEIVED FROM M R . STALNECKER

The $3.00 versus $4.00 tradeoff is the traditional relationship between the interest
cost savings to the issuer of the tax exempt securities and the tax revenue loss to
the Federal Government. This is also the relationship used by the Office of Management and Budget in the discussion of tax exempt credit in Special Analysis F of the




20
Budget. This relationship is based on a 40 percent marginal tax bracket for bond
purchasers and tax exempt interest rates of 70 percent of taxable rates. As tax
exempt bond rates move closer to taxable rates as they have recently, the benefit to
the bond issuer is even less.

Chairman FAUNTROY. Mr. Coyne.
Mr. COYNE. Thank you very much, Mr. Chairman.
I want to congratulate Mr. Stalnecker for his testimony. Let the
record show while I was professor at the Wharton School of Finance at the University of Pennsylvania he was a student, although not of mine which is obvious by the caliber of testimony he
presented which is better than any student of mine.
His testimony raises several questions. He focused clearly on the
question of making the debt policy regular and reliable so that the
market will not be disrupted. I am reminded of a general who instructs all of his soldiers to make sure everybody is marching in
step in a nice regular cadence ordered by the drummer as they are
marching the wrong way off a cliff.
In some cases the testimony seems to focus on the cadence or the
regulation or the regularity of our current policy which covers up
the fundamental need for that policy to change in time.
In the last year and a half we have had a dramatic change in the
inflation rate in this country. So, too, I would hope we have had
changes in the public's expectations about future inflation. This
brings us down to the question of what is the proper philosophy to
explain the high interest rates our country is paying now, not just
the interest rates that the Treasury is paying, but, more importantly, the business rates that every businessman in this country is
paying.
There are two popular theories. One is the competitive theory
which focuses on the fact that different people are competing for a
limited amount of funds. I like to call this the "animals coming up
to the feed trough" theory. Under it you have a limited amount of
capital going to the feed trough because we have fiscal and monetary policies that discourage savings and capital formation.
You have limited animals coming up there. You have the home
buyer who wants to get funds for a mortgage, the businessman who
wants to get working funds for capital investment, and then you
have Uncle Sam who needs funds to refinance the trillion dollar
debt.
It is like two chickens and a hog trying to eat from the same
Federal trough.
Although your testimony would have sounded very reasonable to
a corporate treasurer, to be discussing philosophy, we as borrowers
for the U.S. Government have two very, very different elements in
our position in the credit market.
No. 1, we go into that credit market as a hog, as somebody who
holds an auction saying "I will pay whatever I have to pay to get
our funds." There is literally no other participant in the credit
market who goes into the credit market with that attitude of being
able to pay whatever the marketplace demands.
The homeowner has been faced with 17-percent mortgage rates.
He says "I am not going to buy that house." The businessman is
faced with a 16-percent prime rate. He says "I am not going to
grow."




21

Of course you and the Treasury see what the market demands
and the Government pays it. In addition, the Federal Government
has the unique position of being largely responsible for one of the
major elements of risk that you were discussing that leads to the
determination of interest rates.
You mentioned, of course, credit risk as an important element in
determining interest. Of course, the Federal Government is not a
credit risk. You mentioned liquidity risk. Of course the Federal
Government is not a liquidity risk. Then there is the inflation risk.
What will the dollars be worth that are used to repay the debt?
That is U.S. Government's responsibility. That is their job to determine what the dollar is worth. We therefore have the unique situation of the borrower being the same person who determines what
the unit of measure of that debt is worth.
Of course, we have seen Congress over the past 20 years being
unwilling to make the policies that are required to make sure the
dollar maintains its value. This leads, in my view, to the question
of why must we continue to pay these high interest rates, which
are largely caused by a perception of high inflation risk at a time
when we are trying to bring that inflation down to zero.
Correct me if I am wrong, Mr. Stalnecker. I am trying to look at
this very carefully. Interest rates are the sum of real interest rates
plus inflation premium plus uncertainty. That is basically true?
Mr. STALNECKER. I think as a general characterization that is
true.
Mr. COYNE. And the real interest cost to the Federal Government
in real dollars should be about 2 percent, 2 to 3 percent, looking on
historical evidence that showed what we were paying when there
was no inflation?
Mr. STALNECKER. I think one has to make a distinction here between pre- and after-tax real rates.
Mr. COYNE. That is true. We have an important problem as well
with the bias that our fiscal and tax policy makes before interest
reductions.
Mr. STALNECKER. I would say 3 percent would be as good a
number as any.
Mr. COYNE. Then we should add to that the expectation of future
inflation. Of course 4 years ago, 3 years ago, a prudent man might
have had a 10-year bond with an expectation of an 8-percent inflation rate, let us say. Then in addition to that we have the uncertainty premium.
What is the Government going to have to resolve if the inflation
is going to come down? The marketplace looks to the Government,
the Congress, the Fed, to everybody, for some inkling of information to give them a handle. During the fifties and sixties that uncertainty risk was very low. We weren't paying much extra because there was not much inflation.
I think it is safe to say that the 14-percent interest rate we are
paying now is largely because of the high uncertainty that we have
today, whether the Reagonometrics programing survives, whether
we will continue to have monetary policy that is positive, whether
Congress will learn to bite the bullet, these are the uncertainty
questions that are so troublesome to all the investors out there.




22
When the investors look to the Federal Government paying 14
percent on long-term money, aren't they saying to themselves, well,
that is just one more indication that the Federal Government
really is not serious, that even the brightest minds in the Treasury
have no faith in our ability to control inflation? And aren't we destroying our efforts to bring expectation under control? Aren't we
sending the wrong signal?
Should we not be trying to develop a Treasury plan which is the
key to telling the marketplace, psychologically perhaps, that really
inflation has been beaten and we are going to get interest rates
down?
Mr. STALNECKER. There are several points I would like to comment on.
First, I would disagree with your characterization of business
and homeowners not being forced to borrow, the Treasury is the
only borrower in the market that pays the rates because business
and homeowners won't be willing to pay these rates.
Mr. COYNE. There was a huge drop in housing starts last year, a
70 percent increase in bankruptcies, manufacturing firms and
wholesale. I am not making up the statistics.
Mr. STALNECKER. If business ran the kind of deficit that the Federal Government is running they would also be forced to borrow
whatever the market charged them. Part of the problem here is
not that the Treasury likes paying 13 or 14 percent for its money,
but to finance the operations of the Government we have to pay
what the market charges.
Mr. COYNE. I was a small businessman before coming to Congress, and 8 months ago I used my $300,000 line of credit at that
bank. I know that my company has decided not to borrow any
more and has made a very tough decision not to expand.
There are thousands of small businessmen who are doing exactly
the same thing. They are not expanding their inventories, they are
postponing decisions to buy new plants or warehouses.
To say these people are not being squeezed out in the face of the
Federal Government's insatiable appetite is ludicrous. Two weeks
ago $160 billion capital was lent out and $100 billion of that went
to the Federal Government.
Mr. STALNECKER. I was not trying to make that point. What I
was trying to say was that if the Government ran its operations
the way a business did, it would look at its balance sheet and look
at the borrowing required based on taxing and spending decisions
and say "Are we willing to borrow this much money at that rate?"
The analogy to the business firm that decides not to spend because costs are too high, is that the Government adopts a different
fiscal policy to reduce its borrowing needs. I am trying to separate
the broader issue of fiscal policy and an appropriate level of deficit
from the question of debt management.
Mr. COYNE. On the debt management, let us say you are the treasurer for U.S., Inc. You perceive inflation rates to be coming down
and you go to your board of directors and say we have $1 trillion to
finance. We see interest rates are coming down and we are undertaking every step we can to reduce inflation—Ronald Reagan is
talking to everybody, there is a new majority in the Senate—and
inflation is down to 2.4 percent in February and we are optimistic.




23

Then you would create confidence by floating 30-year bonds, uncallable, at a fixed rate, bonds which are tied in some way to purchasing power index of the U.S. dollar. This is the thing Friedman is
proposing, to put our money where our mouth is if we are serious
about fighting inflation.
Mr. STALNECKER. I would like to expand the picture of the corporate treasurer because he is not just selling $1 trillion in debt. He
has a half trillion dollars maturing next year. His chairman could
also say to him "If rates come down as you expect, you are going to
realize substantial interest rates savings," because you are going to
be refinancing half of our outstanding liabilities already. Maybe it
is prudent not to put our eggs in one basket.
Mr. COYNE. It seems we have allowed one of those baskets to collapse.
Traditionally there was a lot of long-term savings and long-term
investment in this country. Increasingly we have seen that more
and more of the capital market has moved to the short-term
market because only in the short-term market do we have real certainty that your inflation expectations are going to be somehow reliable.
If we are going to build up the long-term savings market in this
country, if we are going to get the pension fund, the trust fund that
your bank and others used to manage, if we have to get those institutions which have legitimate long-term investment goals and objectives back into the sound investment of our Nation's securities,
doesn't it seem that we have to show them that we are going to
give them some sort of realistic assurance that they are not going
to be whipsawed again by Federal policies of inflation and irrational monetary policy?
Isn't it better to give them this debt instrument, as the British
have done, which relieves them of the concern about inflation? Say
to the pension fund management "You don't have to worry about
inflation risk because we are going to accept that in the Federal
Government. We are going to index our bonds to some form of purchasing power index," as the British Government is doing and
thereby rebuild that long-term investment marketplace and once
again have pension funds and others buying 20-year securities. Not
out of bribery by paying these rates, but out of logic on their part
they are going to be protected against the vagaries of Federal Government policy?
Mr. STALNECKER. I would say that the market charges—this is
almost going to sound too trite—the market charges what the
market charges.
If the real interest rate that is required right now on financial
instruments is 4 or 5 percent rather than the 3 percent that was
historically the pattern, I would say if the Treasury attempted to
sell an indexed type security, the real interest rate it would be
forced to pay on such an obligation could exceed the 2 or 3 percent
that would be indicated through historic experience.
Even if it weren't, it is possible that inflation could be more
rapid over the next few years than we hope it will be and the
Treasury's ultimate obligation indexed to inflation could get out of
control relative to the cost of the fixed instrument.




24

Mr. COYNE. IS not our debt fully indexed now? When you say 5 0
percent of it rolls over every year, virtually we have 100 percent
indexed debt now with short-term securities instead of indexing
long term. It makes more sense to have long-term securities reflect
the same risk of inflation as the short term.
Mr. STALNECKER. That is a good point. We feel we are offering in
the marketplace at least a proxy for indexing by the fact that we
sell 3-month bills that are rolled over every 3 months or 6-month
bills that are rolled over every 6 months. We try to offer as many
investors, different investor classes, as possible the securities to
meet their investment needs.
To those investors who are looking for variable rate or adjustable
rate instruments we feel the bill market is the appropriate position. Also we feel to those investors who want to buy longer term
fixed rate assets, we want to offer longer term bonds.
Mr. COYNE. Those people who want long-term assets you have
nothing to give them?
Mr. STALNECKER. At this point you are correct.
Mr. COYNE. There are many people who argue you should use a
Dutch auction. Will you comment on why you are not doing it?
Mr. STALNECKER. We did some Dutch auctions. We held six long
bond auctions.
Mr. COYNE. Will you explain what a Dutch auction is?
Mr. STALNECKER. The Dutch auction technique allocates all the
securities at one price which is the lowest price of all accepted bids.
To explain our normal auction procedure, let us say we offer $2 billion in securities. We would subtract the amounts of noncompetitive bids we would receive from that amount, and sell the rest to
all those competitive bidders who submit tenders. Then we would
allocate the billion dollars, the $2 billion minus the noncompetitive
amount, to the highest bidder first and then accept subsequently
lower bids until we sold the full amount. All the bidders would receive their securities at whatever price they bid.
In the Dutch auction the same mechanism would be followed,
but all the securities would be awarded at the lowest price accepted
by the Treasury. So it would appear that on average the Treasury
would receive a lower price.
Now the theory is that by allocating all the securities at one
price, the lowest price received, that it would increase the willingness of investors and dealers to bid in the auction because they
would not be at a disadvantage if they happened to bid too much
relative to others in the marketplace.
We analyzed or we tried to do some studies on the six Dutch auctions that we held back in the mid-seventies and the results were
inconclusive. It did not appear that there were significant cost savings and frankly our view is that we receive enough bids under our
current auction mechanism, and it is well received by both investors and market professonals, so that after selling six securities by
the Dutch auction mechanisms with mixed results we ended that
experiment.
Mr.. COYNE. You have no plans to reexperiment?
M r . STALNECKER. NO.

Mr. COYNE. Thank you, Mr. Chairman.
Chairman FAUNTROY. The gentleman from Texas, Mr. Patman.




25

Mr. P A T M A N . Thank you, Mr. Chairman.
Mr. Stalnecker, what was your bank before you came to the
Treasury?
Mr. STALNECKER. I was an investment portfolio manager at the
Philadelphia National Bank in Philadelphia.
Mr. P A T M A N . Tell me how do market rates get established. You
said the market charges what the market charges. What does a
person do if he decides the rate of interest is too low? Does he go
out and buy stocks and get in on the economic recovery program or
become a home builder? What does he do with his money?
Mr. STALNECKER. YOU mean if you would like to purchase an investment and you felt the interest rate you could earn on your
funds is too low?
Mr. PATMAN. What is the alternative of people who decide they
don't want to invest in Government securities?
Mr. STALNECKER. They could invest in corporate securities or
stocks or real property. They could purchase a house or other real
estate. There are other collectibles that have been popular investment items from time to time including precious metals.
Mr. PATMAN. To what extent does the Fed set the interest rate?
Mr. STALNECKER. The Federal Reserve System, since it implemented a new policy change in 1979, has been focusing more on the
control of monetary aggregates and less on fixing the interest
rates. I would say that the ultimate determinant of interest rates is
the underlying supply and demand for credit. One could say to the
extent there is large demand for credit in the marketplace and the
Federal Reserve supplies only a limited amount of credit to finance
those demands by the banks, the Fed would have some control over
interest rates, but ultimately, assuming a relatively constant
growth in money supply and reserves, the marketplace determines
the level of interest rates.
Mr. P A T M A N . You don't feel that the Fed's operation in the open
market community really sets the interest rate structure?
Mr. STALNECKER. There is no doubt that the Fed's operation in
the marketplace has a short run effect on interest rate levels. To
the extent that over the long run the money supply grows at a
moderate and predictable pace the marketplace would be the ultimate determinant of interest rates.
Mr. PATMAN. What is your explanation for the fact that the real
interest rate is at an historic high, the highest rate it has been in
50 years?
Mr. STALNECKER. My own personal view is that the excesses of
the past have come home to roost.
Mr. PATMAN. How do those come home? You are talking about
investors deciding they want to to into the stock market instead of
investing in given bonds?
Mr. STALNECKER. I think there was an overexpansion of credit
over the past 10 or 15 years. Many of the institutions, whether
banks, pension funds or any long-term investor, have many assets
on their books that are significantly below water, so to speak in the
jargon of the marketplace. They booked a lot of assets when interest rates were significantly lower than they are now and they are
now locked into the asset. II' they sold them they would have losses.
Therefore they do not have the capacity to expand their asset base




26
by purchasing new assets. That is one explanation for the current
high level of interest rates. There is no money to invest in them
right now, given past mistakes.
Mr. P A T M A N . You are not talking about mistakes in the last
year?
Mr. STALNECKER. I am talking about longer term mistakes over
the last 10 or 15 years.
Mr. P A T M A N . You are not talking about the $ 1 trillion in additional debt we are going to incur in the next 5 years because of the
imbalance between revenues and disbursements?
Mr. STALNECKER. Our prospective budgetary outlook has an
impact on current expectations, but past inflations and past budgetary actions also have impacts as well.
Mr. P A T M A N . The debt we expect to incur this year is the highest
in the history of this Nation, is that true?
Mr. STALNECKER. That is correct.
Mr. P A T M A N . Can you give us some supplement to your table No.
3 that shows the average weighted interest rate paid over these
years in 1973? Do you have any idea the way that has gone?
Mr. STALNECKER. The interest expense component?
Mr. P A T M A N . That is right, expressed as a percentage of debt outstanding?
M r . STALNECKER. Y e s .
Mr. P A T M A N . Could you submit that for the record?
M r . STALNECKER. Y e s .
Mr. P A T M A N . What does it show the average rate to be in 1970?
Mr. STALNECKER. The last number I have is 1 9 7 3 . At that time

the computed annual interest rate on the total interest bearing
public debt was 5 . 8 7 2 percent.
Mr. P A T M A N . What is it today?
Mr. STALNECKER. As of the end of January it was 1 1 . 3 4 5 percent.
Mr. P A T M A N . It has gone up over 100 percent?
Mr. STALNECKER. Nearly 1 0 0 percent. Not quite.
Mr. P A T M A N . Who are these other investors?
Mr. STALNECKER. The other investors represent pension funds,
mutual funds, money market mutual funds in particular as well as
other longer term mutual funds that might invest in Treasury securities and various other investors that are not covered in our
ownership survey.
Mr. P A T M A N . Such as?
Mr. STALNECKER. The reason that we call them other investors is
because we don't really know who all of them are, but they would
also include thrift institutions, savings and loans.
Mr. P A T M A N . You ought to be able to get a pretty good handle on
thrift institutions and savings and loans.
Mr. STALNECKER. Our ownership survey is a voluntary survey.
Many Treasury securities are not registered, they are bearer securities. We try to get as good an indication of the ownership as we
can, but in some instances we can't categorize the owners.
Mr. P A T M A N . Would you say they would be foreign or international and you just don't know about them?
Mr. STALNECKER. There could be some foreign or international
investors included in that. The best guess is that the bulk of those




27

investors are money market funds, pension funds and thrift institutions.
Mr. PATMAN. You mentioned short-term maturity of the U . S .
debt and rolling over half of it every year. How does that compare
with the debt of, say, the major corporations of this Nation?
Mr. STALNECKER. Unfortunately it compares, I wouldn't say favorably, but it looks almost exactly the same as the problems some
of the major corporations have.
I don't have any indication of what the average debt of corporate
America is. Surveys indicate preponderant financing has occurred
in the short-term market. So the corporate treasurer faces the
same problem that the Federal Treasurer does in that he has a lot
of short-term obligations he must refinance in the marketplace
every year. That is part of the problem right now. There is a lot of
short-term debt out there and it should be funded out long. Until
expectations change and inflation expectations are reduced that
will be a very difficult task.
Mr. PATMAN. Are some of those expectations contingent on
whether or not the Fed employs the tight money policy?
Mr. STALNECKER. Certainly the prospective growth in the money
supply is a determinant of longer term expectations. I don't know
how you determine whether monetary policy is tight or not.
Mr. PATMAN. You don't really understand that?
Mr. STALNECKER. Some theoreticians say tight money is represented by 5-percent growth in the money supply and others say 10
percent.
Mr. PATMAN. The lender regards 14 percent as a pretty good rate
of interest whereas the borrower regards that as an outrageous
rate of interest in some cases.
Mr. STALNECKER. When I used to work in the private sector and I
was asked for a prime rate forecast I always used to say "I can't
say what it is going to be. All I know is that it is going to be too
low for me and too high for you."
Mr. PATMAN. The point I am making about the private sector, if
there were a big open field out there for people to get money in the
long term market don't you think they would be doing that right
now?
Mr. STALNECKER. Corporate treasurers do make interest rate
forecasts. Many corporate treasurers do not want to lock their corporation into paying high interest rates at this time. Preponderance of longer term corporate financing has occurred in the 5- to
10-year maturity range in recent years.
Mr. PATMAN. And those big corporations have a corps of economists and people like that, perhaps like yourself, telling them
whether or not interest rates are too high in the long term.
Mr. STALNECKER. Thai is one factor in their financing decisions,
yes.
Mr. PATMAN. Why do you think it is more advisable for us to go
out in the long term than the Fed?
Mr. STALNECKER. I would say many of the same corporate
treasurers who think interest rates are going to come down now
also felt that way 2 or 3 years ago. One of the reasons corporate
debt is so short is that over the last few years when interest rates




28

were high many corporations did not want to lock in high rates at
that time. That was when interest rates were 10 and 11 percent.
Now they find themselves in a very tenuous situation where interest rates haven't performed according to their expectations and,
in addition to financing capital expenditures that have been incurred, now they also have to roll over debt issued 2 or 3 years ago.
I would say interest rate forecasting is hazardous and that many
prudent corporate treasurers also do not base their financing decisions on forecasts of interest rates.
Mr. P A T M A N . Could you submit for us a chart to which you referred there, the table that shows the average interest rate paid?
M r . STALNECKER. Y e s .

[At the request of Congressman Patman, the following response
was submitted by Mr. Stalnecker for inclusion in the record:]
Computed annual interest rate on interest-bearing public debt
End of fiscal year:
197 0
197 1
197 2
197 3
197 4
197 5
197 6
197 7
197 8
197 9
198 0
198 1

Percent
5.557
5.141
5.093
5.872
6.560
6.352
6.436
6.424
7.126
8.057
9.032
11.486

Mr. P A T M A N . DO you find that the projected annual deficits that
economists are seeing for the Nation would tend to increase interest rates in the future?
Mr. STALNECKER. I think that there are several elements that determine interest rates and certainly the level of deficit is one of
them. I think there is some academic evidence that deficits cause a
slight increase in the real rate of interest.
You have to determine what causes the deficit, and to the extent
the deficit arises through lower tax rates rather than through
higher spending levels, presumably additional savings are generated through the tax cuts which help finance the deficit that they
create.
I would not want to quantify what a given level of deficit financing does to interest rates.
Mr. P A T M A N . Most of the interest we pay on the national debt
goes into the national debt ultimately; does it not?
Mr. STALNECKER. Because interest is an outlay, yes, it contributes
to the deficit which in turn has to be finanaced.
Mr. P A T M A N . DO the higher interest rates we are paying now
enter into inflation?
Mr. STALNECKER. I believe that the underlying determinant of inflation is monetary growth and therefore I think to the extent that
monetary growth is controlled, moderated, the interest expense
item in the Federal deficit has a negligible impact on inflation
rates.
Mr. P A T M A N . Thank you.
Chairman FAUNTROY. Mr. Barnard.




29

Mr. BARNARD. Mr. Stalnecker, you commented that Treasury had
asked that the ceiling be increased for long-term bonds paying in
excess of 4V4 percent. On chart 3 if I read it correctly, we have
about $70 billion in long-term bonds that pay a higher rate than
4V4 percent.
Mr. STALNECKER. That is correct, $ 7 0 billion held by private investors.
Mr. BARNARD. You have approximately $ 2 0 billion of still outstanding at 4% percent?
Mr. STALNECKER. Are you referring to the difference between the
dotted line and the solid line?
Mr. BARNARD. Right.
Mr. STALNECKER. The solid line is the total amount outstanding
and includes those held by the Federal Reserve System and various
Government accounts which are not counted against the ceiling.
That full amount is $90 billion-plus in excess of 4 lApercent.
Mr. BARNARD. You are saying that if that ceiling is increasing
the Federal Reserve System would buy the additional bonds?
Mr. STALNECKER. NO. The Federal Reserve holdings of long-term
bonds are not included in the ceiling so that the Fed could increase
its holdings of long-term bonds without regard to the statutory
limit.
What we would like is an increase in the ceiling so that we can
sell additional securities to the private sector, the general public as
it were.
Mr. BARNARD. On table 1, holdings by the Federal Reserve
System are $139.9 billion. You don't have that broken down, do
you? Is that all long-term bonds?
Mr. STALNECKER. We don't have it broken down. We can get it
broken down. Maybe the Federal Reserve people can supply that.
There is a breakdown of that.
Mr. BARNARD. What is the average rate of interest? Do you know
what is the average rate of interest that the Fed is receiving on its
holdings?
Mr. STALNECKER. NO, I don't. The Federal Reserve System does
have those numbers though.
Mr. BARNARD. What indication do you have that the Congress is
going to act at all in repealing this ceiling?
Mr. STALNECKER. Well, the indication thus far is that the Congress is hesitant to do so. The general thrust of this administration
is to remove any kind of artificial price ceilings, whether they be
interest rate ceilings or any other kind of price ceiling that is determined by Federal Government edict. That is why we have requested repeal of the 4 l /4-percent ceiling on long-term bonds and
also complete freedom to set the savings bond interest rate according to market forces.
Our view is that in the case of the 4V4-percent ceiling there is no
reasonable prospect of interest rates declining to that level over
the foreseeable future. Therefore to reduce uncertainty about our
debt management policies, a repeal of that ceiling would be helpful.
Frankly, that decision is one that Congress would have to make.
We would just like to impress upon you that it has entered our

9 5 - 4 4 8 0 - 82 - 3




30

debt management operations recently. If it is not resolved soon, it
will create additional uncertainty in the marketplace.
Mr. BARNARD. With reference to savings bonds, you know when
savings bonds were created—I think they were called war bonds or
something of that kind— people bought them for patriotic reasons
regardless of the interest rate. The funds that are collected by the
Treasury on current savings bonds do not go to any particular fund
or particular account do they? They just go into the Treasury to
finance the debt like everything else?
Mr. STALNECKER. That is correct.
Mr. BARNARD. Therefore, the thing that concerns me about your
request to permit market rates as far as savings bonds are concerned is what effect that is going to have on the very desperate
condition of the savings and loans and the banks?
We have such disintermediation already from those institutions
that we are having wholesale interstate, mergers, violating every
intent of the law as far as interstate banking is concerned.
We are having to go to the newspapers and press trying to convince people that their holdings in savings and loans and in banks
are safe, and that the Government will stand behind them with
their full faith and credit.
What effect do you think raising the interest rates on savings
bonds is going to have on the savings institutions?
Mr. STALNECKER. The proposal, as the administration envisions
it, for savings bonds would not adversely impact thrift institutions.
Let me explain what our proposal is.
Mr. BARNARD. Would you mind repeating that?
Mr. STALNECKER. The proposal that the administration envisions
at this time would minimize the impact of the new savings bond
program on the thrift institutions. The reason we feel it would is
that the market based rate that we envision paying would only be
payable to those who held the savings bonds for at least 5 years so
that it would be an enticement to the longer-term holders of savings bonds rather than the short-term purchaser. Most thrift institutions as well as banks get their consumer deposits in the shortterm area of the market.
We feel this longer-term instrument will not compete as directly
for the small saver dollars as short-term instruments might.
Mr. BARNARD. Y O U can still buy a $25 savings bond?
M r . STALNECKER. Y e s .
Mr. BARNARD. The DIDC

says if you want to achieve a market
rate, on your savings you have to invest $7,500.
Mr. STALNECKER. The DIDC is moving as quickly as it feels it can
to deregulate the financial environment and allow the thrifts and
banks to compete. We do not feel that the savings bond rate because of the long-term proposal we envision, will be a direct competitor for many of these consumer deposits.
Mr. BARNARD. Does the administration support a faster deregulation of regulation Q?
Mr. STALNECKER. I am really not prepared to comment on that.
As a debt manager I am not really in a position to comment on
that on specific issue. I would say, generally speaking, the administration is against any kind of artificial interest rate ceiling and
regulation Q would certainly be one of those.




31

Mr. BARNARD. Thank you.
Mr. STALNECKER. I would also point out, Mr. Barnard, that the
minimum denominations that the D I D C has set for some longer
term deposits are significantly smaller than the $7,500 on the 3month instrument or the $10,000 for 6 months.
The longer term instruments that someone might want to purchase from a thrift institution would be available in a smaller denomination.
Chairman FAUNTROY. Thank you. As you can see, Mr. Stalnecker, you have stimulated a number of questions on the part of
the subcommittee.
I am going to resist the temptation to continue questioning you
now, but I hope that you will respond to a number of other questions which we would like to submit to you in writing.
Mr. STALNECKER. I will be happy to.
Chairman FAUNTROY. We want to thank you, sir, very much for
your testimony and for the kind way you have responded to my
questions.
Mr. STALNECKER. Thank you.
Chairman FAUNTROY. Next is Stephen H. Axilrod, Staff Director
of the Office for Monetary and Financial Policy, Board of Governors of the Federal Reserve System, and Mr. Peter Sternlight,
managing director of the Federal Open Market Committee and
senior vice president of the New York Federal Reserve Bank.
Would you both come forward so that we can receive both your testimonies and then have you respond to questions.
STATEMENT OF STEPHEN H. AXILROD, STAFF DIRECTOR FOR
MONETARY AND FINANCIAL POLICY, BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM

Mr. AXILROD. Mr. Chairman and distinguished members of this
subcommittee, it is a pleasure to appear before you today to participate in your hearings on debt management. Management of the
public debt is of course the Treasury Department's responsibility,
not that of the Federal Reserve, although Federal Reserve banks
do serve as fiscal agents for the Treasury in its financings. The division of responsibility whereby the Treasury concentrates on debt
management and the Federal Reserve on monetary policy helps
insure that monetary policy can be implemented without the complications, not to say possible temptations, that would be involved
in an intermingling of debt management and monetary responsibilities.
Debt management operations are not unimportant to the Federal
Reserve, however, in the sense that an effectively functioning U.S.
Goverment securities market is needed if we are to be assured that
our open market operations—carried out mainly in U.S. Government securities—can be efficiently employed to meet basic reserve
and money supply objectives. We do have such a Government securities market now, and indeed have had for a very large number of
years. Thus, the division of responsibilities between the Fed and
the Treasury has worked well. There have been no pressures on us
to in effect monetize debt by acquiring debt at the initiative of sell-




32

ers, and we have been able to confine the size of our open market
operations to those needed to meet reserve and money objectives.
The value of this wall between debt management and monetary
policy becomes even clearer in the perspective of an earlier period
when the wall had in practice been breached. In the years during
and immediately following the Second World War, the Federal Reserve had agreed with the Treasury that it would peg the level and
structure of interest rates on Treasury securities to the end of
keeping the interest cost on the Federal debt down. This meant
that the Federal Reserve in effect could not avoid monetizing debt
if interest rates reached the support level. At that point the Federal Reserve would be forced to purchase securities offered to it on
the initiative of market participants, whether banks or the nonbank public, thereby adding to reserves and money. The problems
with such a less than arms-length relationship between the debt
managers and the monetary authority became especially evident
around the time of the Korean war. At that point, it became impossible for the Federal Reserve to restrain growth of money and
credit in face of growing inflationary pressures unless the peg were
removed and the public prevented from turning securities into
money at will.
Freedom for the Federal Reserve to manage bank reserves and
money was restored in 1951 when the Federal Reserve and the
Treasury reached an accord. Under the accord, the Federal Reserve
withdrew its wartime commitment to support Treasury financings
by pegging interest rates. Henceforth, the Treasury would have to
meet the test of the market and pay whatever interest rate was
consistent with the underlying balance between credit demand and
the public's propensity to save.
For a number of years thereafter the Federal Reserve did have a
so-called even keel policy in relation to Treasury financings. This
meant that for around a week before and after major refundings
the Federal Reserve would refrain from making significant changes
in money market conditions, which were used at that time as
short-run operating guides, so as to avoid unsettling markets while
the Treasury was in process of selling and the market was in process of distributing new securities. The impact of even keel on monetary policy operations should not be exaggerated, however. It
served at most only to delay for a very short while, or to accelerate, action that was in train in any event.
The even keel approach seemed desirable in part because the
Treasury was offering notes and bonds by subscription, rather than
by auctions, in a -Treasury market that, it was still feared, was relatively thin. The subscription technique involved setting a fixed interest rate and price on a Treasury offering at the time when the
security offering was announced, which was some days before subscriptions for the issue were submitted by the public. The Treasury
of course priced the security to sell at the going market rate, but
even keel provided some protection against failure of an issue in
this sensitive market area. Moreover, once the dealers obtained the
issue at the price set by the Treasury, they could be generally assured of a few days of relatively stable financing costs to facilitate
the process of redistributing securities to ultimate investors.




33

As I mentioned, the practice of even keeling by the Federal Reserve was not an impediment to attainment of longer run monetary policy objectives. Nonetheless, it was an operational complication and its limited role and purposes were often misunderstood.
As a result, the Federal Reserve increasingly sought to move away
from even so indirect and temporary a connection between its monetary operations and debt management.
The growing depth and resiliency of the U.S. Government securities market, and in the early 1970's adoption by the Treasury of an
auction technique as the general rule for coupon issue financings,
facilitated the withdrawal of even keel. Under the auction technique, there is no timelag between the setting of the interest
return and submission of bids. Moreover, the auction itself provides
the mechanism through which an underwriting spread would competitively emerge to the degree needed to balance the risks to dealers in distributing new securities to ultimate investors.
Thus, arrangements between the Treasury and the Federal Reserve entail a clear and logical division of responsibilities. The
Treasury manages debt; the Federal Reserve manages reserves and
money.
Federal Reserve open market purchases and sales of securities
are, therefore, determined solely by the Federal Reserve's target
growth rates for the monetary aggregates and by the relation between those growth rates and the System's securities portfolio.
That relation in turn depends on the mix of money supply that
emerges as between currency and bank deposits, on the mix of deposits as between those that require relatively more reserves and
those that require relatively little or none, and on the extent to
which reserves are provided otherwise through discount window
borrowing and certain other sources. The Federal Reserve, of
course, has to acquire Government securities on a one-for-one basis
to support expansion in currency and on a fractional basis to support expansion in deposits, with the fraction depending on the prevailing reserve requirement structure. When reserve requirements
are lowered—as they have and will be during the 1980's as the
Monetary Control Act of 1980 is phased in—the supply of reserves
must be lowered to prevent an undesired increase in the stock of
money. Such a reduction in reserves would be accomplished by the
sale of securities from the Federal Reserve System's portfolio.
Because of changes in the variety of factors that influence our
securities portfolio—including as noted above borrowing at the discount window, reserve requirements, and the currency and deposit
mix—growth in our holdings is rather variable from one year to
the next.
In 1981, these various influences led to a net increase in Federal
Reserve holdings of securities, largely U.S. Government securities
but to a small extent Federal agency obligations, of about $9 billion. Of course, the total volume of Federal Reserve transactions in
securities is many times the net increase in holdings over a year,
since transactions are necessarily undertaken in the course of a
year to offset changes in highly volatile exogenous factors that provide or absorb reserves in the short-run, such as the Treasury balance at Federal Reserve banks.




34

With Federal Reserve purchases of securities determined solely
by monetary policy objectives, the Treasury must manage its debt
so as to make its offerings attractive enough in terms of yield and
other characteristics to induce private sectors of the economy to acquire them. Last year, for instance, net issuance of U.S. Government debt amounted to $98 ¥2 billion. To market this net new debt,
not to mention refunding a much, much greater volume of maturing debt, securities were offered in all maturity areas—short, intermediate, and long—to fit the varying portfolio needs of banks,
other financial institutions, nonfinancial businesses, trust funds,
and individuals. The debt management task was accomplished with
skill, and the securities were marketed in an orderly fashion at
prevailing interest rates.
The availability of a large and diverse body of potential investors
in U.S. Government securities provides the basis for the continuing
ability of Treasury debt managers to design and sell attractive,
marketable instruments. The existence of this market—because it
eliminates dependence of the Treasury on the central bank as a
buyer of its securities—also represents a continuing safeguard
against any temptation to erode the clear and beneficial separation
of responsibilities between debt management and monetary policy.
Thank you, Mr. Chairman.
Chairman FAUNTROY. Thank you, Mr. Axilrod. We will proceed
now with Mr. Sternlight's testimony and then if you will remain
we would like to query both of you.
STATEMENT OF PETER D. STERNLIGHT, SENIOR VICE
PRESIDENT, FEDERAL RESERVE BANK OF NEW YORK

Mr. STERNLIGHT. Thank you, Mr. Chairman, and members of the
subcommittee. I am pleased to have this opportunity to participate
in your hearings on U.S. debt management policy. I am a senior
vice president of the Federal Reserve Bank of New York and manager of the Federal Reserve System Account for Domestic Operations. My responsibilities include direction of the Federal Reserve's open market operations in the Government securities
market, in order to carry out monetary policy under instructions
from the Federal Open Market Committee. In addition to being involved for a number of years with the Federal Reserve's open
market operations, I also served for 2 years as Deputy Under Secretary of the Treasury for Monetary Affairs, where debt management was one of my chief responsibilities.
In carrying out Federal Reserve monetary policy, the New York
Fed's trading desk is a substantial participant in the market for
Treasury Securities. Last year, the Federal Reserve System's trading activity included about $23 billion of outright purchase and
sale transactions, as well as a much larger volume of repurchase
agreements or matched sale purchase transactions to effect temporary additions or reductions in reserves. The Federal Reserve System's holdings of Treasury securities at the end of last year were
about $128 billion. Our trading desk also arranges a large volume
of transactions in Government securities on behalf of foreign central banks. Indeed, some of the Federal Reserve System's own




35
transactions are arranged directly with foreign official accounts, at
current market prices.
In addition to actual trading activity, the New York Fed's trading desk also serves as a channel of information for the Federal Reserve and the Treasury, in respect to developments in the Government securities market and related markets. Such information is
particularly relevant in the formulation and implementation of
monetary and debt management policies, with implications for
other aspects of national economic policy as well. We gather, analyze, and report on information pertaining to the activities, attitudes and expectations of dealers, investors, and other market participants. Our gathering of information includes data on prices and
interest rates, and on volume of activity, positions, and financial
soundness of some 3 dozen primary dealers in U.S. Government securities. Beyond the collection of statistics, we exercise an informal
surveillance role over the Government securities market, seeking
information on new developments and potential problems.
The Federal Reserve serves as fiscal agent for the Treasury in
the placement and redemption of its debt. These functions are performed at every Federal Reserve Bank and branch, with the New
York Fed playing a particularly significant role since the Government securities market is centered there. Typically, 70 to 90 percent of Treasury issues are awarded in the New York district. New
York's share of the total bidding for Treasury issues sold at auction
is even greater, as there is usually a sizable margin of underwriting bids from major financial market participants that are below
the accepted range of prices but are there just in case. Some underwriting bids are of course also submitted in other financial centers.
There is a long history of close consultation on debt management
questions between Treasury debt management officials and officers
at the Federal Reserve's trading desk. Some of the consultation is
of a relatively routine nature, having to do with the particular
timing or other technical details of Treasury securities sales. There
is also discussion, at times, of the type and size of issues to be sold,
and of the techniques to be used in those sales. Usually, one or two
representatives from the Fed's trading desk sit in with the Treasury's debt management staff when the Treasury is developing its
plans for quarterly coupon refunding operations.
The Federal Reserve's role in such discussions is strictly advisory. The debt management decisions are of course those of the
Treasury. At the same time, it is worth underscoring that while we
at the trading desk have a concern with the orderly management
and marketing of the Treasury's debt, our overriding concern is
with the implementation of monetary policy, as determined by the
Federal Open Market Committee. Our role as fiscal agent and adviser to the Treasury is subordinate to, but in my view not inconsistent with, our primary mission of carrying out monetary policy.
Most particularly, I would emphasize that Treasury debt issues, in
the Fed's view, must stand on their own in the market.
Against this background, I would like to make a few general
comments about Treasury debt management. Obviously, the management of a trillion dollar, and rapidly growing, debt is no simple
task. A trillion dollar debt is substantial, even in a $3 trillion economy. Given the magnitude, growth, and wide dispersion of the




36

Treasury debt throughout the national economy—and indeed the
world economy—the Treasury's debt management policies are of no
small importance. On the whole, I believe the job has been handled
well. An enormous volume of debt has been marketed through
what appears to be a highly efficient mechanism. Primary reliance
on an auction technique, open to a variety of different types and
sizes of participants, provides good assurance, in today's competitive markets, that the Treasury—and ultimately the public—are
well served. This is not to say that there could not be a useful
place, in suitable circumstances, for other selling techniques such
as the large subscription issues undertaken several years ago.
Under the auction technique used most heavily in recent years,
primary dealers play a highly important role. Bidding at prices or
rates based on their market judgments, the primary dealers take
down, for subsequent distribution to investors or other holders, a
sizable part of the Treasury's offerings. Typically, the dealers
might account for 35 to 75 percent of the issues on initial sale to
the public. Also of considerable significance, primary dealers typically feel a sense of responsibility to provide "underwriting bids"
again at prices and rates of their own choosing, even at times when
current market prices and rates are not particularly attractive to
them. The practice tends to assure the Treasury of getting its auctions covered, at some price, even in periods of difficult markets.
The Treasury has also done well, I believe, to continue seeking
the restoration of a better maturity balance in its debt structure. It
has done this in recent years by steadily lengthening the average
maturity from the low point reached in 1975—after several years of
not being able to issue longer term debt because of the interest rate
ceiling. A very short-term debt structure is somewhat akin to an
overabundant money supply in leaving the economy with too much
liquidity readily at hand. Moreover, it leaves the Treasury more
vulnerable to the willingness and ability of the market to roll over
its debt, the greater the portion that must be refunded each year.
It would be desirable, I think, for the debt managers to continue to
be able to make progress in extending the average maturity of the
debt, through continued access to the longer term market.
Another desirable feature of debt management practices in
recent years has been the establishment of regular patterns of debt
issuance—such as the cycles of 2, 4, 5, and other note maturities,
and the fairly regular offerings of coupon issues in quarterly refundings. When the market is able to anticipate approximately
what the Treasury is likely to offer, and to some extent prepare for
it, market participants are likely to have a better appetite for the
Treasury's offerings. This need not freeze the Treasury immutably
into a pattern of debt offerings dictated by market expectations,
but it does strongly suggest that variations be carefully evaluated,
and sounded out ahead of time, if possible, with market participants.
In the overall scheme of national economic policy, debt management probably has a more circumscribed role to play compared
with general fiscal or monetary policy. For example, rather than
seeking to be contracyclical, debt management policy is probably
better directed, in the long run, to achieving and maintaining an
orderly structure of the debt—as I think it has been in recent




37
years. It does not follow, though, that debt management makes
little difference—since mismanagement of the debt most assuredly
could impact adversely on the financial markets and the economy—making it much more difficult for fiscal and monetary policies
to achieve desired objectives. For this reason, I would be quite wary
of making wholesale changes in a debt management approach that
I believe has been serving the Nation reasonably well.
That concludes my statement, Mr. Chairman.
Chairman FAUNTROY. I thank you, gentlemen.
In the February 1982 issue of Money, Banking, and Credit,
Milton Friedman accuses the Fed of what he calls churning. He
says that the open market desk in 1980 made $184 worth of purchases in order to add $1 to its portfolio. He further suggests that
the Fed's open market operations could be drastically reduced with
no ill effects. Would you comment on his article?
Mr. STERNLIGHT. I have glanced at that article, Mr. Chairman.
The figures that Professor Friedman cited there I think overstate
what the trading desk typically does in the market. It included a
large volume of transactions that we undertake pretty much on a
routine daily basis with foreign official accounts more or less for
the purpose of giving those foreign accounts a day-to-day outlet for
their very short-term holdings of funds.
Nevertheless, his point, even if restated in terms of what the
desk did in the market, would come out to a large number. The
volume of transactions, including our short-term operations
through repurchase agreements or matched sale purchase transactions last year, for example, were on the order of $300 billion
while, if you want to measure that against the annual change
which was about $8% or 9 billion, yes, indeed that is a sizeable
amount of short-term activity.
What we are doing there is responding in a defensive or counteracting way to a number of short-term influences that affect the
availability of reserves from one week to the next or one month to
the next. Sometimes even within a week there can be seasonal patterns, although those would be of much less concern to us. But you
do have seasonal flows of funds in the economy. For example, there
is a need for currency supplies in the Christmas season or Easter
season or vacation times.
For us to fail to offset those needs for currency and the reserve
impact that those currency flows generate would impose very drastic changes on the availability of reserves in the economy, and I
think would be rather inconsistent with the Fed's basic mission
from the Congress of maintaining an elastic currency, if I recall
the words in the Federal Reserve Act.
So, I would regard that sizable volume of short-term activity as a
kind of housekeeping response to keep a reasonably smooth functioning of the Nation's financial markets.
Chairman FAUNTROY. Gentlemen, I have a number of concerns
about the interest rate futures market. Its volume had exploded in
the last 2 years when compared with other futures or contracts.
How has this interest affected the Treasury's ability to borrow and
how has it influenced the open market operation? Should the futures market be more regulated than it is presently? Should it be




38

regulated by the Fed and the Treasury instead of the Commodities
Futures Trading Commission?
Mr. STERNLIGHT. If I might comment on that one, Mr. Chairman,
the futures market, as you noted correctly, has grown very substantially. It is clearly having an impact on the Treasury securities
market. I must say that I have not made up my own mind in a
definitive way on every aspect of what that impact is. I think it has
in some respects broadened the liquidity of the market by providing a place that market participants can hedge positions and to
some extent speculate, if that is their business judgment.
I cannot escape some feeling that at times the futures market
also adds to the volatility of rates in the cash market. I am not
sure I could prove this to the staff of this committee or the academic community or perhaps even some of my own associates at
the Federal Reserve or Treasury, but I have a feeling that there is
some impact of that nature.
It might be said that the futures market diverts capital and
breadth of participation from the cash market, but I think it also,
as I noted, provides another outlet for cash market participants.
Probably some of the capital that flows to the futures markets
would most likely not have come to the cash market in any event
even if there were no futures market.
The futures market is very much welcomed by the dealer community, after a kind of mixed and skeptical response at first. I
think the dealers now regard the futures market as a very welcome
development, as a place where they can hedge positions or take positions, and it helps them to cope with rates that are rather volatile in the market these days although, as I say, at the same time I
have some suspicions the futures market may add some to that
degree of volatility.
Another thing I think the futures market does, and this gets a
little technical, is that it provides a strong linkage between shortterm financing cost and long-term bond prices as many participants in the futures market are there for a fairly short-term participation in the market. They are not genuine long-term investors.
The viability of their short-term position in the futures in longterm securities can be very substantially affected by short-term
borrowing costs. I think this may be one of the avenues through
which volatility can be increased by the existence of the futures
market.
I am not prepared to conclude that the futures market is an undesirable thing. I think probably on balance it is a desirable and
fairly inevitable thing. But it is one that has to be watched closely.
It is important to monitor the performance of that market and be
aware of possible problems with deliverable supplies, sizes of positions and adequacy of margins.
You raised a question about where any regulatory authority
should reside. One could alternatively imagine its being several different places. I think what is more important is that there are reasonable cooperation and exchange of information and views among
all the entities that have some supervisory or regulatory authority
in the area, whether it is the Federal Reserve, the CFTC or the
SEC.




39

I think we are moving in the direction of having that kind of
good exchange of information, Mr. Chairman.
Chairman FAUNTROY. The bells having rung, I am going to yield
to the gentleman from Texas.
Mr. PATMAN. Thank you, Mr. Chairman.
If you could make your answers fairly short I would appreciate
that.
Possibly to both of you, how much danger is there today of this
country going through national bankruptcy?
Mr. AXILROD. I would say very little.
Mr. PATMAN. DO you concur in that, Mr. Sternlight?
Mr. STERNLIGHT. I would agree with that.
Mr. PATMAN. HOW much danger is there of this country's sustaining destruction of the monetary system? I think you would say
there is little?
M r . STERNLIGHT. Y e s .
Mr. PATMAN. Are we

heading toward a period in which the monetary debt is unmanageable?
Mr. AXILROD. I don't think we are heading toward a period when
the debt is unmanageable.
Mr. PATMAN. At what level does the debt become unmanageable
in your opinion?
Mr. AXILROD. One way a debt would become unmanageable is if
the Treasury had offered, for example, $5 billion on the market
and there were no takers or there were very few takers. That
would be something like an unmanageable debt. But we are not
faced with that situation nor would I anticipate it.
Mr. PATMAN. Would you consider the direction in which we are
going as possibly reaching the point where the debt would become
unmanageable?
Mr. AXILROD. NO, sir, I would not think we are moving in that
direction at all.
Mr. PATMAN. You are aware of the projections of $ 1 trillion
added to our $1 trillion debt in the next 5 years, are you not?
M r . AXILROD. Y e s .

Mr. PATMAN. What if that were $2 trillion being added to it?
Mr. AXILROD. That would put substantial upward pressures on
interest rates and the Treasury would begin to have to pay very
high rates to market that debt.
Mr. PATMAN. There would be a point where the debt would
become unmanageable if we paid a 50-percent interest rate?
Mr. AXILROD I don't think that would be a very fortunate situation, but the Treasury would be able to market the debt and sell it,
having to pay those high interest rates. However, there would be
repercussions on other people who may not be able to pay that
high a rate.
Mr. PATMAN. HOW does the Fed implement a tight monetary
policy?
Mr. STERNLIGHT. What the open market desk does is to implement the policies of the Federal Open Market Committee and those
come to us in the form of monetary growth objectives that are
translated into objectives for growth in reserves of the banking
system. In recent years there has been an effort to have monetary




40

growth slow down, and accordingly we have objectives for growth
of reserves that are on a moderating pace.
When we follow that moderate pace of reserve growth and there
are demands for credit expansion or monetary aggregate expansion
that run ahead of that moderate pace, then you have upward interest rate pressures and what the financial community, and everyone
else I suppose, observes as tight money.
Mr. P A T M A N . I mentioned 50-percent interest. Of course that is
not intended to be any sort of prediction. What is your prediction
as to the highest rates by which our Government debt could be financed?
Mr. AXILROD. I don't think I should be predicting interest rates,
given my position at this time.
Mr. P A T M A N . Conceivably could you estimate any high rate at
all, any outer limit of the high rates?
Mr. AXILROD. I don't really think, Mr. Patman, I want to make
any kind of prediction of interest rates.
Mr. P A T M A N . You don't predict any limitation on them? You
don't predict any limits?
Mr. AXILROD. I wouldn't want to be indicating that they are
going up or down.
Mr. P A T M A N . Would you tell us how we can lower them?
Mr. AXILROD. I will be very happy to do that. I think that as the
public becomes more and more convinced and evidence accumulates over time, not just over a brief period of a few months, that
the rate of inflation will indeed be lower when we get on the up
side of this cycle if that trend continues, then the interest rate will
be lower over time than it has been in previous years when the inflation rate has been accelerating.
As the public becomes convinced that the inflation rate will decelerate and continue to decelerate over time, you will get a gradual reduction in interest rates consistent with this development. A
smaller prospective budget deficit is important in that regard because it will buttress the public in their view that the rate of inflation will be coming down.
Mr. P A T M A N . Thank you.
Chairman FAUNTROY. Gentlemen, we speak on the optimistic side
and leave little or no room for error. In reality actual results
seldom come close to projections in the budget document. Is this a
correct assumption about this year's budget policy, or is the deficit
for the next 2 years closer to the CBO estimate, say, $109 billion
this year and $157 billion next year?
I think the next marketable Treasury financing will be approximately $90 billion in the second half of this year. A task of this
magnitude will probably require that the weekly bill auctions
expand to nearly $12 billion, that 1- and 2-year note auctions rise
to $6 billion, and the quarterly refunding be increased to about $11
billion, and that 4-year, 5-year, and 7-year issues expand to nearly
$4 billion, and that the long-term issues increase about $3 billion.
The dealers who must underwrite such massive new issues and
investors who are thinking of buying these securities will derive
little comfort from the knowledge that these budget deficits are
only 4 percent of the GNP.




41

What impact do you expect this to have on these rates? How do
you expect the market to react to this level of financing?
Mr. STERNLIGHT. While I can't vouch for the particular pattern
that you lay out, Mr. Chairman, I am sure in financing these large
deficits that the Treasury will have to look at a variety of areas
and they may well head toward the figures that you cite. The
market has coped with enlargements of the different types of issues
that the Treasury has brought to market and I think that in a
growing economy the market will be able to handle increased
amounts.
As Mr. Axilrod and others have said, the larger the deficit, the
greater will be one of the factors putting upward pressure on rates.
At the same time hopefully there are things that will be bringing
rate pressures down. I wouldn't conclude that just because there
will be continuing large deficits to finance, we necessarily face
rising rates over the next year or two.
Chairman FAUNTROY. We are joined by the distinguished ranking
minority member of the subcommittee for a few moments. I will
yield to him.
Mr. H A N S E N . Thank you, Mr. Chairman. I appreciate the opportunity to be here. I am sorry there are so many conflicting interests, which is why I was late.
I understand you are about to conclude the proceedings. I am not
sure my comments would make a difference. I will let you proceed.
Chairman FAUNTROY. Thank you for joining us. We have had an
unusually productive hearing on this fascinating but usually unnoticed segment of the capital markets.
Mr. H A N S E N . I am sure they appreciate this opportunity to have
a forum for their views on these important matters.
Chairman FAUNTROY. Mr. Axilrod, the Federal budget messages,
no matter who delivers them or what their philosophical views,
have certain characteristics in common. First, rather than being
objective guessers, they skew toward the results that the administration in power hopes to achieve. Indeed, one might say the administration first decides what kind of result they would like to
show and then set about working their way back to the assumptions necessary to achieve those results. Additionally projected
trends rarely call for anything but declining deficits. Does the use
of longer term Treasury securities reflect that kind of analysis?
Does it make financing the debt with longer term securities more
costly in terms of reducing the deficit?
Mr. AXILROD. Mr. Chairman, in my view the deficits have been so
large that there has been a great need to tap every sector of the
market you could tap in order to get this debt out in what could be
called an orderly fashion.
So, while in the abstract you could say that maybe you should
put it all in short-term debt in the hope that long-term rates will
decline later, I think that in practice, just looking at debt from a
housekeeping point of view, when we need to get, like last year,
$100 billion of debt out in the public, there is a practical necessity
of tapping every available investor to whom you can sell this debt
and to do so you must meet his needs. Some of them have need for
short-term investment. Some of them, such as pension funds, feel
they are more comfortable with long-term obligations.




42

So, I think it is desirable to structure your debt to meet the
needs of your customers. It is probably not practical to hold yourself to some sort of projections of interest rates which may or may
not come true or to some more abstract theoretical concept as to
when you should be short and when you should be long in the very
practical situation you are faced with.
Chairman FAUNTROY. The 3-month T-bill rate averaged 10 percent in 1979, 11.5 percent in 1980, 14.1 percent in 1981. The administration forecasts the rate receding to 11.7 percent in 1982 and 9.5
percent in 1983 and 7.5 percent in 1984.
The CBO forecast is less optimistic. They see them going higher
and not steadily declining. I believe that one of the main reasons
for the difference in these rates is budget deficit projections. The
administration projects, as you have indicated, $98.6 billion this
year, and $91.5 in 1983, $82 billion in 1984. However, as I indicated,
the CBO estimates a $109 billion deficit this year, $157 billion the
next year, and even larger in 1984. My question is: Would debt
management be different if the CBO figures at some point in the
near future were to become a reality?
Mr. AXILROD. I think they would have obviously a lot more debt
to put out. I think in that kind of situation where they would be
competing with private credit demand as we come out of the current recession, they would find it complicated and difficult to place
the amount of debt that they have to finance. They will have to
continue the policy that I mentioned earlier of tapping every conceivable market source and paying whatever market interest rates
are required to make these investors willing to buy the Treasury
debt as well as helping to finance recovering economic activity by
acquiring more consumer and corporate debt relative to what you
have now.
Chairman FAUNTROY. I wanted to make the case that the Treasury should be allowed a substantial flexibility in setting maturities,
given the persistent debt levels and the short maturities of outstanding public debt. However, I am not sure that selling close to
$5 billion of bonds every quarter, market conditions notwithstanding, is necessarily desirable. Suppose we were to limit the Treasury
to, say, one marketable bond financing per quarter rather than
limiting the total amount outstanding, would this be desirable in
your view?
Mr. AXILROD. Mr. Sternlight may wish to comment on this as
well, of course, but my view would be to give the Treasury as much
flexibility as the Congress prudently feels it can give and not to
hold it to something which is eminently predictable—where the
market can see the Treasury can't do any more, and it is in a
straightjacket.
I think you can minimize the burden of the debt within the existing market structure and minimize its cost by maximizing the
Treasury's flexibility in the maturity areas it can go to.
When you don't have that flexibility in the market, it is difficult
for the Treasury to meet the emerging market needs. In case,
where there is a desire and need for some reason to invest in longterm securities, so that you can put the securities out at a very reasonable rate, the Treasury wouldn't have the capacity to meet the
demand.




105
One other point I would like to make, Mr. Chairman, and Mr.
Sternlight mentioned it earlier. There are various concepts of
money. One of the concepts we publish is something we call "L"
which is liquid assets. That includes the definition of money, Ml,
M2, and M3, plus other assets that are substitutes for money and
among them are short-term Treasury securities.
The more the Treasury is forced to put debt in the short-term security areas the more they are putting out something that is more
readily convertible into spendable type money with minimal capital-loss risk.
I wouldn't want to overstate this, but in a sense you are thereby
feeding demand for money by forcing the Treasury into that shortterm area rather than permitting them to go into a longer term
area.
Chairman FAUNTROY. The Treasury's testimony, as you may
have heard, mentioned that the 4V* percent bond ceiling does not
apply to Federal holdings. Can either of you explain that?
Mr. STERNLIGHT. A S I understand it, there is a cap of $ 7 0 billion
on the amount apart from official holdings, whether it is by the
Federal Reserve or Government investment account. They are
within a few hundred million dollars of that $70 billion limit, so
they are unable now to issue any marketable-size offerings of
bonds.
Chairman FAUNTROY. Your view is that the Federal Reserve's
holdings are included within the cap?
Mr. STERNLIGHT. NO, sir. To the extent that the Federal Reserve
would purchase securities in the market, that in a sense opens up
room for the Treasury to sell more, although I think it would be
defeating the whole purpose of having the Treasury have that
access to the long-term market if the Federal Reserve were to
pursue that course of buying.
You would be kind of spinning your wheels, I think, for the Federal Reserve to go out and buy long-term securities in order that
the Treasury could sell long-term securities. You would not be
changing the structure of the debt that is out in private hands,
which I think is the more legitimate objective of the Treasury debt
management.
Chairman FAUNTROY. In the next few years, because of large refundings of Treasury securities, as you have noted several times
during the course of the hearings, the Treasury will be constantly
coming into the market for new funds in relatively large amounts,
as well as to refinance the existing deficit. Will this create stiff
competition for funds and thus increase the volatility in interest
rates? In addition I have noticed recently that the primary dealers
have overpriced issues and have had to discount them to sell them.
Why did this happen0
Mr. STERNLIGHT. We do have volatile interest rates. The uncertainties about national economic policies is probably one contributing factor in that volatility.
As to whether the Treasury's offerings of debt provide stiff competition in the marketplace, yes, they certainly are competition in
the marketplace. It is perhaps less of a problem while we are in a
recession period than it might be as we move into a recovery phase
and still have very large deficits.




44

Chairman FAUNTROY. Gentlemen, thank you very much for the
long time spent with us this morning. I know you have been here
throughout the entire course of the hearings and we have benefited
both from the testimony of the Treasury and your own and the
questions we have tendered you.
Mr. AXILROD. Thank you, Mr. Chairman. It is a pleasure to be
here.
Mr. STERNLIGHT. I have the same sentiment.
Chairman FAUNTROY. We will now recess the hearings until tomorrow morning at 10 o'clock.
[Whereupon, at 12:25 p.m., the hearing of the subcommittee was
adjourned, to reconvene at 10 a.m., Wednesday, March 24, 1982.].




PROBLEMS ASSOCIATED WITH FEDERAL DEBT
MANAGEMENT
WEDNESDAY, MARCH 24, 1982.
HOUSE OF REPRESENTATIVES
COMMITTEE ON B A N K I N G , FINANCE AND U R B A N AFFAIRS,
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY,

Washington, D.C.
The subcommittee met, pursuant to notice, at 10:10 a.m., in room
2222, Rayburn House Office Building; Hon. Walter E. Fauntroy
(chairman of the subcommittee) presiding.
Present: Representatives Patman, McCollum, Weber, and James
Coyne.
Chairman FAUNTROY. The subcommittee will come to order.
On this, our second day of hearings on the management of the
national debt, we will hear from individuals who are responsible
for the placement of that debt as primary dealers in the private
sector.
Yesterday, we heard from the officials representing the Department of the Treasury and the Federal Reserve System. Their views
represent the perspective of the seller and the fiscal agent of the
debt. These views are not necessarily compatable with those who
are the buyers of the debt. Yet, there can be no seller unless there
is a buyer. So, today we would hear from the other most important
side of the transaction.
Among the issues with which we are concerned is the impact
that continued high deficits will have on the ability of the Nation
to absorb the debt while providing resources to increase productivity and employment as we come out of the most severe recessions
since the Korean War. A corollary of that concern is the impact
that these deficits have on the price which the Government must
pay for the new money and to refinance its existing debt.
The increased interest rates themselves, of course, also contribute to the increased deficit. Today, we devote about 2.34 percent of
our gross national product to the payment of interest on the national debt. This translates into over $114 billion. Ten years ago,
we spent 1.42 percent of our GNP for that same purpose. Quite
clearly the growing use of our national resources for the payment
of interest must be a matter of great concern to all of us.
So, it is with a great deal of pleasure that I welcome to this subcommittee those are a part of the private sector who work to
enable the Government to command the resources to fund its
shortfall of revenues. Your perspective of the market on actions by
the Government, your own roles in advising in advising and assist(45)

95-448

•• -

82




-

4

46

ing the Government to sell its debt, and your advice to this subcommittee on how to better understand the relationships between
Government finance, the private markets need and the price which
all of us will pay for credit undoubtedly be heard by all of us as we
seek to fashion a money and credit policy which enhances our Nation's resources and puts to work the people and productive capability of our Nation.
Before we hear from our witnesses I want to yield to the distinguished gentleman from Ohio, member of the committee, Mr.
Weber.
Mr. WEBER. Thank you Mr. Chairman, I don't have any statement to make other than to express our appreciation to the witnesses for being with us today on this important subject. Thank
you.
Chairman FAUNTROY. And I thank you. We are pleased to have
our first witness Mr. David G. Taylor from Continental Illinois
National Bank and Trust Co. of Chicago. We will then hear from a
panel of Mr. Bunting and Mr. Napoli.
At this time, Mr. Taylor, we would be pleased for you to proceed
with your testimony. We have your written statement and you may
proceed in any fashion that you choose.
Mr. TAYLOR. Thank you, sir. I must say that I'm interested in
your economic forecast. I note that you use the term "coming out
of one of the most severe recessions since the Korean War". I hope
that's a correct forecast.
Chairman FAUNTROY. Oh, my goodness.
Mr. TAYLOR. We are coming out of the recession now. Most
economists feel that, and I hope that it is true.
I would like to read our printed statement.
Chairman FAUNTROY. Surely.
STATEMENT OF DAVID TAYLOR, CHAIRMAN, GOVERNMENT AND
FEDERAL AGENCIES SECURITIES COMMITTEE, PUBLIC SECURITIES ASSOCIATION, ACCOMPANIED BY FRANK SMEAL, GOLDMAN SACHS & CO.

Mr. TAYLOR. Mr. Chairman, and Mr. Weber, my name is David
Taylor, and I am associated with the Continental Illinois National
Bank and Continental Illinois Corp. I am also chairman of the Government and Federal Agencies Securities Committee of the Public
Securities Association, which in this testimony is referred to to as
the committee. With me today is Mr. Frank Smeal who is a partner of Goldman Sachs & Co., and immediate past chairman of the
above committee.
We are pleased to be with you today to respond to your questions. We ask that you understand that our responses represent a
blend of views of our own as individuals, our firms in some instances and the committee's in other instances. I believe that Mr.
Smeal and I can offer responses that are generally representative
of our various constituencies that I have just named. At the outset,
however, I should spend a minute or two in bringing you some perspective on the committee's role as an advisor to the Treasury on
debt management matters.




47
The committee acts as an investment banker or financial advisor
to the Treasury. This role is somewhat analogous to that of an investment banking firm and a corporate client that asks the firm
for financial advice as to the size, structure, and timing of its debt
financing. The committee's role is rather narrow in the sense that
it does not officially offer advice on monetary or fiscal policy or
other broad economic matters but confines itself to judging current
economic and financial trends and offering debt management
advice to the Treasury within the context of these judgments.
Thus, much of our testimony on broader matters cannot be officially attributed to the committee. The committee has advised the
Treasury for over 30 years in a useful and responsible matter. Committee members and Treasury officials are well aware of potential
conflict-of-interest problems, and both parties have initiated rules
and/or procedures to guard against even a semblance of impropriety. And I'm comfortable in assuring you that the highest standards of conduct permeate every facet of our role as advisors to the
U.S. Treasury.
In my remarks this morning, I will attempt to answer the questions which you posed in your letter of March 2, inviting me to
appear before the subcommittee. But before I turn to each of the
questions, I will discuss some of the general principles of debt management that bear on many of your questions.
The Treasury securities market is the cornerstone of the financial markets. It provides the basis upon which corporate and municipal debt is priced. Without the continuity provided by the
Treasury market, financial markets would generally be less fluid
and less efficient. In managing its debt, the Treasury must seek to
be generally neutral in its economic effects and not aggravate the
uncertainty that normally affects markets and market participants.
It has been a number of years since the Treasury's stewardship
of the Federal debt has been a topic of national concern. Over the
last 20 years, the major policy shift in debt management was probably the decision in 1976 to begin a gradual lengthening of the
average maturity of the Federal debt. The goal of lengthening maturity has become a guiding principle in debt management, and I
believe, a good one. Two other characteristics of debt management
that evolved during the seventies are regularization of the schedule
of offerings and use of the competitive auction technique to sell
marketable debt. The Treasury has financed a vast volume of new
debt in recent years. The three principles guiding debt management have apparently been successful. Through years of economic
and financial turmoil, the Treasury's ability to borrow vast sums in
financial markets remains unimpaired. In particular, the Treasury's almost exclusive reliance on the competitive auction technique has enabled the Treasury's offerings to be distributed
smoothly to final investors even within the context of unprecedented volatility of interest rates.
With this as background, I will turn to the first question in your
letter regarding the Treasury's use of long-term financing. You
asked for my assessment of the reasons why the Treasury has appeared willing to sell long-term debt at record high rates. Up to
this point, the Treasury's past decisions to sell long-term securities




48

can readily be justified by the secular rise in both short- and longterm interest rates in the United States. For illustration, consider
a 25-year bond with 20 years of call protection that was sold by the
Treasury 6 years ago. In 1976, such a security was auctioned at the
now-remarkable yield of 8 percent. If the financing had been done
by Treasury bills the interest rate to date would have been considerably higher. For the years from 1977 through 1981, the 3-month
Treasury bill rate has averaged 10 percent and currently the 3month bill rate is around 13 V2 percent. Taxpayers thus far have
benefited heavily from the strategy of offering long-term debt.
It's long been a position of our committee that the Treasury's financing needs are so great that debt structure precludes a focus on
market timing. In order to raise needed funds, the Treasury must
tap all segments of the market in an orderly and predictable
manner and cannot wait for periods of low rates or forego financing in the intermediate or long markets. Because the vast majority
of its debts is still relatively short term—any decline in rates will
be quickly reflected in lower borrowing costs. Should the Federal
Government at some time in the future move to a surplus position
in its budget, questions of market timing could then be considered.
It is a widely held view and a correct one that Treasury demands
for funds in the markets put upward pressure on interest rates. We
believe that the term or maturity of Treasury borrowings also
exerts an influence on the term structure of interest rates. We believe that in general it is desirable for debt management purposes
that a substantial proportion of Treasury borrowings take place
beyond the bill area. A yield curve in which the investor is rewarded for extending his lending commitment is most beneficial to orderly debt management.
Our committee periodically reviews features and changes that
might make the sale of Treasury debt easier or cheaper. These reviews have included call features, sinking funds, indexing, and a
variety of other options. Our consistent viewpoint has been that
these alternatives offer little advantage, if any to the Treasury's
ability to raise funds and would probably result in greater cost over
time.
The financial futures market has generally made it easier and
cheaper to finance Treasury debt. Without the ability to hedge
their underwriting risk, other market participants would be forced
to make certain that interest rates were high enough to insure a
high probability of gain. The financial futures market in a sense
provides an opportunity for dealers to take more risk when bidding
on new issues. It also is increased the liquidity of the market which
helps produce a lower interest cost that might otherwise prevail.
The advent of other market innovations that have occurred in
the last few years, such as money market mutual funds, market
priced deposits at banks and thrifts, All Savers and I.R.A. accounts
have all had an impact on direct individual ownership of the Federal debt. This is not to say that individual ownership of Treasury
debt is declined, but unquestionably direct interest has waned. It
must be noted that money market funds are heavy investors in
Treasury and Federal agency securities.
Federal Reserve policy exerts a strong influence upon interest
rates and market trends. There was a time when Federal Reserve




49

policy was maintained at a stable level or "even keel" through
Treasury financing operations. While I am sure Federal Reserve officials are cognizant of Treasury debt operations and attempt to
avoid disruptive events during these operations, there is certainly
nothing now that resembles "even keel." It is probably fair to say
that expectations as to future—or present—Federal Reserve intentions are the prime movers of markets either in the secondary or
new issue sectors.
It is also important to note that the reality of supply versus
demand is very important in influencing market trend. Thus, we
have seen over the last few months that markets react adversely to
potential sustained high levels of deficit financing and also react to
short term oversupply situations represented by an abundance of
securities in dealer inventories.
Turning now to the Federal Reserve in its relationships with the
Treasury, we must begin with the change in the Federal Reserve's
operating strategy in 1979. This change from pegging the Federal
funds rate to controlling the growth of nonborrowed reserves has
had a profound effect on financial markets here in the United
States and abroad. All debt markets have felt its effects. Interest
rates have moved to historic highs and experienced great volatility
than any time in our history. These effects represent some of the
cost of the Central Bank's determined and commendable fight
against inflation as well as the uncertainties and concerns surrounding record budgetary deficits and resultant Treasury borrowings.
Naturally this enhanced rate volatility has had a broad impact
on the operations of Government securities dealers. The large unhedged positions that the dealer community might have accepted 5
or 10 years ago are too risky today. When the Federal Reserve directly influenced the Federal funds rate, there was a predictable
pattern of movements in interest rates over the business cycle.
Dealers and other investors honed their research skills to predict
where business conditions and Federal Reserve policies were likely
to take interest rates. Over the last 2XA years of the Federal Reserve's new operating strategy, interest rates have not moved regularly with the business cycle. Rather, interest rates have moved erratically and widely as the Federal Reserve has worked to stabilize
the rate of growth of money.
The problems of operating in a fundamentally new environment
were difficult for the dealer community as well as other market
participants. The adjustment process continues. For the Treasury's
part, even before the advent of the new operating strategy the
Treasury recognized that the Federal Reserve had largely abandoned its direct efforts to assist the Treasury in its financing. The
period of "even keeling" whereby Fed acted to keep market conditions stable during periods of heavy Treasury financings were over
well before October 1979. The Treasury's borrowing had become so
persistent and so large, that the Federal Reserve would have had
little flexibility in conducting monetary policy if it limited policy
moves to periods when the Treasury was not in the market with
new offerings. In addition, Federal Reserve support of treasury financing could at times be highly inflationary.




50
With even keeling over, the Treasury already adapted its techniques of marketing its debt to an environment where the Federal
Reserve provided little or no support. Key among the changes have
been the two I mentioned at the outset of my remarks: The use of
competitive auction technique and regularization of offerings. Competitive auctions can be contrasted with the subscription technique
where the Treasury sets the yield on the security before it accepts
tenders. In an auction, dealers and others submit tenders specifying the amount of securities willing to be purchased at specific
yields. This relieves the Treasury of making an independent determination of market conditions. The regularization of offerings permits dealers and others to anticipate coming Treasury issues.
The financing of multibillion dollar deficits is never easy. The
United States is fortunate that it has an economy and a financial
infrasturcture that is capable of accommodating the huge demands
of its Governments as well as its private borrowers. It is vital to
the ongoing health of our economy that the needs for funds of all
of our borrowers be met as inexpensively and efficiently as possible. As the largest borrower, the U.S. Treasury must continue to
observe the principles of debt management that have enabled it to
fund our Government while minimizing the effect on the economy
and other borrowers. Concurrently, the Federal Reserve must continue with its policies designed to provide an appropriate supply of
money and slow the rate of inflation. It must be recognized that
our long range goals cannot be achieved without some shortrun
costs. High interest rates and substantial volatility of rates are but
two of these.
Frank Smeal and I wiM be happy to respond to your questions.
Chairman FAUNTROY. Thank you, Mr. Taylor, for your very clear
testimony. I have several questions I'd like to tend to you. And the
first is how much support should the Federal Reserve provide the
Treasury in the sale of its debt? I'm not suggesting that the Federal Reserve should seek to monetize any of the debt, but I am interested in knowing whether the Feds should buy the long-term bonds
from the Treasury to avoid the problems associated with the 70 billion dollar limit on long-term bonds at 4Vi percent; or whether the
Feds should seek to provide some "even keel," as it's called. Or,
whether some additional regulation of other financial instruments,
such as the money market funds, sweep accounts, cash management accounts should be considered.
Mr. TAYLOR. Well, we could spend a good part of the day on that
question, sir.
Chairman FAUNTROY. That's why I asked you first.
Mr. TAYLOR. Frank, would you like to answer and give my voice
a little rest.
Mr. SMEAL. First I'd like to associate with Mr. Taylor's testimony. I think you've already heard from the people at the Central
Bank—the Fed—that the monetary and debt management policy
should be conducted independently as much as possible.
Even keeling was abandoned because the Treasury is constantly
in the market, it would be necessary for the Fed to be constantly in
the market to support Treasury financing. The market had been
doing quite well on its own without Fed support. If the Fed were to
conduct monetary policy with the intent of supporting Treasury




51
financings it would be inevitable that they would artificially
manage the level at which financings were done, and monetize the
debt in spite of a wish not to do that. We think the market can do
really quite well without Federal support. If the Fed should buy
long-term bonds in support of Treasury financing this too would
create artificial markets. We are quite pleased to have the Fed use
Treasury vehicles for the purpose of managing money, not for the
purpose of managing the price or the availability of money to the
Treasury.
Mr. TAYLOR. I think we feel that the Fed must certainly be cognizant of Treasury financing operations and avoid disruption to the
markets immediately preceding or after Treasury auctions, periods
of heavy Treasury financing. I think it's fair to say the Fed is very
cognizant of the Treasury's financing schedule, and in general, suprises to the market are avoided during the times of Treasury finance. I think we think the relationship is very good, and works
very well.
Chairman FAUNTROY. If we were to attribute the historic highs
in interest rates to, at least partially the change in the Fed operating strategy, I'm referring to the October 1979 decision to which
you make reference, to target monetary aggregates instead of interest rates. I'd like to know whether or not one would then support a
return to the targeting of interest rates should the Fed reserve its
decision and now target interest rates instead of the ends?
Mr. TAYLOR. A very difficult question, and I think that my
answer would be no, they should not return to the old methods of
targeting interest rates. If the focus of the battle is truly going to
be inflation, and if you associate inflation with monetary growth
rates, and I guess I believe there is a correlation. Then the Fed
probably really has to be focused on growth in the money supply,
and if that's the case we're going to continue to have fluctuating—
broadly fluctuating interest rates. So I guess I would say we pretty
much have to live as we are, although I would think that over a
period of time as inflation wains that the rates—the rate pattern
should smooth out somewhat. I think I view the last couple of
years as an aberration in a longer term trend.
Mr. SMEAL. I like the change in procedures from focusing on
rates to focusing on money. The objective was to get better control
of the money supply, and thereby reduce inflation. And there is, of
course, ample evidence that they have succeeded in the larger prospective in this objective. Surely inflation has dropped dramatically
from 14 percent to the figures reported yesterday. Whether or not
this way of managing the money supply has introduced an element
of volatility in markets; whether or not interest rates are higher
because of this, is quite another question. Rates are certainly more
volatile. The ups and downs are far greater, perhaps because they
reflected the volatility of money itself. Whether this is the best
process is subject to much discussion at this stage of the game. But
if there is a better way, certainly it is not to go back to the old
system of trying to manage the money supply, control inflation,
and have some impact on the economic conditions by focusing on
interest rates alone which was really not effective.
Chairman FAUNTROY. Mr. Taylor, in your statement you mentioned that committee members and its Treasury officials are well




52

aware for the conflict in interest problems, and both parties have
initiated rules or procedures to guard against even semblance, as
you say of impropriety. Can you tell us precisely what rules and
procedures you have, and how they are enforced? If you could
make them available to the subcommittee in such written materials as you may have it may be helpful.
Mr. TAYLOR. We might be able to find the material or prepare
them for you.
First of all, the committee is an advisory committee so that our
activities are governed by the Federal laws and regulations that
govern advisory committees. Notice of our meetings and an agenda
is published in the Federal Register. An official from the Treasury
is present whenever we meet. I believe that that part of it is governed by Federal regulations. We do meet four times a year. We
come to Washington, D.C. each quarter. We arrive Monday evening, or we try to. The first official meeting is generally Tuesday
morning at which time we meet with the Treasury and we receive
a briefing on current conditions, the anticipated cash needs, and
other items pertaining directly to the debt. We then adjourn to another meeting where we receive an economic briefing by Treasury
officials. The Under Secretary for Monetary Affairs usually attends
that session and gives the committee its charge, which is a series of
questions Treasury officials would like to have our responses to.
We then adjourn, have lunch, meet that afternoon and the committee chairman gets to spend the night writing the report which is
presented on Wednesday morning to the Under Secretary and frequently the Secretary himself.
During that period of time, the 48 hours from Tuesday morning
until the public announcement of the Treasury's refunding intentions on Wednesday afternoon, we are basically not permitted to
contact our offices. That has been a longstanding rule of the group,
one that I believe is followed to the letter. If there is some type of
an emergency or something like that or an individual needs to contact his office, we generally sit down with him and monitor his conversation with the home office. I should also add that the information which we receive is included in the Treasury's press conference on Wednesday afternoon when they announce the refunding
intention. Thus, we are insiders only for a short period of time.
After the Treasury's press conference on Wednesday we lose that
insider relationship, because the information we've received has basically been made public. Would you add to that?
Mr. SMEAL. Yes. In the 3 0 active years of this committee, there
has been no instance of what might be regarded as a leak from the
committee. That is to say, no information moving from the committee during discussion with the Treasury on the financing to the
markets has been prematurely divulged.
The second thing, Mr. Chairman, and Dave, I might suggest that
we provide the subcommittee with two documents; one, this committee is reconstitued annually and all members are charged with
the things that Dave spoke about. I think it might be of interest to
the subcommittee to have a copy of the document that imposes on
our committee members the rules he talked about. The second is, a
copy of the letter we furnished the Treasury Secretary just about a
year ago when the charter of this committee was up for renewal.




53
In that letter, which is of course proprietary, but the substance of
it can be printed to the committee, the question was asked: What is
the role of this committee in advising the Treasury? I was then
chairman of the committee, and our response to the Treasury Secretary might be useful.
Chairman FAUNTROY. Yes, may I request that you provide us
with that and we'll insert it at this point in the record. You do anticipate some of the questions that I had had on the committee.
[The material referred to follows:]




54

CONTINENTAL B A N K
C O N T I N E N T A L ILLINOIS N A T I O N A L BANK A N D T R U S T C O M P A N Y OF C H I C A G O • 231 S O U T H LA SAI.LE STRF.ET. C H C A G O

March 31, 1982

ILLINOIS 60693

DAVID G. TAYLOR
EXECUTIVE VICE PRESIDENT
312/828-4240

The Honorable Walter E. Fauntroy
Chairman, U.S. House of Representatives
Subcommittee on Domestic Monetary Policy
of the Committee on Banking, Finance
and Urban Affairs
Suite H2-179, House Office Bldg. Annex No. 2
Second and D Streets, S.U.
Washington, D.C. 20515
Dear Mr. Fauntroy:
Frank Smeal and I enjoyed testifying before your Subcommittee on March 24.
It is gratifying when called upon for this type of testimony to find a
high level of interest among the Congressmen.
You will recall that you asked me to submit some information on rules of
the Public Securities Association Government and Federal Agencies
Securities Committee that 3 feel prevent conflicts of interest or other
problems. I am enclosing a copy of my letter of invitation to Committee
members for the current year which will give you some idea of our rules.
Further edification may be gained from a letter that Mr. Smeal sent to
Beryl Sprinkel in early 1981. Because this letter was addressed to
Mr. Sprinkel, it would be inappropriate for me to provide a copy to you.
It is my understanding, however, that Mr. Sprinkel has agreed to share it
with the Subcommittee and that Mark Stalnecker will produce it for you.
In addition, you requested some samples of our Committee reports
Treasury. Again, these reports are directed to the Secretary of
and the decision to release them would be his. It is my further
standing that Mark Stalnecker will furnish some of these reports
Again, it was a pleasure to appear before your Subcommittee.
Your" " — " - —

DGTrEMH
Enclosure
Copy to Mr. Frank P. Smeal
Mr. Mark Stalnecker




125th ANNIVERSARY 1857-1982

125

S Bv I n < O C N N N A li LN I C R O A I N
U f DA
F OT F Tl
I OS O P R TC

to the
the Treasury
underto you.

55
SAMPLE LETTER

CONTINENTAL BANK
: c \ ' NENTAl

CIS NAT 0 \ A L

3A\<

AND " U S T

COV.PANY OF C H I C A G O • 231 S O U T H L A S A L L E STREET. CHICAGO. ILLINOIS 6 0 5 5 !

January 4, 1982

To Members of the Public Securities Association
Government & Federal Agencies Securities Committee

As Chairman of the Government and Federal Agencies Securities Committee of the
Public Securities Association, serving with Jack Runnion as Vice Chairman, I
am pleased to ask you to continue to serve on this Committee during 1982.
The principal, i f not the s o l e , o b j e c t i v e of this Committee i s to contribute
your professional experience and personal judgment to assisting the Treasury
In financing and refinancing US Goverment debt.
Service on the Committee i s everywhere regarded as a p r i v i l e g e carrying the
responsibility to adhere scrupulously to the highly c o n f i d e n t i a l relationship
that must exist with the Secretary.of the Treasury and his a s s o c i a t e s . I t i s
our custom to begin each year by restating the conditions under which the
Committee functions in order to avoid even the slightest hint of impropriety
or i n d i s c r e t i o n .
F i r s t , Committee members should avoid a l l contact, Including telephone c a l l s ,
with their o f f i c e s or other financial market participants from the start of
our meetings with Treasury o f f i c i a l s until a f t e r the Treasury d i s c l o s e s i t s
financing decisions on Wednesday afternoon at about 4 PM. In the event that
some overriding emergency requires communication with a member's o f f i c e , he
should clear this with the committee Chairman.
Second, we make it a rule not to discuss the Committee's decisions on a
financing recommendation with anyone, not even Treasury staff, prior to the
Chairman's report to the Secretary on Wednesday morning. Finally, we should
all continue to observe the prohibition on disclosing Committee
recommendations, points of view within the Committee, or whether or not the
Treasury followed our recommendations, at any time with non-Committee members,
even with respect to past financings.
This is a very stiff code of conduct designed to protect the Treasury and our
Committee from unwarranted suspicion and criticism.




56

©
The i n i t i a l 1982 meetings are scheduled f o r Monday, January 25, t o Wednesday,
January 27. A d e t a i l e d agenda w i l l be sent t o you s h o r t l y .
A l i s t of members i n v i t e d t o j o i n the Committee f o r 1982 i s

enclosed.

One a d d i t i o n a l matter concerns the f a c t that i t has been customary that a
p o r t i o n o f the Committee's meeting expenses be covered by i t s membership.
A c c o r d i n g l y , would you s i g n i f y acceptance of your Committee appointment by
forwarding t o my o f f i c e as soon as p o s s i b l e a check in the amount of $150
payable t o me. At any time, of c o u r s e , you may request an accounting o f these
funds.
Kind r e g a r d s ,

David G. Taylor
Chairman
Government & Federal Agencies
Securities Committee
Public Securities Association
Enclosure




57

THE

UNDER

SECRETARY

FOR

MONETARY

OF THE

TREASURY

AFFAIRS

WASHINGTON. D C. 20220

April 15, 1981

Dear Frank:
As part of an analysis of Treasury operating policies
and procedures, Secretary Regan has requested a review of
all Treasury Advisory Committees. The purpose of the
review is to consider a more efficient utilization of some
committees and the possible consolidation or elimination
of others. Since the charter for the Government and Federal
Agencies Securities Committee expires in Hay, and to assist
us in this review effort, we would appreciate your input
regarding the contributions made to Treasury debt management
and related areas by your Committee and any changes in the
Committee's functions that you might wish to suggest. In
addition, we would appreciate your thoughts on the relative
merits of the current structure of the Committee, the timing
of its meetings, or any other procedural matters.
While I do not envision this subject being formally
discussed during the Committee meetings in late April, I ask
that input from your Committee be provided no later than
Hay 8 to enable us to review the information prior to the
expiration of the charter.
I appreciate your assistance in this review and I look
forward to seeing you in Washington at the end of the month.
Best wishes,

Hr. Frank P. Smeal, Partner
Goldman, Sachs & Co.
55 Broad Street
New York, NY 10004




58
Goldman, S a c h s & Co. 155 Broad Street I N e w York, New York 10004

Tel: 212-676-8688
Frank P. Smeal
Rartner

s a r

April

20,

1981

Mr. B e r y l S p r i n k e l
Under S e c r e t a r y f o r
Monetary A f f a i r s
Department o f t h e T r e a s u r y
W a s h i n g t o n , DC
20220
Dear Mr.

Secretary:

T h i s i s i n r e s p o n s e t o y o u r r e q u e s t t h a t we r e v i e w t h e
r o l e o f t h e U . S . Government and F e d e r a l A g e n c i e s S e c u r i t i e s
C o m m i t t e e a s a d v i s o r s t o t h e T r e a s u r y on debt management.
T h i s C o m m i t t e e , a s you know, i s a committee o f t h e
Public Securities Association.
The o n l y s u b s t a n t i v e r e q u i r e ment f o r membership i s d e m o n s t r a t e d and a r t i c u l a t e a b i l i t y ,
c o n s i s t e n t l y m a i n t a i n e d , t o c o n t r i b u t e i n a s i g n i f i c a n t way
t o a d v i s i n g t h e T r e a s u r y on f i n a n c i n g and r e f i n a n c i n g t h e
Federal debt.
T h i s c o n d i t i o n can o n l y be met by t h o s e a c t i v e l y
i n v o l v e d i n a s e n i o r p o s i t i o n i n d e b t markets a s i n v e s t o r , i n v e s t m e n t a d v i s o r , b a n k e r o r a s a d e a l e r , bank o r n o n - b a n k , i n
debt s e c u r i t i e s .
A l l members, p a s t and p r e s e n t , h a v e had
d i r e c t and d a i l y i n v o l v e m e n t i n t h e market f o r t h e s e c u r i t i e s
o f t h e U . S . Government and i t s a g e n c i e s .
A l l b u t 9 members
a r e d e a l e r s who a r e r e c o g n i z e d by t h e F e d e r a l R e s e r v e Board
f o r p u r p o s e s o f c o n d u c t i n g open market o p e r a t i o n s and a l l s u c h
members a r e a l s o members o f t h e A s s o c i a t i o n o f Primary D e a l e r s .
M e m b e r s h i p , new and c o n t i n u e d , i s d e t e r m i n e d i n p e r i o d i c m e e t i n g s o f t h e Chairman, V i c e Chairman and a l l o f t h e a c t i v e f o r mer Chairmen o f t h e Committee w i t h t h e a p p r o v a l o f t h e T r e a s u r y .
S u b j e c t t o t h e c o n d i t i o n t h a t a l l members must be h i g h l y comp e t e n t , e x p e r i e n c e d and a c t i v e l y i n v o l v e d i n f i n a n c i a l m a r k e t s ,
some e f f o r t i s made t o g e t r e g i o n a l r e p r e s e n t a t i o n s o t h a t
Committee v i e w s a r e a r e a s o n a b l e p r o x y f o r n a t i o n w i d e v i e w s .
As f a r a s p o s s i b l e , t o o , some b a l a n c e between banks and n o n - b a n k
dealers i s sought.
The p r e s e n c e o f a l a r g e r number o f banks
t h a n n o n - b a n k d e a l e r s on t h e Committee r e f l e c t s t h e r e l a t i v e l y
l a r g e r number o f banks who d e a l o r i n v e s t i n t h e s e c u r i t i e s o f
From t i m e t o t i m e , members
t h e U . S . Government and i t s a g e n c i e s .
a r e added o r d e l e t e d t o r e f l e c t c h a n g i n g r e s p o n s i b i l i t i e s and t o




59

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Mr. Beryl
Page 2
April 20,

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1981

p r o v i d e f o r a r o t a t i o n o f membership i n areas where more than
one q u a l i f i e d c a n d i d a t e may be a v a i l a b l e .
Although membership
i s based p r i m a r i l y on p e r s o n a l q u a l i f i c a t i o n s , an a s s o c i a t i o n
with a s i g n i f i c a n t f i n a n c i a l i n s t i t u t i o n i s also a consideration.
No i n s t i t u t i o n i s presumed t o have a " s e a t " on the
Committee.
The Committee's image as a t e c h n i c a l a d v i s o r y c o m m i t t e e - t r a i n e d , e x p e r i e n c e d , and a c t i v e l y i n v o l v e d in debt m a r k e t s - i s appropriate.
Although membership on t h i s Committee has
been a mark o f g r e a t p e r s o n a l p r e s t i g e in the f i n a n c i a l comm u n i t y , members have been proud of the o p p o r t u n i t y t o apply
t h e i r s k i l l s and e x p e r i e n c e t o the e f f i c i e n t and economical
management o f t h e Federal debt in the p u b l i c i n t e r e s t .
The Committee's t r a d i t i o n a l r o l e has been performed by
meetings w i t h the Treasury during the time o f q u a r t e r l y r e fundings.
Q u e s t i o n s addressed in the form of a " C h a r g e " by
the Treasury i n c l u d e :
1.

Size of

the q u a r t e r l y

2.

Amount of cash t o be

3.

A p p r o p r i a t e cash

4.

S i z e of

financing.
raised.

balances.

issues.

5.

M a t u r i t y of

6.

A p p r o p r i a t e s a l e s t e c h n i q u e s , such as y i e l d or
price auction, fixed price subscription i s s u e s ,
reopening of o u t s t a n d i n g i s s u e s or s a l e of new
issues.

7.

Scheduling of

8.

Appropriate




issues.

sales.

r e l a t i o n s h i p between b i l l s

and coupons.

60

»
Mr. B e r y l
Page 3
A p r i l 20»
9.
10.

Sprinkel
1981
S i z e and frequency o f
Call

cycles.

provisions.

In a d d i t i o n t o t h e s e s p e c i f i c t e c h n i c a l q u e s t i o n s , t h e
Committee a d v i s e s the Treasury on the nature of the demand
f o r Treasury i s s u e s , the market impact of the s i z e o f the
f i n a n c i n g or t h e s i z e o f any p a r t i c u l a r i s s u e .
The d i v e r s e
i n s t i t u t i o n a l and g e o g r a p h i c a l make-up of the group e n a b l e s
i t t o r e f l e c t the market e x p e c t a t i o n s and r e a c t i o n s f a i r l y
accurately.
In a wider s e n s e , t o o , the Committee i s a
r e a s o n a b l e proxy f o r how the f i n a n c i a l community views and
might r e a c t t o A d m i n i s t r a t i o n , f i s c a l and monetary p o l i c i e s .
In a d d i t i o n t o i t s p e r i o d i c r o l e in a d v i s i n g the Treasury
on a formal b a s i s during q u a r t e r l y r e f u n d i n g s , the Committee
from time t o t i m e , a t the request of the T r e a s u r y , has undertaken s p e c i a l s t u d i e s of debt management problems.
Most
r e c e n t l y , on September 2 2 , 1 9 8 0 , the Committee h e l d a s p e c i a l
s e s s i o n a t the New York Federal Reserve Bank t o c o n s i d e r " r e c ommendations f o r meeting the a n t i c i p a t e d heavy f i n a n c i n g r e quirements i n the October-December quarter and i n 1 9 8 1 . "
(Exhibit A . )
In the p a s t , t o o , the Committee has made d e t a i l e d
s t u d i e s o f s p e c i f i c " i n n o v a t i v e " f i n a n c i n g techniques t h a t the
Treasury might u t i l i z e t o broaden i t s market.
The Committee has a l s o been the bridge t h a t enables the
Treasury t o absorb s t a f f changes when an A d m i n i s t r a t i o n i s i n
t r a n s i t i o n so t h a t debt management can be conducted i n an obj e c t i v e , c o n s i s t e n t and n o n - p o l i t i c a l way.
Our most c r i t i c a l r o l e , however, i s t o f o c u s t h e Treasury
and the market on debt management p o l i c i e s , p r i n c i p l e s and
t e c h n i q u e s on a r e g u l a r , p r e d i c t a b l e b a s i s in r e l a t i o n t o r e a l
market e v e n t s .
This a s s u r e s t h a t a t l e a s t f o u r times a y e a r
a l l a r e a s o f the Government i n v o l v e d with management of t h e
Federal d e b t - - t h e Fed, the Treasury and o t h e r a g e n c i e s o f the
Federal G o v e r n m e n t - - c o n c e n t r a t e with r e p r e s e n t a t i v e s of t h e
market on s p e c i f i c problems of managing the d e b t .
The Committee

95-118

149

New York ! Boston ' Ch.ca go ! Dallas ! Detroit I Houstor.
I Los




Angeles I Memphis ! Philadelphia I St Louis! San Francisco

61

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Mrw Beryl
Page 4
April 20,

Sprinkel
1981

f e e l s t h a t a g r e a t d e a l would be l o s t i f i t s d e l i b e r a t i o n s
were conducted a t times u n r e l a t e d t o major f i n a n c i n g s so
t h a t the dynamics o f the market would be l o s t .
Committee members do not c a l l t h e i r o f f i c e s during the
p e r i o d o f t h e i r d e l i b e r a t i o n s u n t i l a f t e r the p u b l i c announcement o f r e f u n d i n g t e r m s , u s u a l l y a f t e r the 4 PM p r e s s c o n f e r e n c e
on Wednesday.
Emergency c a l l s on u n r e l a t e d m a t t e r s may o n l y be
made w i t h t h e a d v i c e and p e r m i s s i o n of the Committee Chairman.
There have been no known v i o l a t i o n s o f t h i s r u l e .
Although " r e g u l a r i z a t i o n " has reduced d e c i s i o n - m a k i n g
somewhat f o r the time b e i n g , i t i s r e a s o n a b l e t o assume t h a t
debt management problems w i l l be d i f f e r e n t i n the f u t u r e , as
they have i n the p a s t , and t h a t t h e s e new d e c i s i o n s w i l l p r o b a b l y be made or e v o l v e from major q u a r t e r l y f i n a n c i n g d e c i s i o n s .
The winding down of l a r g e d e f i c i t s and the emergence of balanced
budgets w i l l s h i f t the problem from r a i s i n g cash t o r o l l i n g over
o r perhaps even paying down d e b t .
I t may be t h a t o l d techniques
i n v o l v i n g exchanges and r i g h t s o f f e r i n g s may need t o be r e c o n sidered.
The Treasury w i l l have t o be a b l e t o respond t o changes
i n the ownership o f the debt and the impact of f i n a n c i a l i n s t i t u t i o n s ' u n w i l l i n g n e s s t o h o l d l o n g e r term, f i x e d - r a t e debt and
may r e q u i r e a review of the e n t i r e s t r u c t u r e of the d e b t , i n c l u d ing the f r e q u e n c y and s i z e of c y c l e s .
In summary response t o your r e q u e s t , t h e r e f o r e , we f e e l
t h a t inasmuch as the membership of the Committee was r e v i s e d
e a r l y t h i s y e a r with the r e t i r e m e n t of two s e n i o r members, the
" r o t a t i o n - o f f " o f t h r e e members and the a d d i t i o n o f f o u r members,
the p r e s e n t membership i s a p p r o p r i a t e .
Further changes are
a n t i c i p a t e d during the next y e a r or s o , but membership i n the
range o f 2 0 - 2 2 i s regarded as optimal f o r w o r k i n g - d i s c u s s i o n
purposes.
The Committee's procedures f o r responding t o charges and
f o r t r a n s m i t t i n g recommendations t o the Treasury has been e f f e c t i v e , and we have no p r e s e n t recommendation f o r change.

95-448




0 - 8 2 - 5

62

Mr. BeTyl
Page 5
April 20,

Sprinkel
1981

The s c h e d u l i n g o f meetings a t times of q u a r t e r l y r e f u n d i n g s i s regarded as a major f a c t o r i n t h e Committee's
effectiveness.
The U . S . Government and Federal Agencies S e c u r i t i e s
Committee o f t h e P u b l i c S e c u r i t i e s A s s o c i a t i o n s h o u l d be
viewed as investment bankers t o the U . S . T r e a s u r y .
As t h e
l a r g e s t i s s u e r o f debt s e c u r i t i e s i n the world w i t h an i t i n e r a n t s t a f f o f debt managers on both a p o l i c y and t e c h n i c a l
l e v e l , i f t h i s r e l a t i o n s h i p between t h e Committee and t h e
T r e a s u r y d i d not e x i s t , i t would have t o be c r e a t e d .
The
a l t e r n a t i v e , a t b e s t , would be h i g h e r c o s t Federal d e b t .
I , t o g e t h e r w i t h David T a y l o r , V i c e Chairman o f t h e
Committee, Bob Bethke, r e t i r i n g Chairman of Discount Corpora t i o n , . Bob S t o n e , E x e c u t i v e V i c e P r e s i d e n t of I r v i n g T r u s t
Company, and Dan Ahearn, S e n i o r V i c e P r e s i d e n t o f W e l l i n g t o n
Management, a l l former Chairmen of t h e Committee, would v a l u e
an o p p o r t u n i t y t o d i s c u s s t h e r o l e o f the Committee w i t h you
i n g r e a t e r d e t a i l a t your c o n v e n i e n c e .
Kind r e g a r d s 9

F

eal

FPS:bl
Enclosure

N e w Y o r k ! B o s t o n ! C h i c a g o ! D a l l a s I Detroit I H o u s t o n I L o s A n q e i e s I M e m p h i s ! P h i l a d e l p h i a I St L o u i s ' S a n F r a n c e s c o




63

DEPARTMENT OF THE TREASURY
WASHINGTON.
ASSISTANT

SECRETARY

D.C

20220

June 23, 1981

Dear Mr. Chairman:
On behalf of the Secretary of the Treasury, I am
transmitting for filing with the Committee on Ways and Means
the current charter for the Government and Federal Agencies
Securities Committee of the Public Securities Association.
This committee is utilized by Treasury, upon request, for
management of the public debt.
This charter is filed in accordance with the
requirements of the Federal Advisory Committee Act
(P.L. 92-463). A copy of the charter is also being filed
with the Committee on Finance of the United States Senate.
Sincerely

Cora
Assistant Secretary
(Administration)
The Honorable
Dan Rostenkowski
Chairman, Ways and Means Committee
House of Representatives
Washington, D.C. 20515




64

DEPARTMENT OF THE TREASURY
WASHINGTON.
ASSISTANT

SECRETARY

D.C.

20220

June 23, 1981

Dear Mr. Chairman:
On behalf of the Secretary of the Treasury, I am
transmitting for filing with the Committee on Finance the
current charter for the Government and Federal Agencies
Securities Committee of the Public Securities Association
This committee is utilized by Treasury, upon request, for
management of the public debt.
This charter is filed in accordance with the
requirements of the Federal Advisory Committee Act
(P.L. 92-463). A copy of the charter is also being filed
with the Committee on Ways and Means of the House of
Representatives.
Sincerely,

Cora P. Beebe
Assistant Secretary
(Administration)
The Honorable
Robert Dole
Chairman, Finance Committee
United States Senate
Washington, D.C. 20510




65
CHARTER FOR THE
GOVERNMENT AND FEDERAL AGENCIES
SECURITIES COMMITTEE OF THE
PUBLIC SECURITIES ASSOCIATION
This charter is prepared and filed in accordance with
the provisions of the Federal Advisory Committee Act, Public
Law 92-463, enacted October 6 , 1972.
A.
Official T i t l e . The official title of the
Committee is the Government and Federal Agencies Securities
Committee of the Public Securities Association.
B.
Objectives and S c o p e . The objectives of the
Committee are to provide informed advice as representatives
of the financial community to the Secretary of the Treasury
and his staff, upon his r e q u e s t , in carrying out Federal
financing and in the management of the public d e b t . The
scope of activity of the Committee is to consider commercial
and financial information relevant to its objectives and to
consult with and advise the Secretary of the Treasury and his
staff with respect to debt management o p e r a t i o n s , and to make
reports and recommendations in connection therewith.
C.
Time period. The period of time necessary for the
Committee to carry out these purposes is generally a two-day
period.
D.
Recipient of r e p o r t s . The Committee reports to
the Secretary of the Treasury or to his delegate having
immediate responsibility for debt management o p e r a t i o n s .
E.
S u p p o r t . The Department of the Treasury is
responsible for providing the necessary support for the
meetings of the Committee at the Treasury Department and for
maintenance of records and reports required under the A c t .
The expenses incurred by m e m b e r s of the Committee in
attending Committee m e e t i n g s are borne by the Public
Securities Association and the individual members of the
Committee.
F.
D u t i e s . The duties of the Government and Federal
Agencies Securities Committee are to meet with the Secretary
of the Treasury and T r e a s u r y o f f i c i a l s , consider proposed
debt management operations and develop reports and
recommendations in connection with these o p e r a t i o n s . The
duties of the Committee are solely advisory and no
determination of acts or policy to be expressed will be made
by the Committee.




66
G.
C o s t s . The estimated annual dollar and sta£f year
cost to the Department of the Treasury for the support of the
Government and Federal Agencies Securities Committee is
$36,000 and 1 staff y e a r .
H.
Number of m e e t i n g s . The Committee is expected to
meet at least four times a year, at the invitation of the
Secretary of the T r e a s u r y .
I.
Termination d a t e . Authority to utilize this
Committee expires two years from the date this charter is
approved.
J.
Filing d a t e . The charter of the Committee is
filed with the Secretary of the Treasury as of J u n e 2 3 ,
1981 and is filed with the Finance Committee of the S e n a t e ,
and the Ways and Means Committee of the House of
Representatives as of the date of receipt by those Committees
of the transmission of the charter by the Secretary of the
Treasury.

Submitted By:

Assistant Secretary
(Domestic Finance)

JUN 2 3 1981
Approved By:




Cora P . Beebe
Assistant Secretary
(Administration)

Date

67
Chairman FAUNTROY. In your testimony, you indicated that the
committee's role toward the Treasury is analogous to that of an investment banker or financial advisor. What precisely do you tell
the Treasury? Do you make many suggestions as to the actual size
of sales, timing, composition of the sales, and so forth? Does your
committee keep detailed minutes, for example?
Mr. TAYLOR. The committee does have a secretary and does keep
minutes. The minutes, I must say, are very brief. The essence of
our recommendations are contained in a written report which is
presented to the Secretary at the Wednesday morning session. I
think it is fair to say our recommendations are very specific. We
recommend the size of the issues to be offered, the way they should
be offered. As I've said in my testimony, and I don't ever like to be
thought of as being narrow, but we do act in a rather narrow fashion. We respond very specifically to the questions that are asked of
us, so they are very specific recommendations.
Chairman FAUNTROY. YOU say you meet four times a year?
Mr. TAYLOR. We meet four times a year on a regular basis. We
usually have a special meeting or two. If the Treasury's secretary
has specific questions that may not be specifically related to a particular refunding. We also have a strategy meeting once a year in
which we look at the longer term picture and where we attempt to
both strategize and improvise and do some inventive thinking
about what the Treasury might do. We had such a meeting 2 weeks
ago.
Chairman FAUNTROY. The four meetings, are they always with
the Treasury during that 2-day period?
Mr. TAYLOR. Always. The pattern I describe to you is followed
without exception.
Chairman FAUNTROY. I see. And I take the strategy means a
caucus of the committee members?
Mr. TAYLOR. Yes. Again with the same notification in the Federal Register. A Treasury official present and the same kind of a setting.
Chairman FAUNTROY. How many people are generally present at
your meetings, the four?
Mr. TAYLOR. The committee has 26 members and it's rare that
we have someone not attend.
Chairman FAUNTROY. I'd be interested in whether we have—they
have any contact or decision authority on security sales in your
firm or before the final action and the Treasury debt sales, or at
least its announcement?
Mr. TAYLOR. I'm not sure I understand the question.
Chairman FAUNTROY. I think I heard Mr. Smeal indicate—no, it
was you who indicated that none of this is available to you before
the public announcement.
Mr. TAYLOR. We make our recommendations to the Treasury in
the morning, and at around 4 o'clock in the afternoon the Treasury
announces what it is going to do. We have no way of knowing
whether they are going to follow our recommendations or not.
Mr. SMEAL. We know the questions which could be important,
and we know what our answers are. We do not know whether or
not this will be accepted by the Treasury, and frequently these recommendations are not followed.




68
Chairman FAUNTROY. I see. Where do you meet, generally?
Mr. TAYLOR. We meet at the Treasury and at a hotel.
Chairman FAUNTROY. At the Treasury. Would you make available to us those minutes, that you reference, that you have from
time to time?
Mr. TAYLOR. Yes; I don't think there would be any problem.
Mr. SMEAL. I think they're all published as part of the record
after a delay, I think it's about 3 months.
Chairman FAUNTROY. Sure. After the appropriate delays. I'd just
like to have a look at them for the record. All right. I want to yield
now to the distinguished gentleman from Florida, Mr. McCollum.
Mr. MCCOLLUM. I'm just curious about how long your committee
has been in existence to follow up on the chairman's questions?
Mr. SMEAL. We believe about 30 years.
Mr. TAYLOR. Since the development of Treasury financing in the
postwar period, I believe.
Mr. SMEAL. We say 30 years partially because prior to 1952,
which was 30 years ago, debt management was conducted under
conditions in which the Fed agreed to maintain the long-term price
of securities. There was no real substantive role for an investment
banker to give input to the Treasury then.
Mr. MCCOLLUM. I want to change the topic somewhat. At the
weekly auctions that Treasury has what would be the consequences
of imposing a ceiling on interest rates paid by the Treasury or on
some or all of its obligations if that interest rate ceiling were to
float some measure of inflation? Mr. Taylor, have you got any
thoughts about that?
Mr. TAYLOR. The markets are so big that you can't push them
around. If that ceiling imposed a limit that was too low, the Treasury simply would not be able to sell its debt because nobody would
bid for it. There are numerous examples of this in the municipal
securities market because in most States there are interest rates
ceilings imposed by the legislature. Thus, frequently over the last 2
years, municipalities have been unable to finance simply because
they could not get anybody to bid for their issues at below market
level rates.
Mr. MCCOLLUM. Suppose a ceiling was reached gradually over a
period of time to establish relationship between inflation and some
fixed place, you know historically. I'm trying at history. We've had
a relationship between inflation and interest rates in our country.
In our distorted marketplace of money today, interest rates seem to
be abnormally above that area. And, the curiosity question of the
day of the psychological forces, people will be talking about the
psychology of the marketplace. Possibly the Government debt is a
major factor in that, both real and psychologically.
What I'm really driving at and wondering about if we were to
take a basic point at which interest rates are today, derive some
measurable design on where we would like them to be, the Treasury pays out and where we would like them to be in terms of historical inflation. Could we not start at some point of the ceiling so
there's not an effect, even over a period of weeks branch it down to
fractional percentage point and reach that points and have a psychological impact on the marketplace?




69
Mr. TAYLOR. I'm afraid not. I think that the markets are simply
too vast. They are really worldwide. And, as you are aware, there
is a market in offshore dollars—Eurodollars—which, I think, is currently around 1 trillion dollars.
Mr. SMEAL. A very large number.
Mr. TAYLOR. It is a mammoth market. Thus, I'm afraid that you
simply cannot dictate to markets the price of money.
Mr. SMEAL. Could I add to that? If you're talking about floating
rate U.S. Government securities, which is a device that corporate
America has attempted to use from time to time to raise money in
the capital markets; this is a device that works under specific circumstances. We have found, and we were finding it out right now,
that you can sell floating rate securities when investors believe
that rates are going to rise and they want to take advantage of
that rise and float up. However, they don't want to float down. If
you have a market in which investors feel rates are going to go
down, you cannot do it. It is a kind of index. And free market
people have a violent reaction to indexes. They feel that indexes
institutionalize inflation and removes any discipline to get inflation
under control. So, you'll find those who are relatively free market
people—believe the market is efficient and best sets interest rates
and, it should not be done by artificial means. That would pose
grave difficulty with financing, especially in raising massive
amounts of the Federal money if it were indexed to some rate of
inflation.
Mr. MCCOLLUM. Don't you find it to be abnormal in the circumstances the disparity of interest rates are not normal?
Mr. SMEAL. In the past, the real rate was thought to be 2 or 3
percent plus a rate of inflation. Now we are finding real rates of 5
or 6 percent. We suspect that the market generally is expressing
low expectations about our ability to curb inflation. I would not
call the rates abnormal, however, given current conditions.
Mr. MCCOLLUM. How about a national usury ceiling for all the
interest rates in the United States indexed to the rate of inflation?
Mr. SMEAL. I have problems philosophically with such a system. I
suspect it would be unmanageable. I don't think it would produce
any money more cheaply.
Mr. MCCOLLUM. You're still talking about Eurodollar that have
its money overseas. I can't buy that. I think America where everybody wants to invest today. Isn't it a natural thing the Saudis want
to come here, surreptitiously or otherwise, to put their money?
Mr. SMEAL. The Saudis are more interested in the value of the
dollar than the rate at which they invest their money. They have
no place else to go.
Mr. MCCOLLUM. If we close down this market so to speak, are all
American investors going overseas? Wouldn't that market come
down? Aren't we that powerful if we close down the market with a
limited ceiling?
Mr. SMEAL. I have no idea what would happen if we closed the
market. There is no other market that could absorb the massive
global needs for capital.
Mr. MCCOLLUM. What I'm getting at that's true and we wouldn't
close it down if we put a national index ceiling. Would we? We




70
really wouldn't close it down. People would live within that ceiling.
You wouldn't like it but you would live within it?
Mr. TAYLOR. You're trying to pin down a couple of bond traders
on a huge economic question here that really has no easy and
simple answer. What we really ought to do is ask some of the
economists in the audience to respond.
Mr. MCCOLLUM. I'll yield back my time. I find the issue intriguing and related to my problems of Treasury and interest rates. I
yield back.
Chairman FAUNTROY. The gentleman from Texas, Mr. Patman.
Mr. PATMAN. Thank you, Mr. Chairman. Do you represent other
plans and private business on their debt management problems?
M r . SMEAL. Y e s .
Mr. TAYLOR. It's

a big part of Frank's business.
Mr. SMEAL. As David said, we regard ourselves as investment
bankers. Goldman Sachs represents private clients.
Mr. PATMAN. And, do you represent private corporations, primarily?
Mr. SMEAL. We represent both, private and public corporations.
Mr. PATMAN. Foreign governments?
Mr. SMEAL. Yes; in some instances.
Mr. PATMAN. In general, do you subscribe to the theory that
large deficits and high national debts result in higher interest
rates?
Mr. SMEAL. Absolutely.

Mr. PATMAN. What seems to be the future if we continue this
process of adding to the national debt? The Republican Senators
. went last December to the President and said, we have deficits aggregating over $1 trillion if something isn't done in the next 5
years. That doubles our national debt at that point from what we
have now.
Mr. TAYLOR. The interest burden becomes increasingly onerous.
Mr. PATMAN. I assume that is built into their projection in the
last year where it is up to $299 billion deficit.
Mr. TAYLOR. Certainly, as the deficit grows, interest payments
become a substantial portion of it. If you take 100 billion dollars'
worth of debt over a 10-year period you probably will, in interest
and principal, repay about $400 billion.
Mr. SMEAL. That is something called compound interest. And I'm
glad the committee understands it.
Chairman FAUNTROY. Oh, yes.
Mr. PATMAN. And then you add that to the debt.
Mr. TAYLOR. And thus the number becomes very, very onerous.
Mr. PATMAN. HOW does that impact on the economic system?
Mr. SMEAL. Well, can I make a point? You know that some years
ago, in 1975, we told the city of New York they could not run the
city on borrowed money. I think the Federal Government ought to
take judicial notice of that same point. In the case of the Federal
Government, when they borrow huge amounts of money, they can
simply print it. The city of New York cannot do that. This country
will face some of the same problems as New York City if we spend
an awful lot more than we take in. Thus when deficits reach the
massive amounts they are now, the markets require a higher price
to finance them—and that is the interest cost.




71
Chairman FAUNTROY. Mr. Patman, if you would yield. I think we
should call ABC, CBS, and NBC and ask them to broadcast this.
Mr. PATMAN. You're telling that to the Treasury as well as us.
Mr. TAYLOR. They're aware of that, surely.
Mr. PATMAN. Does it help to stretch it out over a long-term debt?
Mr. TAYLOR. We believe the needs are so massive that the Treasury has to use all maturities and all types of debt.
Mr. PATMAN. Why weren't the private corporations and so forth
taking advantage of the open field that seems to be present in the
long-term debt. Is it simply not there?
Mr. TAYLOR. There is quite a bit of long-term financing going on
currently. Frank can speak to that better than I. I believe he has a
record calendar of corporate issues.
Mr. SMEAL. A corporation has to relate the cost of its financing
to the price of its products. And at some level, that price is too
high. Today for many private corporations the price of long-term
money is simply unexceptionally too high in relation to business.
In addition, investors generally are skeptical about our ability to
control inflation and reduce the size of the deficits. Investors are
spending their money in the maturities 10 years and shorter. They
are not willing to make long-term commitments. And the private
capital users are going to the market that exists, and that is the
market of 10 years and shorter.
The Treasury's problem is somewhat different. The Treasury
must play all the instruments in the band. They have to go from
overnight to 30 years to raise all the money that is needed. The
problem of the Treasury is not the long-term debt, because most of
the debt is really quite short term. As as technical advisers to the
Treasury our general philosophy is now: starve the short-term
market to produce a positive yield curve so we can reduce the price
of the short-term debt. Only 10 percent of the debt is over 10 years.
I think the emphasis on the long-term versus short-term financing
is misplaced. We have to be concerned about the cost of short-term
financing as well.
Mr. PATMAN. We can't float securities on the long-term market.
Is that the feeling of the Treasury?
Mr. TAYLOR. The Treasury has generally tapped the long-term
market as well as the short-term market.
Mr. PATMAN. The basic philosophy now emphasizes the long-term
market.
Mr. TAYLOR. NO; I think the Treasury observes the action in the
long-term market, and I believe that they have decided to continue
with their program of issuing longer term securities. It so happens
that they're up against the statutory limit on their ability to finance long term at the moment, and they will be coming to you,
I'm quite sure, to have that limit expanded.
Mr. PATMAN. Now, are there Federal Reserve members on your
committee, too?
M r . TAYLOR. NO, s i r .
Mr. PATMAN. You

have communication with the Fed? But
they're not sitting with your committee at the time these decisions
are made?




72
Mr. TAYLOR. Oh, no. However, this committee does regularly go
over and visit with the Fed Governors when they are down here for
their meetings.
Mr. PATMAN. What do they tell you about the prospects?
Mr. TAYLOR. They use us as a resource subject. They don't tell us
very much. They generally are interested in market conditions as
we see them. Of course they do ask us the questions. I don't remember their having giving us a lot of information.
Mr. PATMAN. DO they apprise you of their intention to employ a
tight money situation?
Mr. TAYLOR. Not in any specific fashion, but certainly through
their testimony before the Banking Committee through conversations with them I'm certainly aware of their objectives.
Mr. PATMAN. When you hear the tight money policy is in the immediate future do you anticipate a higher rate of interest?
Mr. TAYLOR. That would generally be the market's initial expectation for the immediate future, yes.
Mr. PATMAN. And interest rates have actually fallen in the last
few months on the U.S. Government securities, have they not?
M r . TAYLOR. Y e s .
Mr. PATMAN. A quarter,

a third, or roughly what?
Mr. SMEAL. Long-term bond yields at their peak were around 15
percent. That yield is now about 13 V2 percent.
Mr. PATMAN. That's not as significant as I thought. How about
the Treasury bills?
Mr. SMEAL. Treasury bills yield at their peak were about 17 percent. They are now close to 15 percent.
Mr. PATMAN. NOW, that's where half the debt is now as I understand it.
Mr. SMEAL. NO; about 75 percent of the debt is due within 3
years.
Mr. PATMAN. When they talk about short term on half the debt
they're talking about just
Mr. TAYLOR. Treasury bills.
Mr. PATMAN. Ninety-one day and hundred and eighty?
Mr. SMEAL. Also 1 year bills.
Mr. PATMAN. One year, two. All right. Now, the prime rates fall
in portion to Treasury issues?
Mr. TAYLOR. They move in the same direct direction but not necessarily the same proportion.
Mr. PATMAN. DO foreign governments have their interest they
pay on U.S. rates?
Mr. TAYLOR. Foreign rates are strongly influenced by U . S . rates
at this time.
Mr. PATMAN. Why do the Japanese get it at such a low rate?
Mr. TAYLOR. Japan is different. It's a smaller more maternalistic
system-type of society. Rates of inflation are lower. I think the
comparison of Japan to the United States and interest rates is not
a good one to make.
Mr. PATMAN. YOU mentioned about the change in Fed policy of
going from basing monetary policy on interest rates to basing it on
monetary aggregates of the money problem. At the same time are
they not considering interest rate results of others?




73
Mr. TAYLOR. I think undoubtedly that they are cognizant of the
general impact their decisions are going to have on interest rates,
but in a sense you can't have it both ways. If you're going to control one the other is going to be a variable. And I think that is
their dilemma. I'm sure they don't like this volatility in rates.
Mr. PATMAN. I think I saw in the Wall Street Journal that we've
got both the worst of both worlds with the new Fed policy—high
rate of volatility and interest rates. Did you see that?
M r . TAYLOR. NO.
Mr. PATMAN. DO you
Mr. TAYLOR. I think

find it current on the street?
you must give this policy time. There is a
cost to beating inflation, and we're going through some of those
costs—high rates and high volatility in rates.
Mr. PATMAN. It's not just that I'm concerned about. But the permanent damage to the economy in our productivity.
Mr. TAYLOR. True.
Mr. PATMAN. I'm wondering if we really consider all the ramifications of all these policies. Just look at these nice little charts. We
don't have charts on unemployment and housing and these other
things.
Mr. TAYLOR. All those things are considered by the Fed. They are
aware of these things.
Mr. PATMAN. YOU think they compute the rate in unemployment
that's going to occur?
Mr. TAYLOR. I'm quite certain that they do.
Mr. PATMAN. And the lower housing starts?
Mr. TAYLOR. Yes, I'm certain all of those things come out of their
great big computer model.
Mr. PATMAN. Mr. Chairman, let's get us one of those computers.
Thank you very much gentlemen.
Chairman FAUNTROY. Mr. Weber.
Mr. WEBER. I'd just like to talk to these gentlemen as bond traders and not as economists. That's where their real expertise comes.
Certainly every member on this panel, and the Members of the
Congress as a whole are very, very interested in getting interest
rates down, and one of the things we're hearing is that the Federal
deficit, as you've stated, has direct influence on interest rates.
What are the people on the street telling each other as to the
Federal deficit before we can see a decline in interest rates? Will it
take a deficit of $90 billion, $75, $100, or what? Is there a connection? What can you say to us about the level of deficit that we've
got to come out with in this budget resolution for 1983 if we're to
have interest rates come down? Is there a correlation?
Mr. TAYLOR. Certainly there is some correlation, but I couldn't
quantify it for you, Mr. Weber.
Mr. WEBER. Well, that's important. In other words, is there a
magic figure that the street is looking for?
M r . TAYLOR. NO.

Mr. SMEAL. However, it is significantly smaller than the present
amount.
Mr. TAYLOR. I think that the street is probably willing to accept
a $90 billion deficit this year, and excuses it on the basis of the
business cycle. But when economists are predicting recovery and
better economic conditions, and the deficit grows instead of becom-




74
ing smaller that is when markets become concerned. So what
Frank said is exactly right. A substantially smaller deficit will
help, but be very hard for me to put a number on it.
Mr. WEBER. Does the street want us to reduce that deficit by decreasing Government spending or increasing taxes?
Mr. TAYLOR. I'm sure the street would say reducing Government
expenditures.
Mr. SMEAL. Our second best choice would be to reduce the tax
cut somehow, sometime.
Chairman FAUNTROY. Somehow.
Mr. TAYLOR. Somehow.
Mr. SMEAL. The best guess is if the Government has the money
they will spend it. So I would focus on spending cuts.
Mr. WEBER. If there were pressures to increase Government revenues would you do that by increasing income taxes or by putting
some sort of excise tax on?
Mr. TAYLOR. Well, that becomes a personal choice, and I wouldn't
profess to be able to give you the right answer. There may be some
merit in excise taxes. Something you hear frequently is to decontrol natural gas and slap an excess profits tax on companies that
benefit from that. There may be some reasonableness in that
scheme. But now you're talking to us as economists and you said
you weren't going to do that.
Mr. SMEAL. If you want talk as philosophers we can do that.
Mr. WEBER. I was wondering if there was a general psychology
on the street waiting for us to take a particular action.
Mr. TAYLOR. The street is certainly sitting on tender hooks wondering how it will be resolved.
Mr. WEBER. We've had a number of witnesses come before this
committee, including Under Secretary of the Treasury Sprinkel a
week or so ago, who said if you see periods of rapid expansion of
the money supply interest rates increase, they don t fall. And Beryl
Sprinkel said very positively he would stake his whole reputation
on the statement that tight money reduces interest rates, rather
than increases interest rates. Now, somebody is wrong and somebody is right on that.
Others have said that more expansive monetary policy growth is
needed to lower interest rates.
Mr. SMEAL. YOU both could be right.
Mr. WEBER. The general impression of the public is that tight
money means high interest rates.
Mr. SMEAL. In the short run that very well might be true.
Chairman FAUNTROY. Let him explain that.
Mr. WEBER. Yes. Is it a question of difference between short run
and long run?
Mr. SMEAL. We change interest rates because there is a connection between the level of interest rates and the quantity of money
though we don't completely understand it. That is why the Fed is
focusing on the money side of this question now and not on the interest rate side. Since this connection is known, when the Fed has
a tight money policy, it knows that, in the short run, interest rates
will rise. This rise will help the Fed's policy by further reducing
the money supply and thus produce economic conditions which
reduce demand. In the longer run this will produce lower interest




75
rates as the demand for money decreases. Thus there is both a
short-term and a different long-term connection between the rate
of inflation and interest rates.
Mr. WEBER. Thank you. I just wanted to make sure that I was
understanding earlier testimony correctly.
Mr. SMEAL. Can I make one point here. I think it is important
for this committee to understand who we are and who we represent. We are not the market! We are nowhere big enough to be the
market. But in many respects the market acts through the people
you'll be hearing today including Dave and I. We do not manage or
control interest rates, but reflect the view of people who do affect
rates.
Chairman FAUNTROY. We'll yield for a burning question from
Mr. Patman.
Mr. PATMAN. I just have a question to you as bond dealers and
observers of the market. What happens when people decide they're
not satisfied with the bond market rate that's offered on the
market? How do they boycott it or pressure it to give them a
higher rate of interest?
Mr. TAYLOR. They just do not buy.
Mr. PATMAN. What do they buy.
Mr. SMEAL. They go farther. They actually sell. First you stop
buying and then, if you're really convinced, you sell something that
you don't own because you think you can buy it back more cheaply.
Mr. TAYLOR. A S temporary investment you could invest in a
money market fund if you are an individual. Or you could go into
the market and purchase Treasury bills which are a haven where
investors wait for what they feel are better rates to come.
Mr. PATMAN. What's the last one you mentioned? Money market
funds and what else?
Mr. TAYLOR. Treasury bills are a good haven.
Mr. PATMAN. What if they don't satisfy the Treasury bill rate?
Mr. TAYLOR. It's all relative.
Mr. PATMAN. Commercial paper, that sort of thing?
Mr. TAYLOR. There are a whole array of short-term investments.
Mr. PATMAN. That's one thing that bothers me about the whole
situation. I wonder, we've built in the high interest rates throughout the economy how are we going to get them out? And there's so
much debt coming on board, becoming more available. It's becoming more of a buyer's market and that's really what's going to
drive the rates up, isn't it?
Mr. TAYLOR. It is supply and demand and it is real. It's what
makes markets move.
Mr. PATMAN. I think, in general, it works extremely well. Especially in your area. That is as far as establishing the market rate.
But I just wonder about these other extraneous forces, directly impacting forces like the Feds policies seem to be—seem to have been
in recent years designed to produce high interest rates.
Mr. TAYLOR. NO, they are designed to produce tighter credit, and
again supply and demand would say that if money is less available
in relation to demand the price for money will go up. And the Feds
basic methods of operation have been designed to slow the growth
in this economy—to take the heat out of it—and ultimately slow
inflation. That is a long-term process.




76
Mr. PATMAN. Tell me this is one last question. What happens
when the Fed monetizes the debt and how that impacts on the
market?
Mr. TAYLOR. Basically it increases the supply of money.
Mr. PATMAN. What does that do to the market?
Mr. SMEAL. It raises interest rates.
Mr. PATMAN. The supply of money
Mr. TAYLOR. Increasing the supply of money increases the
demand pull of inflation. More money in peoples' hands brings a
greater demand for goods.
Mr. PATMAN. How does it monetize the debt? Would you like to
get into that or prefer not to? We hear that
Mr. TAYLOR. The Fed could monetize the debt by simply buying
Treasury securities and paying in dollars that it uses to buy them.
It thus increases the money supply.
Mr. SMEAL. When you borrow in the Treasury bill market it is
equivalent to printing dollars. Treasury securities are convertable
into dollars at a very slight cost. Mr. Patman, I think if I were a
member of the Fed I would object to some of the things you said.
They are not really managing monetary policy by way of the interest rate. They are looking at the money supply, presumably, and
the interest rate that falls out from that, not vice versa.
Mr. PATMAN. I appreciate you taking up for the Fed on that
point, but actually it just looks like they're talking about money
supply, but thinking about interest rates.
Mr. SMEAL. We have to psychoanalyze.
Mr. PATMAN. I think we can see the results.
Chairman FAUNTROY. Thank you, so very much, gentlemen. I
certainly appreciate your testimony. Mr. Taylor, I would hope that
you had the wisdom of clearing your time all morning and could
therefore remain while we are hearing the next two witnesses just
in case we'd like to raise questions with you as well that their testimony may stimulate.
Mr. TAYLOR. We want to see them get sync'd with some of those
questions.
[The following letter from Deputy Assistant Secretary for Federal Finance Mark Stalnecker, of the Department of the Treasury,
dated April 6, 1982, was submitted for inclusion:]




77

DEPARTMENT OF THE TREASURY
WASHINGTON.

D.C.

20220

DEPUTY ASSISTANT SECRETARY

April 6, 1982

Dear Mr. Chairman:
Mr. David Taylor, Chairman of the Government and Federal
Agency Securities Committee of the Public Securities Association,
advised me of your request to him for copies of the committee's
recent reports to the Secretary of the Treasury.
The committee reports contain sensitive market information,
and the committee provides copies of its reports only to the
Treasury, although the Treasury does make them available to
the public several months after the reports are submitted.
Accordingly, I advised Mr. Taylor that I would provide
you with copies of the committee's reports, and I am enclosing
copies of all reports submitted by the committee in 1981. I
am also enclosing a copy of a letter of April 20, 1981 from
the then chairman of the committee, Mr. Frank Smeal, which
discusses the role of the committee in advising the Secretary
of the Treasury on debt management matters.
Please let me know if I can be of further assistance.
Sincerely,

A\<uA s - W w j ^
Mark Stalnecker
Deputy Assistant Secretary
(Federal Finance)
The Honorable
Walter E. Fauntroy, Chairman
Subcommittee on Domestic
Monetary Policy
House of Representatives
Washington, D.C. 20515
Enclosures

05-448 0 - 8 2 - 6



78
REPORT TO THE SECRETARY OF THE TREASURY
FROM THE GOVERNMENT AND FEDERAL AGENCY
SECURITIES COMMITTEE OF THE
PUBLIC SECURITIES ASSOCIATION
October 29, 1980
M r . Secretary:
The Committee recommends a 3-pronged refunding of $8*g
billion to refund $4.9 billion of privately held coupon issues
maturing November 15 and to raise $3,350 billion of new m o n e y ,
as follows:
1.

$3'-, billion of a 3's-ycar note issue to mature on
5/15/84.

2.

$2-3/4 billion of a 10-year note to mature 11/15/1990.

3.

$2 billion of a 30-year bond to mature 11/15/2010,
redeemable at par in 2005.

Although a substantial majority of the Committee preferred
an $8*j billion refunding, some felt'a slightly smaller $8 billion
package would be more appropriate in view of recent market weakness.
3b-Year Note
The 3h-year anchor issue was chosen rather than a shorter
3-year issue in order to avoid adding excessively to the $6.2
billion already maturing on 11/15/83.
10-Year Note
The Committee reaffirms the recommendation developed at its
special meeting on September 22, 1980 that the 10-year note be
made a regular part of quarterly refundings. Consistent with
that recommendation, we include $2-3/4 billion of a 10-year note
to mature 11/15/90 in this refunding.
Long Bond
There was total agreement on the sale of $2 billion 30-year
b o n d s , although the group is tending to seek to increase the size
of these longer issues.
7-Year Note
The Committee has also recommended that the 7-year note be
cycled in on a quarterly basis at some appropriate time. It was
suggested that this note be auctioned early in the last month of
a q u a r t e r , to mature on the 15th of the month 7 years later.




79
This would avoid conflict with the 4-year n o t e , auctioned
later in the month. Although we do not see the need to inaugurate
this as a regular quarterly cycle during the current quarter, we
would expect to recommend the introduction of a 7-year cycle note
early in this fiscal year.
15-Year vs. 20-Year Bond
A substantial majority of the Committee would not (repeat,
would not!) favor the substitution of a 20-year bond for the
regularly scheduled 15-year bond.
This recommendation is based principally on the belief that
a 20-year issue would increase the cost of longer-term money
without any collateral benefits. Although the 15-year bond has
not had an auspicious history in the market, a bond 5 years longer
would probably have done worse. The reduced volatility of the
shorter 15-year issue also accommodates the increasing preference
of a diminishing group of longer-term investors for shorter maturities. We did not feel that the value of creating an issue deliverable against futures trading would overcome these objections.
Furthermore, a reasonably vociferous minority was violently opposed
to doing anything to support that market.
Cash Management Bills
The Committee suggests the sale of $7Jj billion of cash management bills, $5^-4 billion should be sold in early November and
scheduled to mature on the last day of the y e a r , 12/31/80. The
maturity is selected to both accommodate the strong demand for a
year-end maturity and to give the Treasury some flexibility against
the debt ceiling.
These bills would be refinanced free of debt limit constraints
to mature in the surplus second quarter in mid-April 1981. The
additional amount of cash management bills should be sold in early
December to mature in mid-April 1981.
Summary
The Committee proposes total financing of $25.3 billion for
the quarter, as follows:
$5.2 billion

1.

Done or announced

2.

November refunding

3.4 billion

3.

Cash management

7.3 billion

4.

Increase 7 series of weekly
bills, $11/13-12/26) to
$7.8.

3.0 billion




80
5.

Increase Nov.-Dec. 2-year
year
notes to $4?s billion each

$ 3.1 billion

6.

5-year note (mid-Dcc.)

3.0 billion

7.

Increase Dec. 4-year note to
$3 billion

0.3 billion

TOTAL

$25.3 billion

Cash Balance
This would produce the projected cash balance of $15 billion
which is thought to be adequate.
Techniques - Timing
All issues should be sold at yield auctions, as follows:
The $34 billion note issue on Wednesday, November 5;
the $2-3/4 billion 10-year note on Thursday,
November 6; and the
$2 billion 30-year bond on Friday, November 7.
The Committee felt that markets were too volatile to risk
,
reopening the ll-3/4 s of 2/15/10 or any other issue.
We also felt that a Friday auction was to be preferred to an
auction with a short delivery in a holiday w e e k .
Rates
In view of the recent and prevailing volatility in the bond
and money m a r k e t s , we do not opine as to the level of rates at
which this financing will be done.
The Committee's deliberations this time were significantly
briefer than they have been in the p a s t . This is due to two
factors. First, because a large part of the strategic planning
for financing the expected large deficit this year was accomplished
at our special meeting in New York on September 22. This is an
agenda we will suggest become a regular part of our service to
the Treasury in advising on debt management issues. Secondly,
adhering to the sound principle of "regularization" and the
establishment of recurring cycles by which this is accomplished,
sharply reduces the areas in which decision-making is necessary.
The uncertainties and random events to which the international
economy and the markets will be exposed in the days and months
ahead have become so inscrutable recently, that we are withholding
our usual gratuitous preamble and comment.
We would be pleased to expand on these recommendations or to
answer any questions you may have.




Frank P . Smeal
Chairman

81
REPORT TO THE SECRETARY OF THE TREASURY
FROM THE GOVERNMENT AND FEDERAL AGENCY
SECURITIES COMMITTEE OP THE
PUBLIC SECURITIES ASSOCIATION
January 28, 1981

M r . Secretary:
Before responding to the "Committee Charge," it would
doubtless be helpful if we announced briefly the basic
principles that have guided this Committee in advising the
Treasury on management of the Federal debt over the y e a r s .
With the obvious principal objective of offering proposals
designed to raise the required funds in the most efficienteconomical w a y , the Committee believes that the Treasury should
continue to adhere to what is felt to be sound principles of
debt management emphasizing debt extension and regulari zation.
Regulat i zat ion
Debt extension can be achieved by raising as much
as possible in a maturity area of two years and longer, and
confining bill financing to 15-20' of total financing n e e d s .
Regularized offering cycles have provided the Treasury with
access to substantial S U I T S in all maturity sectors and allowed
investors to plan on predictable offerings for their investment
n e e d s . IVe feel that regularization has thus encouraged broaderdeeper investor participation in the Government securities market
by reducing uncertainty concerning Treasury financing p l a n s .
The Committee alsc believes that the auction t e c h n i q u e ,
yield o_r p r i c e , is the most effective method of achieving the
lowest available borrowing c o s t s .
We have not favored short or shorter call provisions for
Treasury issues in the belief that this would be paying for an
option not- likely to be exercised and would severely diminish this
uniquely attractive feature of Treasury b o r r o w i n g . The massive
size and frequency of financing and refunding needs presents
continuous opportunities to refund at prevai1ing,deelining or
lower interest r a t e s .
February Refunding

Proposal

3-1/2 year Note due A u g . 15/84
?
9 year', 9 m o . Note-Reopen 13 0 of N o v . 15/1990
29 year 9 m o . Bond - R e o p e n 12-3/4 of N o v . 15/2010
Total




$4,250
2.500
2.250
59.000

82
The Committee recommends that the February financing be
designed to produce $9 billion, as follows:
(See above).
This would refund the $4.9 billion privately-held coupons
maturing on February 15 and raise $4.1 billions in c a s h . The
Committee expresses in this recommendation its deep conviction
that quarterly financing totals should be and can be raised
in tranches larger than u s u a l , $1/4 billion, and that the coupon
components of these financings also can and should be raised.
Although this produces slightly more than the "reasonable portion"defined as $3-1/2 billion suggested in the charge, the Committee
feels it is urgent to begin the projected heavy borrowing
program now. If it is necessary to limit borrowing because of
debt limit constraints, reductions should be in bill sales
(as proposed). If the total financing were to be reduced, we
feel that such reductions should be made first in the 3-1/2 year
note.
The Group was unamimous in recommending a reopening of the
13% note due N o v . 15/90 and the 12-3/4% b o n d . It was not
felt that the prevailing or prospective market premium would
affect the bidding for these issues in a negative way and that
the Treasury could use the extra cash arising from the probable
premium bids.
The issues should be auctioned in the usual sequence on
Tuesday, Wednesday and T h u r s d a y F e b r u a r y 3, 4, and 5; at a
yield auction for the short n o t e , anchor issue, and at a price
auction for the reopened issues.
In view of the high volatility that continues to characterize
the debt markets, we do not opine as to the price or yield at
which these issues might be sold next w e e k . In connection with the
high volatility that has prevailed in debt markets during the
past y e a r , the Committee associates with the observation of
Milt Hudson at Morgan Guaranty ..."inescapably, a return to
tranquility in credit markets will prove elusive until inflation
is subdued, a prespect that clearly is not imminent."
Financing Requirements
Jan - Mar 1981
(billions)
For the quarter as a w h o l e , net market borrowing has been
estimated at $36 billion. $10-1/4 billion of this has already
been done. The cash balance is expected to drop $4-1/4 billion from
$12.3 on Dec 31/80 to $8.0 on Mar 31/81. This cash position
is felt to be adequate. We suggest that the balance of the financing,
approximately $25-3/4 billion be raised as follows:
(Exhibit A ) .




83
(Exhibit A )
1981
First Quarter Borrowing Plan
(Rill ions)
Issue
1.

I ssuc
Si zc

To Be
Done

Total

4.2

A1ready
Done

6.9

.5
.5

2.0

Kkly Bills:
January
Feb.-Mar.

8.4-8.6

2 auctions 2/5 2/12
6 auction? 2/19-3/26

8.3*
8.6 (68.2-64)

2.7

2. 52 Week Bills
Januarv (2")
Feb.
Mar.

4.5
4.5
4. 5

1.0

4.5
5.0
5.0

2.0

2.5
1.5
4.0
4.0
9.0

2.7
1.5

3. 2-Year Notes
Januarv
Feb.
Mar.

2.5
2.2

6.:

4. Longer Coupons
7-Year
20-Year
4-Year
5-Year
Refunding
(Adiust to Treas est.)
"Add .350
Cash management bill

9790
.35
10725

TW7IZ

1.4
4.0
4.1

llTTO

29730

6.25
25.65

3T75T)

*Feb 5 auction has been announced at$8.6. If debt ceiling
problem is not solved, do only 8.0 on Feb 12. Announce
this plan.




6.25

84
$4.2 billion thru increases in the regular
3- and 6-month auctions to $8.6 billion.
$1 billion by increases in the 52-week bills.
$4.7 billion by increases the monthly 2-year
note sales to $5 billion.
$5.4 billion by the sale of $4 billion each
of the 4- and 5-year notes.
$4.1 billion in new cash in this financing.
The Committee is confident that these increases will
not create unmanageable burdens for the market.
The balance of $6-1/4 billion would come from
the sale of cash management bills.
The proposed financing for the first quarter will thus
include $55-1/2 billion in coupon issues.
Increases in bill auctions ($600 million total on the
Feb 5 and Feb 12 issues) plus the $4.1 billion derived from
this financing raises $4.7 billion; leaving a cash balance of
$3.7 billion on or at the Feb 17 low point projected to b e ,
without borrowing, a deficit of $1 billion at that time.
The proposed schedule - including the sale of $6-1/4 billion
cash management bills at the end of the month; for delivery
in early March - will produce a cash balance of $2 billion at
the low point on the first of A p r i l .
Seven-Year Note
The Committee reconsidered and reaffirmed its belief
that the 7-year note introduced in January should be cycled in
on a regular quarterly basis.
20-Year Bond
The Group was impressed with the results in the auction
of the 20-year bond. At 11.84%, the stop was about 5 basis
points above the curve, a sharply lower discount than the 11 to
30 basis points that the Treasury paid in the earlier 4 auctions
of 15-year bonds. Selling an issue deliverable against
futures contracts thus may have saved the Treasury as much as
15 basis points in interest costs. However, in when-issued
trading, the 20-year issue appears to have performed as
badly as previous 15-year issues. Altho we include a^l-1/2 billion
20-year issue on the 15-year schedule this quarter, we are not yet
prepared to propose this as a regular replacement for the 15-year
maturity.




85
Altho these recommendations represent the views of a
substantia] majority of the Committee, in some cases a unanimous
v i e w , a persistent, if not always persuasive, minority position
existed on some issues. Those opinions can be expected to
be expressed at this open meeting ... with or without a leading
question from the Secretary of staff.
This is the end of our Report.
respond to questions.




We will be pleased to

Frank P. Smca]
Chairman

86
REPORT TO THE SECRETARY OF THE TREASURY
FROM THE GOVERNMENT AND FEDERAL AGENCY
SECURITIES COMMITTEE OF THE
PUBLIC SECURITIES ASSOCIATION
April 2 9 , 1981

M r . Secretary:
The deep emotion which greeted the President last night in
his call for enactment of his spending and tax program (and a
simultaneous call for a stable-predictable monetary policy)
probably altered the odds on passage of that program in a
significant w a y .
The impact of this event on expectations is such that is
would be foolhardy, at least in the short r u n , to predict w h a t
the ultimate impact on the real economy might b e .
The Committee's response to the Treasury charge is presented
in the framework of a financing plan for the calendar quarter
April through June as follows:
We took the cash balance of $10.7 billion at the beginning
of the q u a r t e r , the projected surplus of $8.3 billion at the end
of the q u a r t e r , plus the $6.5 billion in financing completed so
far and reduced it by the attrition on savings bonds and other
non-marketables of $2 billion, and the redemption of $14 billion
of cash management bills and further by a proposed reduction of
$3.9 billion in the regular weekly bills (from $8.3 plus billion
to $8 billion), together with the one-year bill at $4 billion.
This left a $5.6 billion cash balance. To achieve a cash balance
of $15 billion on June 3 0 , it is necessary to raise the difference,
$9.4 billion, in this financing and by additions to cycle notes
maturing during the next two m o n t h s .




87
Treasury Financing Rest of April-June Quarter
Billions of Dollars
plus

Cash Balance March 30
Estimated Surplus

minus

Attrition on Savings Bonds Non-Marketables

minus

Redemption Cash Management Bills

minus

Reduction of Regular Bills to $8 billion
and One-Year Bill to $4 billion

plus

Already Done

minus

Estimated Cash Balance, June 30

(15.0)

Needed to be Raised in Refunding
and Cycle Notes

($9.4)

(2.0)

$TTjT
(14.0)
$ 3.0
(3.9)

(JOT9T
6.5

376"

W e propose doing this by raising $7 billion in this refunding
as follows: Cycle notes maturing in the next two months would be
adjusted as follows:
Financing

$9.4

Cycle Notes:
2-year
5-year
2-year
4-year

note due 5/31 from $2.1 to $4.25
note settled 6/8 from $0 to $2.75
note due 6/30 from $2.7 to $4.2
noted due 6/30 from $2.4 to $3.0

Total
Needed to be Raised
Balance from Refunding

$2.25
2.75
1.50
0.60
$7.10
(9.40)
($2.30)

Refunding
3-year note due 5/15/84
10-year note due 5/15/91
30-year bond due 5/15/11

$3.00
2.00
2.00

Total Refunding

$7.00

Minus Maturing Issues
N e t Cash




(4.70)
$2.30

88
This raises an additional $7.1 billion, which, together with
the $2.3 billion acquired in the May refunding produces the required
$9.4 billion and the projected $15 billion cash balance on June 30.
Cash Management Bills
Cash management bills will have to be sold in early June to
cover the low cash balance in mid-June.
Rates
In view of the prevailing high volatility in debt markets, and
the predictable market response to the President's awesome reception
in his economic message to the Joint Congressional Session, this
Committee does not opine as to the rate at which any of these issues
might be sold.
Financing Schedule
The Treasury should follow its usual pattern of selling all
the refunding issues at yield auctions: The 3-year anchor on
Tuesday; the 10-year on Wednesday; and the long-bond on Thursday.
The $7 billion three-pronged refunding package lies on the
low end of market expectations, refunds the $4.7 billion of
maturing issues and produces a "moderate" $2.3 billion in the cash
required to achieve the proposed $15 billion cash balance on June 30.
On the basis of some continuation of higher-than-expected
economic activity and the resulting larger tax receipts, we would
expect the actual cash balance to come in higher than the planned
$15 billion. To the extent this is realized, it would be a welcome
addition to a good start we hope to make against the relatively
heavier financing requirements of the third calendar quarter.
The Quarterly Plan
The total financing plan, including the refunding, has the
following desirable qualities:
1. The substantial paydown in bills may help tilt the yield
curve toward the positive side.
2. The reduction in bills also produces great flexibility
so as to give the option not to reduce if present projections
are not realized.
3. Paying down bills and emphasizing coupons in a surplus
quarter reserves the use of bills for larger, more difficult
deficit quarters.
4. The market will be pleased with both the smaller size
of the refunding package and the relatively smaller size of its
components and the smaller size of cycle note issues.




89
Changes in Maturities
The Committee does not propose changing the maturities of
coupon issues during the second quarter.
Although the Treasury has been using the coupon market
persistently in recent years, only about 10% of total marketable
debt natures beyond 10 years — about the same ratio that
existed 10 years ago. Also, with the massive amount of bill
financing that has been done, average maturity of the debt has
actually declined slightly in the past year.
Long Bonds
The Group does not, therefore, believe the Treasury should
de-emphasize the use of the longer-term market at this time.
The Treasury has carefully and systematically developed a
viable, relatively liquid market for its longer-term debt over
the years. Access to that market will be a continuing need and
it should not be abandoned now. Furthermore, private borrowers
who do not have access to this longer market at all or at an
acceptable price, have shifted to shorter maturities so that
"crowding out" would occur at every maturity. It may actually
be that more crowding out would develop in shorter/intermediate
maturities. About half of recent corporate issues have been
sold with maturities of 10 years or less. If only the actual
dollar proceeds of deep-discount bonds are counted, that fraction
is close to 75%.
Call Provisions
Although there may be circumstances sometime in the future
when the Treasury should sell debt with earlier redemption
provisions, the Committee does not believe that these circumstances
presently exist. Contrary to the position of private issuers of
debt, the Treasury utilizes every sector of the market all the
time so that the opportunity to refinance at lower rates constantly
occurs.
However, as a supplement to the initial charge, we were
asked ("in spite of your traditional opposition to shortened
call provisions"):
Question: "If the Treasury were to shorten the period during
which its issues could be called (at par) for early redemption
from the prevailing 25 years to 1-3-5- and 10 years, respectively,
what would be the cost, if any, in basis points, assuming the
coupon on a 30-year bond callable in 25 years is 13-1/2% and is
selling at par?" (The 13-1/2% was the Committee's - not the
Treasury bench mark.)
All members of the Committee wrote down their views in
response to the Question, with the following results:




90
The range of views on shortening the call from 25 to 10
years was 13.90% to 14-3/4%, with 14% the mode and all but one
view in a range of 14 - 14-3/4%. A spread of 125 basis points
over a 25-year call.
Shortened to 5 years, the range rose to 14% to 15% with
14-1/2% the node. "~A spread against the range of 50 to 150 basis
points.
For 3 years, the range was 14% to 15-1/2% with 15% the mode.
A spread of 50 to 200 basis points agains the predicted range.
mode.

For 1 year, the range was 14-1/2% to 16% with 15-1/2% the
A spread of 100 to 250 basis points against the range.
10

Ahearn
Barry
Brickley
Clyde
Crittenden
Ford
Grimm
Horowitz
Jackson
McMennamin
McMillan
Peters
Reifler
Runniun
Slonaker
Smeal
Stone
Taylor
Toffey
Tritz
Range
Mode

14.40 %
14-1/2
14-1/2
14-3/8
14-1/4
14
14-1/8
14-1/2
14
14-1/4
14
14
14.25
14
14-1/2
14
14-3/4
13.90
14
14
13.90/14-3/4
14

3

5
14-3/4%
14-3/4
15
14-3/4
14-1/2
14-1/2
14-1/2
15
—

14.90%
15.00
15-1/2
15-1/8
14-5/8
15-1/2
15
15-1/4
—

1
15-1/4%
15-1/4
15-1/2
15-3/8
15-1/8
16
15-1/4
15-1/2
- -

14-1/2
14
14-1/4
14-5/8
14-1/2
14-5/8
15
15
14
14-1/2
14-1/2

15
14-1/2
14-1/4
14-3/4
14-1/2
14-7/8
15-1/2
14.50
14-1/2
14

15-1/4
15
14-1/2
15-1/2
14-1/2
15-1/2
16
15-3/4
15
15
14-1/2

14/15

14/15-1/2

14-1/2/16

14-1/2

—

15

15-1/2

The Committee does not - repeat - does not believe that the
criteria applied to this financing are inviolable principles imbedded in Senate concrete. We do believe that changing economic
conditions can and should alter financing strategies and perhaps
even the structure of the debt and that this Administration's
success in significantly reducing inflation has major implications for management of the debt in the future. It may be even
an actual paydown of debt. Although these are circumstances
devoutly to be wished, a skeptical, deeply scarred holder of
fixed-rate debt may have to have realization before perception
before he becomes a believer.
These views, surprisingly and untraditionally, reflect the
virtually unanimous opinion of the Committee on all significant
questions and issues. We would be pleased to answer any questions.




Frank P. Smeal
Chairman

91

REPORT TO THt SECRETARY OF THE TREASURY
FROM THE U.S. GOVERNMENT & FEDERAL AGENCIES SECURITIES COMMITTEE
OF THE PUBLIC SECURITIES ASSOCIATION
Special Session - July 14, 1981
In compliance with a request of the Department of the
Treasury, the U.S. Government £ Federal Agencies Securities
Committee of the Public Securities Association held a special
meeting on July 14, 1981 at the Federal Reserve Bank of New
York for the purpose of advising the Secretary of the Treasury
on the management of the public debt, specifically as contained
in the "Charge" attached, dated June 17, 1981.
A list of Committee members who participated in the meeting
is attached. Mr. Francis X. Cavanaugh attended for the Treasury.
July - September Quarter
You have asked our views on "the appropriate financing techniques, procedures and strategies which the Treasury should pursue
in the July-September quarter and thereafter, based on your assumption? as to the then current economic and financial environment."
Inasmuch as we will address the specific needs of the third
calendar quarter during our meetings with Treasury on July 28-29,
we make no specific recommendations at this time.
In general, the group does not anticipate a significant decline in economic activity in the near term and would expect business to be sustained b\ a tax cut and increased spending for defense.
Inflation was expected to stay close to recent levels with interest
rates declining but regaining at high levels. Some felt rates could
go to new peaks before year-end. All felt that cash balances should
be accumulated during the current quarter to anticipate heavy requirements in the final calendar quarter. Emphasis should be put
on coupon issues even to the extent of raising money in that area
to pay down bills. This process would also contribute to the emergence of a highly desirable positive yield curve.
Indexation
The Committee was unanimous in the view that it would not be
advisable for the Treasury to issue debt linked to some measure
of price inflation. This conclusion was based on the following
observat ions:




92
1.

Almost half of the outstanding marketable debt matures within
one y e a r , with 75% due in about three years. This rapid runoff of debt is a practical equivalent of indexing since it
provides opportunities continuously to finance and refinance
at prevailing rates. In effect, the 90-day Treasury Bill is
indexed four times a y e a r , the 2-year note 12 times a y e a r ,
and other securities as regularly scheduled.

2.

Increasing the constituency that is insulated from the costs
of inflation (capital losses) to include bond investors reduces the constituency with an interest in reducing inflation.

3.

It would be difficult to find a credible, stable index with
which to link the securities; the CPI, the Deflator, or any
other index exempt from random shock (oil) or distortions
(mortgage rates).

4.

Recent experience of the British government in the sale of
indexed Gilts does not contradict these expectations. The
initial one billion sterling 15-year issue linked to a 2%
real rate of return above the consumer price index was bid
at 1011 reducing that return to 1.9%. The market price subsequently dropped to produce a 2.9% real rate and the second
issue of 25-year bonds was auctioned at about that level.

5.

Rational investors will buy indexed bonds mostly to assure
that they will participate in an increase in interest rates.
The recent failure of several major financial institutions
plans to raise money on floating rate money market-type instruments under conditions ».here rates were widely expected
to decline is strong evidence of that attitude.

6.

Indexing would create large variances in interest cost to the
Treasury and work against the budget process.

7.

To some degree, too, indexing has been utilized by and associated with relatively weak borrowers whose access to markets
has required offering "sweeteners" or other "gimmicks" to
attract buyers.

8.

Indexing U.S. Government securities might either "crowd out"
and/or increase the cost of both private borrowers and state
and local government issuers who cannot secure their undertakings by printing the money required to service their debts.

Although the group was unanimously opposed to any general form
of indexing, a mild case was made for indexing non-marketable savings bonds. It was n o t e d , however, that a realistic indexing of
such bonds would not improve the position of the troubled thrift
industry.




93
Floating Rate Securities
Brief discussion was had of the merits of indexing Treasury
,,
,,
issues to a rate index rather than a "price" index, i.e. selling
"floating rate" securities. Floating against a long rate was not
seriously considered since the long-term U.S. Treasury is^ itself
the only appropriate bench mark that could be used. Floating
against a shorter rate was felt to be more costly then selling
the debt against which it was floated.
Long-Term Bonds
The overwhelming view of the Committee was that the Treasury
should not eliminate or even reduce long-term borrowing at this
time, and that 30-year bonds callable in 25 years should be sold
on the established schedule during quarterly refundings.
Only 111 of marketable debt is scheduled to mature in ten
years or m o r e , unchanged in a decade, with average life declining
slightly in the past year. Furthermore, history records that longf
term financing, even when real rates of interest were high (1950 s
and 1960's) was a sensible thing to do.
In addition, during the past three years of so-called negative yield curves, it has been cheaper to finance long term
than short term. Although eliminating or reducing long-term
borrowing might reduce interest costs over time, the necessary
replacement of these amounts by more inflationary shorter-term
financing was not regarded as a trade-off in the public interest.
About half of the group would favor abandoning the 15- and
20-year bonds whose market performance has been less than distinguished and substituting some larger amount, 2]-3 billion, of
30-year bonds to be sold four times a year only, during quarterly
refundings. The sense of this group is that the frequent trips
to market for 15-, 20- and 30-year money gives the appearance of
heavy borrowing and raises financing costs.
Some felt that merely scaling back the 20-year to two times
rather than four time^ a year would be helpful.
If the Treasury should decide to eliminate the 15- and/or
20-year issues, it is recommended that an announcement should be
made at the time of the quarterly financing simultaneous with the
announcement of a larger longer-term issue.
Only one member felt scaling back the size of long-term issues
would be desirable.

95-448 0




- 82

94
Callability
The Committee reaffirms the response to the question in April
when it felt that there may be circumstances sometime in the future
(balanced budgets, reduced deficit financing) when the Treasury
should sell debt with earlier redemption provisions. It does not
believe these circumstances presently exist. Contrary to the situation of private borrowers, the Treasury utilizes every sector
of the market all the time so that opportunities to finance at
lower rates constantly occur.
The prospect that high coupon Treasury issues m i g h t , in a very
low rate environment, attain high p r e m i u m s , was not felt to be a
problem and would be w e l c o m e , market-broadening relief to fixed
rate investors.
A further concern discussed in connection with paying the
price of shortening the call was the fact that those who established the shorter call and paid the price will not likely be the
ones who would exercise the call.
If, in spite of the Committee's virtually unanimous recommendation (one member would shorten the call from 25 to 20 years)
the Treasury should decide to offer securities redeemable sooner
than the prevailing 25 y e a r s , it was felt that the cost of the
process could be accurately determined by selling simultaneously
two issues, one of which is callable in 25 y e a r s , with the other
redeemable in some shorter p e r i o d , such as five or ten years.
Under prevailing market conditions, a callable issue would
be priced to call d a t e , increasing cost. It was also felt that
the issue would be priced to yield something more than non-callable
issues maturing on the call date in order to cover the risk that
the issue may not be called. It was also the opinion of the group
that offering such an issue not deliverable against a futures contract would add to its cost relative to a longer call.
Individual judgments of the cost, in basis p o i n t s , of reducing the period during which the Treasury can redeem its securities,
at'par, are shown in Exhibit I.
Other Techniques
In addition to the techniques discussed in detail by the
Committee, brief discussion was had of: asset-based issues,
adjustables, drop-locks, extendables and warrants.




95
Zero Coupon Bonds
The Committee considered at length and a respectable minority
supported the idea that the Treasury could sell an issue of zero
coupon ("Streakers") bonds at yields below those on current coupons.
This is because private pension plans continue to express interest
in establishing investment portfolios which either "lock-in" a
predetermined rate of return over a specific time horizon or which
match asset and liability cash flows over a specific time horizon.
These strategies generally use Treasury fixed income securities
but are currently constrained by the relatively short "durations"
of Treasury coupon issues. (At current yield levels, a 30-year
Treasury coupon has a "duration" of approximately eight to nine
years.) Since duration is a key parameter in these strategies,
the investment horizon is limited. A zero coupon long Treasury
issue would have a duration which equalled its term to maturity.
Such a security would significantly lengthen the period of years
over which one of these strategies could be applied, thus providing added flexibility to pension plan investment programs.
Thus a neu and growing market might be developed if the Treasury
were to experiment with long-term zero coupon bonds.
In response to the criticism that zero coupons issued by
private borrowers denies Treasury tax revenues, some members
felt that the Treasury's use of this market would "preempt" that
market and limit use by private issuers. Others felt that it
would be poor public policy for the Treasury to utilize a technique not generally approved when used by others.
Withholding Tax
The Committee would like to reaffirm its recommendation that
the Treasury continue to promote efforts to remove the u.. thholdinc
tax on interest income of foreign investors which it is felt would
significantly broaden the market for Treasury issues.
Fiscal 1982 Financing Plan
At a Special Meeting of the Committee on September 22, 1980
it was felt that it would be useful to consider debt management
strategies and problems by doing some tentative planning for the
forthcoming fiscal year. A pro-forma financing schedule meeting
that objective is attached as Exhibit II.




96
Conclusion
A cyncical, skeptical market seems focused more on what
it regards as fundamental causes of high interest rates-deficits, inflation--and would not be likely to respond favorably to undocumented assertions of faith in a program whose
results are uncertain, unknown and untested with the possibility
that fear of inflation might be increased rather than diminished
by debt management policies which effectively pile short debt
on short debt. In a w o r d , the Committee believes that existing
policies should be continued with minimal reliance on Treasury
bills and maximum reliance on coupon issues, regularization and
debt extension whenever possible.




Frank P. Smeal
Chairman

97
REPORT TO THE SECRETARY OF THE TREASURY
FROM THE U.S. GOVERNMENT AND FEDERAL AGENCIES
SECURITIES COMMITTEE OF THE PUBLIC SECURITIES ASSOCIATION
July 29, 1981
Economic Environment
For many market participants, the striking resiliency of
real economic activity in the face of near-record interest rates,
remains a major concern. Uncertainty over the financial market
impact of an emerging confrontation between a stimulative fiscal
policy and a restrictive monetary policy over the next year
appears to weigh heavily on the market and may be reducing the
interest rate effect of a relatively low rate of inflation in
the belief that the moderate weakness in economic activity will
be short lived.
The Market
Uncertainty over whether or not the Treasury will make any
changes in the structure of the debt has probably restrained
dealers from setting up positions in advance of a major financing as is normally the case. It was the unanimous view of the
committee that the Treasury conduct this quarterly refinancing
as a three-pronged offering of 3 - 1 / 4 , 1 0 , and 30-year coupon
issues. A large majority (13/18) of the group favored a package
consisting of:
S4 bil.
3-1/4-year notes due 11-15-84
*2-1/2 bil. 10-year notes due
5-15-91
* * 2-1/2 bil. 30-year bonds due
5-15-11
$9 billion total.
Reopening
The 10-year and 30-year funds should be raised by reopenings of the 14-1/2% note due 5-15-91 and the 13-7/8% bond due
5/15/2011. The 3-1/4-year issue should be sold at yield auction,
and the reopened issues at price auctions. As follows:
3-1/4-year note on Tuesday, 8/4
10-year note on Wednesday, 8/5
30-year bond on Thursday, 8/6.
Although all agreed that $9 billion was the total amount that
should be raised in notes and bonds, a smaller group preferred
to raise $3 billion at 10 y e a r s , reducing the 30-year bond to
$2 billion. A $9 billion financing would refund the $5.4 billion
of privately-held coupons maturing on August 15, and raise
$3.6 billion in new m o n e y .
*Reopen 14-1/2's
**Reopen 13-7/8's




98
Cash Balance
In view of the exceptionally large, $30-33 billion
estimated needs of the fourth calendar quarter, the committee
recommends a closing cash balance of at least $18.3 billion
on 9/30/81. This would not be out of line with the seasonallytraditionally high cash balances held on that d a t e . As in the
p a s t , the committee believes that quarterly financings can and
should be enlarged so as to take some of the weight off the large
requirements of quarter-ending-months.
Uses
The financing problem for the quarter requires covering
a cash deficit of $12-1/2 billion, a decline of $4 billion in
non-marketable sources of funds (savings bonds, foreign, and
state and local) and an increase of $1.8 billion in cash to
produce a balance of $18.3 billion on 9/30.
Sources
$6.8 billion has already been done in coupon issues, $3.6
billion is to be raised in this refunding, cycle notes are to
be increased by $6.2 billion and $1.7 billion raised in the
bill market (i.e., $3.0 billion less 1.3 paid-down in July).
Third Quarter
(calender)
Summary
Uses
Cash Deficit
Non-marketables
Increase Cash

$12.5
4.0
1.8
$18.3

Sources
Done in Coupons
Refunding
Cycle Notes
Bills Net

$ 6.8
3.6
6.2

1.7
$18.3

Cycle Notes
Increasing the 2-year note issues to $4-1/2 b i l l i o n , the
4-year to $3-1/2 billion and selling $3 billion of a 5-year
note in September raises $6.2 billion.




99
(Cycle Notes)
Coupons
New
Cash

Date

Issue

$
Due

Offer

August

2-year note

3.2

4.5

1.3

September

2-year note
4-year note
5-year note

3.3
2.8
0

4.5
3.5
3.0

1.2
.7
3.0
6.2

TOTAL NEW.
Bills

Modest increases in weekly auctions of the 3 and 6-month
bills from a total of $8.4 billion to $8.6 and a $0.5 billion
add-on to two auctions of 1-year bills will produce
$3 billion...raising $1.7 billion net of the $1.3 pay-down in
July.
Bills
Date

Due

13-Week

26-Week

Year

July
August
6
13
20

27

September
3
10

17
24

Change
(1.3)

$8.4
12.6
8.4
8.4

4.0
4.0
4.0
4.0

4.6
4.6
4.6
4.6

8.3
12.4
8.4
8.3

4.0
4.0
4.0
4.0

4.6
4.6
4.6
4.6

(3-1.3=1.7)

4.7

4.7
NET.

+ .2
.7
.2
.2
.3
.9
.2
.3

T77

Cash Management Bills
It may be necessary in both September and December to
issue cash management bills to cover low points in cash balances.
Although final size and timing of such issues is essentially a
"housekeeping" job for the Treasury, consideration should be
given to offering longer dated issues to mature in the relatively
light second quarter.




100
Coupon-Bill Mix
The group feels that the appropriate mix of bills and
coupons on Treasury financing p r o - a m s should be somewhere
in a range of 10% to 20%.
Two-Pronged

Financing

Although no member of the committee would recommend a twopronged financing, with or without a b o n d , if the Treasury
should, nonetheless, decide to finance in that w a y , we would
suggest selling $5 billion of a 3-1/4-year note due 11-15-84
(16/18) and $3 billion of a 10-year note due 5-15-91 to raise
$8 billion in this financing. In order to reach a cash balance
of $18.3 at 9/30/81, an additional $1 billion would have to be
raised by additions to bills. This could be done by adding an
additional $125 million to the 8 weekly auctions from 8/6 to
9/24 raising these to $8,525 million or other combinations such
as adding $100 million each to the 3 and 6-month bills for the
5 auctions 8/27 through 9/24. Another alternative, of course,
would be to target a cash balance of only $17.3 on 9/30 and
plan to pick up the financing in the fourth quarter. In view
of the heavy requirements of that quarter, this is not
recommended. One member would raise $9 billion in this financing consisting of $5 billion in 3-1/4 years and $4 billion in
10 years. Most felt this was overloading the 10-year and would
be very costly, at best.
Two Prongs With a Bond
There was some discussion though no real support for
a two pronged financing made up of $5 billion of a 3-1/4-year
note and $3 billion of a 30-year bond. This package would
accommodate those who m i g h t , ultimately, choose to focus on longterm Treasury financing more narrowly and eliminate the 15 and
20-year bonds and/or to reduce or eliminate even the 10-year
note. This rationale is based on a belief that there is no
real discrimination in the market at 10 years and longer and
that the Treasury would then abandon that area to private
borrowers.
No Bonds
If no bonds are o f f e r e d , the Treasury w o u l d , of c o u r s e ,
have to increase the size of both note and bill issues.
Eliminating Bonds
If the Treasury should decide to finance in 10 years or
less at this time, it should be prepared to announce the limits
of a strategy w h i c h , to be consistent, would also mean the
elimination of the 15 and 20-year issues and they should also
announce the alternative sources for those funds.




101
It is probable that the market would assume very heavy bill
financing since most regularly scheduled longer coupon issues
are at or near practical auction limits now.
Fixed Price Subscription Issue
Discussion of a fixed price offering to raise large amounts
in coupon issues was limited because of the difficulty in pricing
such an issue in a highly volatile market.
1981-Fourth Quarter
If the Treasury were to begin the fourth quarter with a
balance of $18.3 billion, projected maximum financing requirements of $33 billion could be met by modest increases in cycle
notes (2-4 and 5-year), a $9 billion refinancing in November to
raise about $4 billion for total coupon financing of about $14
billion. A modest increase in bill financing plus the sale of
$7-8 billion of cash management bills would result in a cash
balance at 12/31/81 of about $15 billion.
Callability
The committee would also like to reassert its belief that the
30-year bond callable in 25 years is the most viable vehicle for
Treasury bond financing. This conviction has been strengthened
by the increasing value of these terms to the financial futures
m a r k e t , which has been reflected in lower borrowing costs to the
Treasury.
Non-marketable Sources
The committee noted the continuing decline in non-marketable
sources of funds (foreign, state and local and especially savings
bonds) and would encourage all reasonable efforts to arrest the
decline if not add to this source. The most obvious open course
is to continue to raise, by the authorized amount (1%) semiannually, the interest returns on savings bond issues.
Conclusion
The committee's unanimous - unequivocal recommendation for
a 3-pronyed financing including a long-term bond should be viewed
as the strongest possible restatement of its conviction that the
Treasury should neither abandon nor scale back financing in that
area of the m a r k e t . Inasmuch as the committee considered some of
the principal issues in debt management at its special meeting
on July 1 4 , we do not repeat those positions in this report.
We are prepared to expand on these positions or answer any
questions you may have.




Frank P. Smeal
Chairman

102

REPORT TO THE SECRETARY OF THE TREASURY
FROM THE U . S . GOVERNMENT AND FEDERAL AGENCIES
SECURITIES COMMITTEE OF THE
PUBLIC SECURITIES ASSOCIATION
October 2 8 , 1981
M r . Secretary:
The committee is in general agreement with the Treasury
view that although we are in a recession, it is not likely
to be long and d e e p . We a g r e e , too, that historically high
rates of interest are a function of high rates of inflation
and that a sustained decline in rates of inflation will
produce lower rates of interest. It is also agreed that the
deficit will be very substantially larger than the initial
estimate of $42 billion and that both spending cuts and
revenue increases will be difficult to achieve.
The monetary policy is perceived as wholly appropriate
to prevailing economic-financial market conditions. In view
of the fragility of assumptions about business activity,
inflation, revenues and expenditures and the real prospect
that the probabilities seem to favor results that would
materially increase the d e f i c i t , the committee strongly
recommends a significant increase in financing this quarter.
Overall Size Of Financing
The committee is also concerned about the diminishing
size of quarterly financing relative to cycle and other
financing needs which have to be met in between quarterly
d a t e s . It was felt that some of this weight should be shifted
from these less visible intermediate financings to the more
visible quarterly financing and that it would be appropriate
to initiate that shift now. The group was virtually unanimous
in proposing a financing package of at least $9 1/4 billion.
Half of the committee preferred to raise m o r e , as much as
$9 3/4 billion. The total $9 1/4 billion of financing would
include:




103
Proposal for November Refunding
3 1/4 year note due 2/15/85
$4.75 billion
10
year note due 11/15/91
2.50
30
year bond due 11/15/06-11 2.00
Total
$9.25 billion
Maturities due 11/15/81
5.00
Net Cash
$4.25 billion
Willingness to increase substantially the total
financing was also influenced by a belief that there is
a very large demand for the 3 1/4 year "anchor issue".
Ten members favored an issue of $5 billion rather than the
proposed $4 3/4 billion.
The ten year issue at $2 1/2 billion and the 30 year
issue at $2 billion are within market expectations. About
a third of the group preferred an issue larger than $2
bilion for the long bond. On balance, therefore, it was
agreed that the market would not be shocked by a larger
than expected financing package weighted in the 3 1/4 year
area.
Quarterly Recommendations
1 . We accepted a fourth quarter cash need of $42 1/2
bi11ion.
2. Our proposal suggests a cut back in weekly bills
from the $9.4 billion recently sold to $8.8 billion. In
the nine weekly auctions remaining in the q u a r t e r , this
would raise $2.8 billion, w h i c h , when added to the $4 1/2
billion already raised, would bring total raised through
the weekly series to $7.3 billion.
3. The October 52 week bill already sold was for
$5 billion, and it has been announced that the November
bill will be of the same size. We suggest continuing this
program to raise $3 billion in the quarter.
4 . The $10.3 billion raised in the bill market would
be about 24 percent of the quarterly cost requirement of
$42 1/2 billion. If the Treasury were to continue issuing
$9.4 billion of weekly bills and $5 billion of one-year
bills, bill financing would be 35 percent of cash needs.
5. We recommend modest increases in the cycle 2 , 4 ,
and 5 year notes to $ 5 , $ 4 , and $3 1/2 billion respectively.
This would raise $6.3 billion for the remainder of the
quarter. Adding this to the $6.4 billion that has already
been raised in the 2 and 7 year notes and the 20 year
bond sums to $12.7 billion.




104
6 . If we add that $12.7 billion to the $10.3 billion
raised through regular bills, we are left with $19.5 billion
to be handled in this refunding in cash management bills
and/or by a reduction in the Treasury balance.
7 . We suggest raising $9 billion in two issues of
cash management bills, $4 1/4 billion in this refunding
and a drawdown of the cash balance of $6 1/4 billion. The
$4 1/4 billion new money is slightly larger than the $3-4
billion sought by the Treasury and the drawdown is slightly
smaller.
Cash Balance
The committee was unanimous in the view that the cash
balance of $18.7 billion should be drawndown by $6 1/4
billion during the quarter so that the balance on 12/31/81
would be $12 1/2 billion. The drawdown of only $6 1/4 billion
is $500 million less than Treasury had planned from this source
and would be part of net market borrowing. The cash balance
of $12 1/2 billion is in line with the cash balance of $12.3
billion on 12/31/80.
In summary, we propose as follows:
Regular bills
Cash management bills
Coupons
Balance reduction

$10.30 billion
9.00
16.95
6.25
$42.50 billion

The worksheet, attached, outlines our recommendations
in d e t a i l .
Bills versus Coupons
A major objective in debt management policy, in general
and in this financing, was to minimize the use of the bill
market so as to accelerate the development of a positive yield
curve. The realization of that objective would have a much
greater impact on reducing the cost of carrying Treasury debt
than withdrawing or reducing issuance of long term issues.
With half of the debt maturing in less than a year and 3/4
within 3 y e a r s — a l l being financed at rates significantly
higher than long bond r a t e s — i t seems clear beyond a doubt
that the major focus now should be on getting short rates
d o w n . The heavy carrying costs are much less a function of
continuing the relatively modest 10 percent or so of total
financing in the longer coupon market than of the much higher
cost of financing massive amounts of debt short term on an
inverted yield c u r v e . The prevailing slope of the yield
c u r v e , rising sharply in the first y e a r , invites this kind




105
of debt management strategy. Even in the bill area itself,
3, 6 and 12 m o n t h s , we would add to the pressure to tilt the
yield curve up by weighting bill financing toward the year
bill and away from the 90-day bill.
In view of the widespread discussion, especially by
academic economists, of the merits of the Treasury abandoning
the issuance of long term bonds because of high interest
rates, the committee reviewed its longstanding recommendation
that the Treasury neither withdraw nor reduce financing in
this area of the market. With only one exception, the group
would like to reaffirm that recommendation for reasons outlined in previous reports. We would also like to restate our
deep conviction that existing debt management policies be
continued with minimal reliance on bill financing, maximum
use of coupon issues, regularization and debt extension
whenever possible.
Auction Schedule
It is suggested that all three issues be sold at yield
auctions: the 3 1/4 year note on Monday, November 2 at
2 p.m., 30 minutes after the regular weekly bill (a small
group preferred a 1 p.m. sale); auction the 10 year note
on Wednesday, November 4 and the long bond on Thursday,
November 5.
The proposed schedule is designed to avoid a bond
auction on Friday before the money figures. It was generally
agreed, too, that a note auction following the bill auction
on Monday would be preferable and would get the financing
done closer to the announcement so that interest would not
have declined because of a delay.
Rate Levels
In view of the high volatility that has characterized
the bond and money markets in recent years, it would be
unrealistic to predict the rate levels at which these issues
could be sold. We are satisfied that the issues have been
fully discussed by the committee and are pleased with the
level of agreement that has been reached on the recommendations.
Even s o , there are at least shades of differences among us
on both the size and structure of the proposed financing.
Members are encouraged to reveal those differences. We will
be happy to respond to your questions or comments.
I need to report offically that M r . David Barry, Executive
Vice President of the Manufacturers Hanover Trust C o . , who
has served on this committee long and well will be retiring
at the end of the year, so that this will be his last working
meeting.
Thank you.




Frank P . Smeal
Chairman

106
WORKSHEET
ASSUMED CASH NEED IN FOURTH QUARTER OF $42.5 BILLION
Proposed Financing - Billions of Dollars

Issue
Weekly Bills

Already
Raised

To be
Raised

Total for
Quarter

Issue
Size

4.5

2.8

7.3

8.8

1.0
1.1
—
—

—
—

.4
.5

1.0
1.1
.4
.5

5.0
5.0
5.0
5.0

4.5
4.5

4.5
4.5

4.5
4.5

52 Week Bill
Oct.
Nov.
D e c . #1
D e c . #2

Cash Management Bills
to Mature, in Apr-June Quarter
Nov.
Dec.
Misc.
(Late non-comp. and
add-ons)
.7

.7

2 year notes
Oct.
Nov.
Dec.
4 year notes
5 year notes
7 year notes
20 year bond
N o v . Refunding

Total

.9

3.0
1.8

TTTO

Reduce Cash Balance




4.25

.9
.8
1.3
.7
3.5
3.0
1.8
4.25

23.25

36.25

.8
1.3
.7
3.5

6.25
42.50

4.8
5.0
5.0
4.0
3.5
3.0
1.8

107
Chairman FAUNTROY. Next we will hear from David Bunting,
managing director of the First Boston Corp., and Daniel Napoli,
vice president and manager of Government securities trading for
Merrill Lynch.
I am pleased to have you gentlemen. And we have your prepared
testimony and you may proceed in whatever manner you choose.
Thank you for making yourselves available.
STATEMENT OF D A V I D BUNTING, MANAGING DIRECTOR, FIRST
BOSTON CORP.

Mr. BUNTING. Thank you very much. We decided to go alphabetically.
I am David Bunting, a managing director of the First Boston
Corp., responsible for the trading and sales activities in Government securities for that firm. In addition, I am serving this year as
president of the Association of Primary Dealers in U.S. Government Securities, which is a group of 36 firms whose trading volume
and position reports are accepted by the Federal Reserve. The purposes of this organization as specified in the articles of association
are:
(1) To foster high standards of commercial honor and business
conduct among its members and to promote just and equitable
principles of trade.
(2) To promote practices conducive to efficient conduct of the
business of its members.
(3) To provide a medium through which its members may be enabled to confer, consult, and cooperate with the Federal Reserve
System, the U.S. Treasury Department and other U.S. Government
agencies with respect to matters affecting the market for U.S. Government and agency securities. Government securities dealers perform three principal functions in the marketplace: (1) maintaining
secondary markets for investors in outstanding Treasury and Federal agency issues; (2) underwriting Treasury and agency issues by
bidding on these securities and distributing them to the public; and
(3) trading with the Federal Reserve when the Fed conducts open
market operations. Unlike investing institutions and private investors, who may choose the circumstances under which they participate in the market, dealers stand ready to trade daily in all conditions, and as a result, cannot by themselves influence interest rate
levels, but rather reflect the market "as is." As I respond to the
nine issues raised in this subcommittee's invitation to testify, may
I emphasize that the opinions expressed are my own, although I
have consulted with my colleagues on matters of fact. Members of
the subcommittee have been furnished with copies of the First
Boston Corp.'s 1980 edition of the "Handbook of Securities of the
U.S. Government and Federal Agencies," which I hope will prove
useful in providing background information on the instruments
and activities of the Government securities markets.
ISSUE NO. L

The decision to continue to raise funds with the use of long-term
financing in light of recent high interest rates. The Treasury's ongoing need to raise large amounts of cash—estimated at approxi-




108
mately $2 billion net new money per week in calendar 1982—requires the use of all market sectors. Long-term Treasury debt accounts for only 10 percent of outstanding marketable debt and
based on recent experience, will account for perhaps 15 percent of
the new cash to be raised in 1982. In recent years, borrowing in
shorter term markets has carried higher interest costs than long
term issues. Also, because of the uptrend in rates, financing in the
long markets has proved to be the cheapest for the Treasury. Between 1970 and 1979, the Treasury issued a variety of long-term
bonds bearing rates ranging from 6Vs percent to 9Vs percent. Although many were issued at then record-high rates, most trade
today at 60 to 70 percent of their par value. In retrospect, if more
long-term bonds had been issued, the burden of interest costs would
be much lower today. If the Treasury were to withdraw from the
long markets, two adverse consequences might result. First, and
most important, is the possible damage to the capital markets for
private sector issuers. Treasury paper is the reference by which all
other issues are priced. When the Treasury resumed regular bond
sales in 1970—after a 6-year hiatus—the ensuing growth of the capital markets helped process the large long-term debt requirements
of all issuers. Investors will not generally commit money or attention to securities for which there is no active secondary market or
regular calendar of new issues from which they can assess relative
investment values. Second, if the Treasury stopped issuing longterm bonds because rates are "too high," any attempt to reenter
the market would presumably warn potential investors that the
Treasury felt rates were "too low." Interest rate forecasting is difficult at best, and the Treasury should avoid the appearance of
trying to play the market while meeting its debt management responsiblity.
ISSUE NO.

2

The impact of Treasury financing and refinancing operations on
current interest rates, including the impact of the different terms
for debt securities. The frequency of treasury borrowing undoubtedly has an effect on interest costs, but it is unavoidable, because of
the large current cash-raising requirements. Dealer capital for underwriting and investor cash flow for investment are occasionally
overwhelmed by the supply of new debt, particularly when interest
rate expectations are pessimistic. At the moment, the Treasury has
little choice as to the frequency of sales, but by issuing regular
cycles in all maturity sectors, the impact of the large aggregate
sales seems evenly distributed.
ISSUE N O .

3

Any features or changes which might make the sale of the debt
easier or cheaper. Many features, including floating coupon rates,
"tap" issues, put bonds, optional maturity issues and various call
provisions have been studied carefully in the past, but most of
these ideas are viewed as gimmicks used to shore up marginal borrowers and have not been recommended. No matter how the Treasury structures its issues, the funds attracted by innovative forms of
securities would come at the expense of other borrowers and the




109
investing public. Since the Treasury now competes successfully for
available investment money, it is doubtful that any savings would
be accomplished by resorting to gimmicks. The Treasury's current
practice of issuing bills, notes, and bonds in regular cycles has demonstrated an ability to generate sufficient cash to satisfy all requirements, while allowing market participants to prepare for
known patterns of issuance. It is occasionally suggested that lowering minimum denominations of Treasury issues—currently $10,000
for bills, $5,000 for some short-term notes and $1,000 for all other
issues—would increase public participation and lower borrowing
costs. Historically, the Treasury has sold some marketable issues in
pieces as small as $50—World War II tap issues—but in recent
years has raised the minimum because of prohibitive processing
costs for a large volume of small orders and to prevent large outflows from thrift institutions during periods of high interest rates.
Lowering minimum denominations is not likely to significantly increase public participation in Treasury sales, given the variety of
alternatives now available, especially money market mutual funds.
ISSUE NO.

4

The impact of the financial-futures market on the ability of the
Treasury to market its debt. The advent and growth of the financial-futures markets have greatly increased the breadth and depth
of the Treasury market. Hedging and arbitrage activities in the futures markets have clearly eased the burden on the cash market
during Treasury financings and have probably had the net effect of
slightly reducing borrowing costs. The fact that the Treasury has
designed some issues—selected bills and the 20-year bond cycle—to
mesh with financial contracts indicates that Treasury sees those
markets as beneficial. In this regard, it should be noted that if the
Treasury were to discontinue sales of long-term bonds, it might
serve to undermine the fundamental premise of the futures markets; that is, an ample supply of the underlying or deliverable commodity. Regarding subsidized alternative instruments, whether taxfavored—Industrial Revenue bonds and All Savers Certificates—or
federally guaranteed—GNMA's, etc.—the net impact is always negative to borrowers not so favored. As the easy example, All Savers
Certificates never grew to the proportions originally estimated, but
the result was a transfer of funds from private business borrowing
toward housing-related debt.
ISSUE NO.

5

The problem of coordination between Fed policy and the refunding auctions. Federal Reserve policy, like Treasury financing, is a
daily market factor. Perceived Fed policy actions can obviously
affect the level of rates whether the Treasury is financing or not.
Almost all market participants try to analyze the Fed's posture
and position themselves accordingly. I feel that, usually successfully, the Fed tries to avoid issuing confusing signals in their open
market operations. It would be hard to single out uncertainty
about Fed intentions as a major negative affecting Treasury borrowing cost. As long as the future course of the economy is unclear,
the outlook for fiscal and monetary policy will be equally so.

95-448 0 - 8 2 - 8




110
ISSUE NO. 6

The impact on the market when dealers with underwriting responsibilities are left with higher than normal amounts of new
issues. Dealers and other market participants bid for Treasury
issues based on their position requirements and/or market viewpoint. Although more frequent Treasury auctions tend to result in
higher dealer positions, dealers assume these positions at their own
risk and the time of distribution depends on the market level,
trend, and order flow. Occasionally, the pace of Treasury sales can
"overload" the market but when dealers are left with larger than
expected new-issue positions, we assume that we, not the Treasury,
have made an error in market judgment, and efficient markets
usually adjust quickly.
I doubt that future financings are greatly affected by recent
"bad" experience among underwriters. Dealers are in the business
of assessing and accepting risk and bidding levels are determined
by that collective risk judgment.
ISSUE NO. 7

The role of the advisory committee of primary underwriters who
advise the Treasury.
The discussions of the Public Securities Association—PSA—Government and Agency Advisory Committee are confidential; since I
am not a member of the committee, the results of these discussions
are not available to me.
ISSUE NO. 8

The October 1979 Fed change in its open market operating procedures abandoning the pegging of the Federal funds rate and
moving to control directly the day-to-day supply of bank reserves
on a basis consistent with long-run targets for monetary growth.
The new FOMC operating procedures in effect since October 1979,
have produced greatly increased volatility in rates. The most notable consequence of increased volatility is the "real" rates of return
have risen, and now apparently include a volatility—or marketrisk—premium. The Treasury has had to finance in this environment, thus paying the cost of greater market volatility, but significantly, the Treasury has always been able to sell the full amount of
proposed issues, regardless of market conditions. Dealers have adjusted to this changed environment by increased reliance on arbitrage and hedged positons and by carrying smaller outright risk positions and by carrying smaller outright risk positions for shorter
time periods. As dealers have adjusted to the fact of volatility, they
have noticed that the number of price swings and trading opportunities in a given time span have increased; therefore in a roundabout way, greater volatility in the market has probably increased
trading volume and liquidity.
ISSUE NO. 9

Assessment of the relationship between the Treasury and the
Fed in the placement and sale of the Treasury's debt. I have no
way of knowing what kind of specific Fed-Treasury consultations




Ill
may occur regarding debt management, but it seems to me the Fed
and the Tresury can hardly be other than well informed of each
other's plans and policies. Both attempt to perform their duties in
a way that is least burdensome or confusing to the public. I am not
aware of any occasion when a lack of coordination was visible or
disruptive to the market. I would observe that both the Treasury
and the Fed are well behind private sector market participants in
the use of computer and communications technology to accomplish
open market activities and auction bidding.
The Fed—as the Treasury's fiscal agent—still adheres to many
antiquated procedures that tend to inhibit dealers' and investors'
willingness and ability to bid in Treasury auctions and participate
in open market operations.
Chairman. FAUNTROY. I thank you, Mr. Bunting, particularly for
the structure of your testimony. And we look forward to questioning you once we've heard from Mr. Napoli.
STATEMENT OF DANIEL NAPOLI, VICE PRESIDENT, MERRILL
L Y N C H G O V E R N M E N T S E C U R I T I E S INC.

Mr. NAPOLI. Thank you. Mr. Chairman, distinguished members
of the subcommittee, my name is Daniel Napoli, vice president of
Merrill Lynch Government Securities Inc. I'm pleased to have this
opportunity to assist this subcommittee.
The original text has been handed out for the record. I am
pleased to have this opportunity to assit the subcommittee in its
review of the U.S. Treasury's debt management efforts. Any assessment of current debt management policies must above all be based
on an understanding that the magnitude of today's Federal debt financing, with its unprecedented deficits, leaves the Treasury with
an enormous task to perform and relatively few options open to it.
The No. 1 one priority of the Treasury must continue to be the
maintenance of its greatest strength, namely, its reputation as the
strongest, soundest borrower in the world. Maintaining this stature
is not an easy task, in view of the enormous amounts of new cash
needed to finance the country's deficits. To accomplish this its
reputation for prudent financial management must be maintained.
In my opinion, a critical factor in maintaining the Treasury's financial stature in the face of persistent, growing deficits is the
policy of debt extension which has been followed during the last
few years. In order for the Treasury to successfully finance the
large deficits that the Federal Government has been running
throughout the last decade, it has had to utilize a wide selection of
maturities. By issuing longer dated debt as the first chart indicates,
the average maturity of the Treasury's debt has been stretched out
to 4 years from the low of 2 years and 5 months in the first quarter
of 1976. Since the Treasury aggressively started lengthening the
average debt maturity in the last 6 years, an aggregate budget deficit of $358 billion has been financed by issuing a total of $363 billion in new bills, notes and bonds. Presently the average length of
marketable debt is about the same as that in early 1969. As the
second chart indicates, the financing of the Treasury's debt has
been accomplished by increasing the size of all the maturities. Had
the treasury utilized only the short-term market throughout the




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1970's it is clear that it would find itself in a very uncomfortable
position today in terms of requirements to refund maturing debt.
The combination of substantial needs for new funds and significant
rollovers of maturing debt would severely restrict the Treasury's
flexiblity in the area of debt management. To a significant degree
the maturity structure adopted by the Treasury in conducting its
debt management activities reflects an effort on its part to satisfy
its own needs for funds by matching these needs with those of a
wide spectrum of potential investors. While the outstanding marketable debt has expanded by $482 billion or 203 percent from 1970
to the end of 1981, the supply of funds to finance this debt has been
increasingly provided by nonbank investors. As the first table
clearly illustrates, holdings of Treasury securities by commercial
banks have declined from 18.5 percent in 1970 to 10.3 percent at
the end of 1981. The burden in financing the debt has rested, for
the most part, on all other investors which include individuals.
All other investors have increased their share in holdings of
Treasury debt from 38 to 64 percent over the last 11 years.
An ongoing concern with respect to the debt extension program
is the issue of cost, in particular the possibility that the issuance of
longer term debt during a period of high rates creates a burden of
higher interest cost for years to come. First, it should be stated categorically that the Treasury as a constant and primary borrower in
the Nation's financial markets has an ongoing obligation to carry
out its operations in the least disruptive manner possible. The performance of this task leaves no room for the Treasury to speculate
on the future course of interest rates by structuring its market activities to conform to a particular interest rate forecast. The one
thing that the Treasury should not do is to attempt to establish or
influence interest rate levels.
Nevertheless, the issue of interest cost cannot be ignored. With
regard to this question it should be noted that the lengthening of
maturities since 1976 has already had a significant, positive impact
on the average cost of the debt. As the chart below illustrates, the
yield curve has remained flat or negative since then. Over the last
5 years we experienced only temporary spells of declining interest
rates; if the Treasury had limited itself to issuing only notes and
shorter dated Treasury bills, even larger deficits would have been
experienced since greater emphasis on financing in the shorter maturities would have been much costlier. It is important, therefore,
to keep in mind that the question of cost should be viewed with
some historical perspective. While the present cost of raising long
term debt may at first sight seem excessively high, we should remember that 5 years ago a 7%-percent coupon seemed expensive.
Now such low cost seems a bargain for a 25-year maturity. A fair
and realistic assessment of the Treasury's regular selling of longterm debt requires that the program be viewed since inception.
Efforts to reduce the cost of the debt usually include consideration of changes in the structure of the debt obligation itself. During
the last few years the Nation's private capital markets have been
forced to become increasingly innovative, utilizing such techniques
as floating rate notes, zero coupon and original-issue discounts,
complex sinking funds and call provisions, et cetera to enable borrowers to raise necessary capital. In my opinion the use of financ-




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ing gimmicks of this type would be inappropirate for the U.S.
Treasury. Resorting to techniques utilized by less credit-worthy entities will only act to reduce the Treasury's reputation as the finest
credit in the world. Furthermore, the potential cost savings derived
from these techniques may be open to question. More frequent use
of call features, for example, is likely to raise the initial interest
cost of an issue since it reduces its attractiveness to a prospective
investor. Similarly, I would be skeptical of the usefulness to the
Treasury of zero coupon or original issue discount securities. The
issuance of a sizable amount of securities whose par value is significantly higher than the initial amount of cash generated would only
exacerbate perceived debt managment problems in periods of large
deficits. In addition, by the use of such instruments the Treasury
would forego the possibility of refinancing a stream of coupon payments at lower cost if interest rates fall in the future. In considering the possible use of such financing techniques, it is important to
keep in mind that the market for U.S. Treasury securities is the
largest, deepest, most liquid financial market in the world and that
at least one reason for this is the simplicity of the debt instrument
itself. It seems to me that it would be imprudent to risk damaging
this in the pursuit of dubious short-run cost savings.
Before leaving the subject of financial innovation, I would like to
comment briefly on the financial futures market and its impact on
the ability of the Treasury to market its debt. My opinion is that
the existence of futures contracts on debt instruments have had a
generally positive impact on related cash markets because they
have brought new participants into the market and provided existing participants with greater flexibility in managing their portfolios. By creating hedging and arbitrage opportunities financial futures serve to increase trading volume and improve market depth
and liquidity. This, in turn, has led to more efficient markets and
reduced spreads which benefit debt issuers and investors alike.
This pattern of development appears to have been the case with
Treasury debt futures, in particular the so-called long-bond contract. Volume of trading in the long-bond futures contract is now
approximately three times the size of related cash market trading.
Studies that we have performed at Merrill Lynch show that over
70 percent of our firm's trading volume in this contract represents
public participation which indicates to me that there is a widespread public interest in this instrument. Through the risk-transfer
process that the futures market facilitates, this strong public participation is channeled into the cash market by creating liquidity
and hedging opportunities for all market participants including underwriters. As a consequence, dealers have greatly enhanced capabilities to underwrite more debt. This, in turn, materially increases
the Treasury's access to the long-term market.
Having just touched on the use of financial futures by securities
dealers in relation to their primary bidding activities it may be appropriate at this time to comment in greater depth on the role the
dealer community plays in underwriting Treasury debt. Concerns
have been expressed that the existence on occasion of higher than
normal holdings of new Treasury issues by dealers may have a negative impact on future Teasury financings. Regarding this I would
like to express my view on the appropriate role of a dealer in par-




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ticipating in new issue auctions. Primary or reporting dealers are
expected to assist the Treasury in marketing new issues by participating in the auction process. The price levels at which an individual dealer bids, however, is totally at his discretion. In participating in the auction each dealer competes not only with the rest of
the dealer community but with the public at large as well. In the
event, therefore, that the dealers as a group find themselves holding an excessive position of new issues it is essentially a reflection
that price levels or investor demand have been misjudged. Since a
dealer's stock in trade is market knowledge, responsibility for
market misjudgments must rest solely with the dealers themselves.
It has been my experience that losses sometimes suffered by the
dealer community in carrying out its underwriting commitments
are unlikely to influence dealer behavior in future new issue flotations. Dealers, as professional risk takers, must of necessity have
short memories. Success in this field of endeavor requires that full
attention be directed to present and anticipated market conditions
only. The mistakes or successes of the past cannot be allowed to influence current decisions. This is not to say that the recent volatility of interest rates with its heightened risk of loss has had no
effect on dealers' attitude toward auction participation. It is obvious that a dealer who witnesses a market decline in 1 day of perhaps 5 points for a long-term bond is going to approach an auction
differently than he would if his experience of potential price
change was one-eighth or one-fourth of a point. Clearly, current
rate levels include an additional risk premium to reflect increased
volatility and market risk. Considering this environment of higher
risk and sizable new offerings, I think it is fair to say that the competitive auction procedures currently utilized by the Treasury are
working with reasonable efficiency.
Nevertheless, I would like to recommend the following changes
to the auction process that could improve it further. First, I believe
that consideration should be given to reducing the number of note
and bond auctions.
Currently, the Treasury issues 40 notes and bonds per year or
the equivalent of a coupon issue being auctioned every 9 days. This
is in addition to 64 bill auctions and an occasional cash management bill. Including the agencies there are, on average, three financings per week. Replacing this with a schedule of larger, less
frequent auctions could have a positive impact on the tone of the
market for a number of reasons. For one thing, less frequent entry
into the market would give dealers more time to distribute a given
issue in an orderly way. In addition, a reduction in the frequency
of auctions should generate greater participation from those investors who must purchase securities but who now often choose to
delay their participation with minimal risk because of the certainty that the auction of a similar security will shortly follow.
My second suggestion regarding the structure of the Treasury
auction process is to give consideration to reviving the use, on occasion, of two auction techniques which differ from the competitive
bid auctions currently being used. The first auction technique is
the subscription method which can be an attractive way to raise
substantial amounts of money with wide distributrion. Before analyzing the subscription method, let us briefly review the current




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auction method. With this technique investors and underwriters
bid for blocks of securities at levels which, to them, represent fair
market value. The Treasury collects those bids starting with the
highest price paid and accepts all those bids until their offering
needs are completed with the lowest price accepted receiving a percentage allocation.
With the subscription, the Treasury sets the coupon and receives
subscriptions at a specific price preset by them. Obviously, to
achieve this, the Treasury must make it attractive to investors to
subscribe to their new offering. This is not as simple as it sounds
because of the extreme volatility of recent years, but I will outline
the mechanics of the way it would be undertaken. First, it is my
opinion that the subscription method be used primarily in the 10year maturity which is offered in the quarterly refunding operations. The amount of the offering should be left open with the
coupon assigned on the morning of the offering.
Sufficient press coverage as well as dealer advertising will keep
potential participants involved and well informed. At 12 noon, New
York time, the Treasury can assign a dollar price adjusting for any
volatility that may have occurred that morning. The price stipulated should be offered with a 15-basis point concession to the outstanding 10-year maturity to attract a large participation from the
investor public. Considering the amount of potential tenders that
would be received, the Treasury would then allocate a percentage
of the amount of the total customer bid. Since each participant realizes that he will not be awarded all that he subscribes for, his
inclination will be to bid for more than he needs hoping to receive
a substantial award.
With this type of financing technique, the Treasury may be able
to raise, in one offering, $10 to $15 billion. With this result, it may
allow the debt managers to come less frequently to market with
future financings while achieving maximum distribution of their
securities. Some of the underwriting fear factor would be eliminated creating a better market tone while raising substantial amounts
of money. Another technique which should be considered is the
"Dutch Auction" method of issuing long bonds. The "Dutch Auction" has been used successfully in Europe and should be considered domestically when the market comes under abnormal stress.
The principle of the "Dutch Auction" is that all winning bidders
receive their awards at the lowest price. If, for example, the range
of bids covering the amount offered is 13.85 to 14 percent all winning bidders receive their bonds at the lowest price, 14 percent.
Many institutional investors are not participating in the markets
on a daily basis and their fear of overpaying at auction discourages
them from bidding. This phenomena is what, many times, creates
the long, disruptive bidding ranges that result in higher cost to the
Treasury. With the fear of bidding reduced, putting all bidders on
equal footing, most participants will bid more aggressively realizing that his award would be received a the cheapest price. In conclusion, these two techniques—which by the way are not beneficial
to the professional underwriters—can result in wide distribution,
less fear, and substantial financing at market prices.
Finally, I would like to suggest that the minimum purchase price
for Treasury auctions be reduced to encourage greater public par-




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ticipation. The rationale that a low minimum price encourages disintermediation no longer seems appropriate in view of the wide
array of alternative investment vehicles currently available to individuals. Assuming, therefore, that it is not prohibitively costly to
administer, a reduction in the minimum level should be adopted.
Before completing my remarks on the subject of the debt-raising
process, I would like to comment briefly on another factor that I
think can contribute to the continued success of Treasury underwritings. That factor is the maintenance of a close professional
working relationship between the Treasury, the Federal Reserve,
and the dealer community. It is my understanding that, within the
constraints of their separate functions, the Federal Reserve and the
Treasury cooperate with one another in terms of exchanging advice
and market intelligence. Another channel of communication is the
committee of primary underwriters who advise the Treasury. Since
my firm presently does not have a representative on this committee, I am unable to comment specifically on the role that it plays in
shaping Treasury borrowings. It is my impression, however, that
the committee acts solely in an advisory capacity and, in so doing,
performs a useful service by providing additional information to
the Treasury on market conditions. In confining itself to this advisory function no conflict of interest appears to me to exist.
The market for U.S. Treasury debt is simply too large to be
unduly influenced by any one group of participants.
I would like to conclude my remarks by attempting to assess the
impact on the market and the debt-raising process of the changes
in Federal Reserve open market operating procedures which were
adopted in October 1979. There can be little doubt that, however
necessary, these changes have contributed to the much more volatile markets we have been experiencing. The Fed's reserve targeting methods have greatly differed from the previous pegged rate
environment and this has had an impact on the Treasury's debt
raising activities.
In the current market environment it is not uncommon for bond
prices to move 3 or more points in a single day; on several days 5
point moves have been experienced. This type of market action
makes premature market decisions very visible and extremely
costly to investors and dealers alike. The fear of capital loss will
many times keep investors in as short a maturity as their investment policies allow. Price movements such as this will create even
more volatility because underwriters will be more likely to liquidate inventories if a positive investor response is not immediate.
What occurs many times is a self-fulfilling prophecy. Investors deliberately will not commit funds in primary offerings anticipating
dealer liquidations at lower prices soon after the auction. This
occurs when dealers attempt to price the new issues instead of allowing the overall market to do the pricing. The result is overhanding inventories which then seek the appropriate market prices. The
role of the dealer is to distribute the debt in the most efficient
manner possible and fear of these wide rate movements often
makes this objective more difficult to accomplish.
Particularly during times of extreme market volatility, it is important that Federal Reserve policy is carried out in as orderly and
consistent a manner as possible. I wish to make it clear that I am




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not suggesting a return to the even keel policies under which the
Fed undertook to stabilize credit market conditions during Treasury financings. As a practical matter such a policy would be impossible to implement given the current increased number of major
new financings. It is important, therefore, regardless of whether or
not a Treasury financing is in progress, that the Federal Reserve
act consistently and objectively in carrying out its stated duties.
Any deviations from a stable, consistent pattern of operations will
create additional fear and mistrust, resulting in still larger risk
premiums as investors attempt to protect themselves from further
risk of loss. In assessing the cause of market volatility, attention
should also be directed to the Federal budget situation. It is my
opinion that present perceptions of the size of anticipated Federal
finanacing needs have also played a role in increasing market volatility. If the Treasury is to operate in a more stable financial environment in a period when deficits must be financed, then two
things are necessary. First, an open and consistent Fed policy.
Second, greater public awareness that the administration and the
Congress are willing to work together to address the budget situation realistically. In my view these two conditions would greatly
improve the possibilities for market stability and a reduction in the
risk premiums built into current interest rate levels.
Chairman FAUNTROY. Thank you so very much, Mr. Napoli, and
Mr. Bunting. We've had a number of our members to join us in the
committee hearing as you've seen, but we have a bit of a management problem in terms of the conduct of business on the Hill, so
many of our members have other Committee meetings. I just had
to leave to make a quorum for another subcommittee of the Banking Committee, so that there may be a time we'll invite you back to
give us advice on how to manage our responsibilities as members of
this Congress. Certainly every Member of the Congress should have
been here to hear the expert testimony we've heard from all of
you, and I would like to invite Mr. Taylor and Mr. Smeal back to
the witness table and invite them to respond to any of the questions we may tender to Mr. Bunting or Mr. Napoli.
One of our colleagues suggested the use of an inflation-protected
instrument. He would sell this instrument at some price of real interest rate return. He suggested he thought 2 percent with a remainder of the interest being adjusted periodically for inflation.
Again some index. I wonder if you give this subcommittee your reaction to such an offering.
One of the questions I would like you specifically to address is
the real rate of return that you believe would be minimally required by the market for such an instrument to be successful. Not
everybody at once.
Mr. BUNTING. I'll volunteer my body first. I think as a person
from a trading background, I can easily support some of the comments that have gone before about the similar publicity of the Federal debt, the lack of the Treasury's ability to play the market, the
prejudice against the use of gimmicks, the type of financing instruments that are usually reserved for less creditworthy borrowers. I
see a great deal of difficulty in indexing.
First, there would be huge inflation numbers used today. Second,
indexing in general, I think, tends to implant inflation as a no-cost




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situation, whether it is for the Treasury or for other issuers or investors. I think it is significant that in the reviews we have made
of the recent history of debt issuance that the market expected
that inflation in the late 1970's to be temporary. This is why, in
retrospect, Treasury was able to finance at very low rates of interest. The market, I believe, now fears a short-term recurrence of inflation or fears that the numbers we are now seeing fluctuate on
the low side. Thus, in effect, the market is fighting the last "war"
when interest rates were extremely high and rising.
The volatility of the marketplace has added some unmeasurable
component to the real rate of interest. I'm not an economist, but I
feel it is my duty to study all aspects of the marketplace. My understanding of the real rate of return tells me it is an artificial concept which is designed for zero inflation, therefore, 2-percent guaranteed return would be absolutely ideal. I don't think you can construct any environments where rates of inflation are steady or
zero. They move around, especially now.
Chairman FAUNTROY. I'll be happy to yield to the author of the
suggestion.
Mr. COYNE. I'd like to clarify my proposal a little bit. Under my
proposal inflation would be put into the principal column rather
than the interest column. Inflation, then, would be reflected in the
principal.
You re quite correct. We don't want gimmicks involved. My concern relates to real cost. Go back to the interest rates that the. Government paid in the early fifties, when the interest rates were low
and the inflation rate was pretty close to zero, at least very nominally low.
Can you give us some estimate of the lowest financing cost by
the Federal Government during those periods of low inflation
costs?
Mr. BUNTING. Back in the 1950's?
M r . COYNE. Early 1950's.

Mr. BUNTING. There was a time when the Treasury was issuing
4-percent notes. I may look young, but I'm old inside.
Chairman FAUNTROY. New model car; a lot of mileage.
Mr. COYNE. Under my proposal, I believe that 3, or 4, not 2 percent interest would be appropriate. I question Treasury's requirement that inflation be reflected in the interest column while not in
the principal.
Mr. BUNTING. It is a form of indexings because in a period of
rapid inflation the particular value of the debt outstanding would
be escalating rapidly since we are talking about deficits which
might be large plus inflation.
Mr. COYNE. I sense I have a potential adversary. I would prefer a
friendly colloquy than a debate.
Why should somebody take assets out of our Nation's economic
private sector and transfer those assets to the U.S. Federal Government when that person could lose the worth of those assets? That
lender should be entitled to receive back from the U.S. Government the same purchasing power and asset value he once lent? Is
that not the purpose of lending and borrowing? To help other
people who need access to credit and also preserve purchasing
power of capital?




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Mr. BUNTING. I think I heard a pretty good answer to that. In
effect, you're talking about indexing or floating something. Earlier
testimony indicated when people believe rates are coming down
they would not buy anything that is protected. Both borrowers and
lenders in the recent past have inappropriately assessed the risk of
borrowing and lending.
Mr. COYNE. As we previously discussed the real interest rate is
traditionally around 4 percent. There is an inflation premium over
and above that to reflect inflation expectations or the devaluation
of the dollar. Inflation is nothing more than the lenders speculation about the devaluation of the denomination of the loan, the
dollar in this case. The third component of interest rates is the uncertainty factor, what many call the insurance premium, because
somebody might be wrong about their guess as to future devaluation of the dollar.
Now, the Federal Government is paying these three components
in the interest column. I believe we should index the loans, and tie
the long-term debt principal to inflation using the GNP—which
would be a nondebatable index and is widely used in economics.
Then we would pay only a real interest rate. The Government
would be responsible for the inflation adjustment and the uncertainty premium. This would release the investor, the lender, from
the need to wonder whether the Government was going to allow
the dollar to devalue. Devaluation would not hurt the lenders, because the Government would accept that risk.
Mr. TAYLOR. Mr. Coyne, you're building inflation into the system.
Mr. COYNE. Let me finish. We're doing the opposite. We're penalizing the Government for allowing inflation, because if the Government allows inflation to continue it will have to pay for it. Now
during inflationary times who wins the most? The Government. If
inflation is higher than we expect right now, higher than the
market expects, who will be the winner? The Government. Will the
lender or the borrower win? Won't the U.S. Government be the
winner?
Mr. SMEAL. The borrower will be the winner.
Mr. COYNE. Obviously. So the U.S. Government has won a very
substantial windfall due to the inflation of the last decade. Is that
right?
Mr. TAYLOR. Correct.
Mr. COYNE. IS there any reason why the American investor, the
American lender, should be exposed to the risk of inflation when in
fact it is the creditor, the U.S. Government, that is responsible for
that inflation?
Mr. TAYLOR. He should not be.
Mr. COYNE. NOW let me proceed, therefore, the intelligent lender
has tried the best he can to protect himself from inflation. He has
moved away from long-term securities to short-term securities. Is
this correct? The principal reason for this move is that the shortterm securities are really his best way of indexing himself against
inflation, because he can rollover those securities every 30, 60, 90
days. This is why the entire Federal Government's debt is increasingly becoming de facto indexed—because it's becoming entirely a
short-term debt. Now, why are we paying the price for indexing
and not receiving any of the benefits? Indexing in long-term securi-




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ties could then shift investors away from this tremendous reliance
on short-term debt and reestablish long-term debt instruments,
which would have credibility and encourage the investment of pension funds or college endowments in the government. Many people
would prefer to secure long-term investment, which would eliminate the headache of refinancing every 90 days to keep up with financing. Additionally, they wouldn't have to become speculators on
the dollar. They can get out of the business of speculating as to
what the dollar was going to be worth and get back the original
purpose of lending money to the Government to preserve their purchasing power.
Mr. TAYLOR. I like my way better.
Mr. COYNE. What is your way?
Mr. TAYLOR. My way is to cure inflation.
Mr. COYNE. You're not going to stop inflation, under our current
method of financing. It is too easy for us to painlessly borrow and
increase the deficit by pumping up inflation and repaying the debt
with cheap dollars. We might stop inflation if we stop this practice
and withdraw the pressures and built in incentives for run away
spending.
Mr. TAYLOR. I would be skeptical that that scenario would work.
Mr. COYNE. I believe it would work if instead of financing our
debt with short-term debt instruments, on which we are paying 13
or 14 percent, we replace them with long-term instruments on
which we pay 4 percent interest plus escrowed inflation every year.
Under my proposal we would pay a 4 percent interest—or whatever interest was negotiated at your Dutch auctions, Mr. Napoli,
although the Treasury doesn't share your enthusiasm for them—
and escrow the inflation premium equivalent to the GNP. Last
month, for example, we would have paid only whatever the negotiated interest was and put into escrow a 0.2 percent of whatever
last month's escrow amount was (reflecting the 0.2 percent inflation of last month). Instead of paying 14 percent or 13 percent, the
Government would be paying a much lower amount of money
during times of declining inflation. This would not only save the
Government a lot of money in financing its debt, but would give
people an incentive to invest long term.
Mr. TAYLOR. I think you have a marvelous cure for this particular problem.
Mr. COYNE. I believe we must move in this direction.
Mr. TAYLOR. And Brazil has done this, they have devised ways to
live with inflation.
Mr. COYNE. We're trying to solve it.
Mr. TAYLOR. Their way is to have only overnight and 30 day
loans. The interest rates renegotiated every 30 days. You can
devise ways to live with inflation and this is a way. Our Government tolerates inflation by offering its debt to investors on an
index basis.
Mr. COYNE. It's exactly the opposite. Instead of indexing everybody to our dollar, declaring our dollar the standard, our Government's debt is going to have a legitimate purpose. We're going to
say that if someone lends money to the Federal Government he's
guaranteed the purchasing power of the original amount of the




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loan. Your way yielded de facto high interest rates that squeezed
out the rest of the economy from the credit market.
Mr. SMEAL. I think the basic assumption you're making is that
by increasing the cost to the Federal Government you are going to
force the Government to do something with the cost.
Mr. COYNE. We're really not increasing the cost. The cost of inflation to our Government now is reflected in the rollover of our
short-term debt. We're paying more now. We're paying short-term
rates at astronomical levels because all of our debt is short term.
Shifting it to long term and trying to get essentially the same incentives for people to go into the long-term debt market would
lower our cost of financing. We would be underscoring for Congress
every year the $115 billion we are paying in "interest" only. A
third of our current "interest" is really interest. The other twothirds is caused by Government mismanagement and the cost of
our policy.
Mr. SMEAL. Were you impressed by the British experience?
Mr. COYNE. The granny bonds have been a success in England for
25 years or so. Their recent experience with these bonds shows that
granny bonds resulted in a lower cost for the British Government. I
think there were shortfalls in their system, however. It didn't allow
for a marketable bond, which I think would be allowed given the
statute I have proposed for our Government.
Given England's experience, I believe that our short-term markets would be drawn out with these bonds and I think we have to
do what we can to establish long-term debt instruments.
Mr. BUNTING. DO you mean the corporate bond market in connection with futures? The use as to the Federal reserves are in the
billions of dollars. The Treasury has never had a problem in a
single auction day receiving twice the adequate bids—in fact there
is always a keen interest.
Mr. COYNE. If I were selling bonds at 13 percent over the rate of
inflation I wouldn't have a problem selling bonds either. That's the
point. They're paying a very, very high premium over the current
inflation.
Mr. BUNTING. However, for 9 years they paid an insignificant
premium because people did not expect inflation to persist.
Mr. COYNE. People have come to learn that they must add a tremendous insurance premium over and above their expectations of
inflation. We're going to get them to change that perception. We in
the Government have got to relieve them.
Thank you very much, Mr.. Chairman.
Chairman FAUNTROY. I'm going to shoot that time having been
yours and move on to questions from Mr. Patman.
Mr. PATMAN. Thank you. Mr. Napoli, I appreciate your description of the Dutch auction, because I think it's the first time I've
really understood it. It's mentioned the other day when you talk
about it being the winning bidders receive their bonds at the lowest
price you're talking about really the best price for the lender, and
the lowest price and the worst price for the issuer, right?
Mr. NAPOLI. What we're talking about is eliminating one of the
biggest problems which creates the additional risk premium and
that is the fear factor. We can talk about the economics of the markets, and the complexities of the markets, but at this point in time




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what we're dealing with is emotion and fear. What I'm saying is
that the volatile bidding ranges of long-bond offerings encourages
many investors who would normally bid, to postpone their bid because of the fear of overpaying. We have seen wide bidding ranges
in these long-term securities because of that fear. These investors
are not always present in the market on a daily basis, so this apprehension takes them out of the auction process.
What we are advocating is taking away some of that fear. This
would bring in more bidders who would normally participate in the
auction if the environment is beneficial to do so. We have to make
it more comfortable. I think if the potential buyers of long-term securitities had these fears eliminated, they would tend to bid more
aggressively. This would benefit the Treasury by creating more aggressive bidding. If the account was sure he would be awarded
bonds on an equal footing at the lowest price he will tend to bid
higher to buy those securities.
Mr. PATMAN. It seems it would be encouraging for bidders to get
together one bid on one and another bid on one. Someone bid 85
percent of his requirements. And withhold hoping that somebody—
he wouldn't get them all or he and the others wouldn't bid them
all but that somebody will end up bidding a very low price. And all
benefit from it.
Mr. NAPOLI. Not everyone wins. If there's $2 billion to be allocated, the highest bidder will start the process which continues
until the $2 billion is raised. All bidders who bid too cheaply will,
not be awarded any securities.
Mr. PATMAN. And basically for all the panel the people who buy
bonds want to get the highest rates of interest they can get in
every case, don't they?
Mr. NAPOLI. There is that fear.
Mr. PATMAN. NO question about that. And many talk about the
uncertainties they feel and the rate of inflation and all that sort of
thing. If they can possibly get the rate up they will get it up, will
they not? They will buy bonds with the highest possible rate and be
encouraging higher rates. There's no benefit to them to be seeking
lower rates. Except perhaps some consideration in the long range
about the financial security from which they're buying the bonds.
Mr. NAPOLI. We've had a situation over the last 3 years where
many economists saw the onset of recession in 1978 and 1979 causing investors to become invested in long-term securities based on
that assumption. Market timing is certainly important in investment decisions. Considering where we are today, it would take a 60
point rally in the long-term market to bring prices back to original
cost. Investment decisions are made to achieve maximum return
and price appreciation. Early market purchases are very costly and
visible.
Again, I think what we're talking about here is the comfort
index which really has been violated over the last year in terms of
the volatility of the market. The lack of comfort, and the fear
factor that is attached to it adds risk premium to the levels of interest rates.
Mr. PATMAN. All right. Now, you mentioned, Mr. Bunting, about
the interest of investors in longer term maturities. I can understand that, because a lot of people can see we're going to have




123
lower interest rates in the future, or some do. Talking about the
advantage from the standpoint of a person who would speculate in
bonds. If a person bought a 30-year bond at 20 percent interest and
that bond declined, and then comparable bonds were issued subsequently, 30-year bonds at 10 percent interest, what would be the
value of that bond at 20 percent? 100 percent?
Mr. BUNTING. That is one of the computers I didn't bring. At this
moment, the Treasury has a 14-percent issue outstanding which
was sold last fall. For trading purposes, each 100 basis points
equals 7V2 price points. If the yields drop by 10 full percentage
points on that bond would be something in the vicinity of 70 percent over the par value. This issue in particular would move to 170,
let's say. The mathematics of bonds makes them move at different
speeds depending upon the coupon rate.
Mr. PATMAN. Your example there was say a $ 1 , 0 0 0 bond would
be worth $1,800?
Mr. BUNTING. That is correct, sir.
Mr. PATMAN. It had been bought at what rate of interest?
Mr. BUNTING. 14 percent.
Mr. PATMAN. And currently at what rate?
Mr. BUNTING. It's at around 13 V2 percent interest.
Mr. PATMAN. Just that small amount of interest?
Mr. TAYLOR. Your example of 2 0 percent going to 10 would be
worth 107.
Mr. PATMAN. What's the actual market of each comparable
issue?
Mr. BUNTING. In this particular bond each point of interest that
it loses from between 14 and 13 percent is around 7V2 percent of its
value in price.
Mr. PATMAN. And that's what maturity?
Mr. BUNTING. A 30-year bond.
Mr. PATMAN. Obviously that added incentive is not present on a
short-term debt, is it? Two years you don't have that increase at
all, although some. Is that part of the interest in the long-term
bonds?
Mr. BUNTING. I would say that it has been my experience. I have
watched long-term bond rates go from 4 percent to 14 percent over
18 years. That assumes every step of the way the majority opinion
of the market is that rates are going to work lower, rather than
higher. It is always, of course, and has been the official policy of
the Government to predict lower rates or attempt to manage themselves.
Mr. PATMAN. We had those for the budget anticipation.
Mr. BUNTING. The Treasury feels they are getting a good deal if
everything comes out all right. Our recent experience is that their
"guesses" have been all wrong and investors are paying the price.
But the interest in the long-term market is for both permanent investment and speculation on price improvement.
Mr. PATMAN. What is the traditional real rate of interest, 4 percent, 3 percent?
Mr. BUNTING. I would say 3 percent is what we read most often.
Mr. SMEAL. Recent spreads are much higher. You might come
out with Mr. Coyne's 4 percent, or even 5 or 10 percent.
Mr. COYNE. I said 3 to 4 percent yesterday.




124
Mr. BUNTING. I would assume that a perfect system where inflation was dead flat zero, rates of return would be 1 or 2 percent.
However, that is Utopian.
Mr. PATMAN. Real rates are at the highest in 50 years. Is that
generally accepted? Some even say the highest of the history of
this Nation.
Mr. BUNTING. The highest rates occurred during the depression
when we had deflation and real interest rates were 8 or 10 percent.
Mr. COYNE. Yesterday the CPI was up 2.4 percent according to
the Times.
Mr. SMEAL. Yes, but that was on a month-to-month charge, not
long term. Year over year it is still above 8 percent.
Mr. PATMAN. Mr. Taylor, I think you wanted to tell us about
wanting to cure the inflation? Your idea was to cure inflation. You
want to give us for the record how to cure inflation?
Mr. TAYLOR. I don't know how to do it.
Mr. PATMAN. YOU think we ought to cure it. Which I agree with.
Mr. TAYLOR. I think we made some real progress in the last year
or so. I think the rate has obviously come down. The question is, is
it going to stay down? We're seeing signs now that it might. One of
them is the renegotiation of labor contracts. I think that's highly
significant in terms of the future of the country and the inflationary outlook. I am becoming optimistic. The oil situation is certainly
beneficial. It can change, but it is now helpful. There are signs that
the inflation battle is being won, in my view.
Mr. PATMAN. And what has caused this? Is it the tight money
policy?
Mr. TAYLOR. Yes, that would be my opinion.
Mr. PATMAN. The highest interest rates, have they caused it?
Mr. TAYLOR. They have helped, yes. But, they are also the result.
Mr. PATMAN. YOU think the highest interest rates do help control
inflation.
Mr. TAYLOR. I would say higher rates are the result of slower
growth in money or of a decrease in the availability of money relative to its demand, and there are consequences. I wouldn't say
they're to be desired, but they are consequences of policies designed
to deal with inflation.
Mr. PATMAN. Like tight money?
Mr. TAYLOR. Like tight money.
Mr. PATMAN. Anything else? That's the most prominent.
M r . TAYLOR. Y e s .
Mr. PATMAN. That's what causes high interest rates.
Mr. TAYLOR. Supply and demand, and expectations.
M r . PATMAN. Y e s .
Mr. TAYLOR. Investor expectations are, in my view,

the reason
that we continue to have these high rates. There is a definite fear
factor built into the interest rate levels at this point.
Mr. PATMAN. That's something I have a hard time understanding
how the expectations operate in the free-market system on this
sort of thing. I'm sure they do. They are present, and so forth.
Would either one of you gentlemen care to comment?
Mr. NAPOLI. All right. In terms of investor expectations, it is the
public's perception of what the policies will ultimately produce that
is a major consideration. Tight money is a tool for bringing infla-




tion under control. Through a tight money policy you will tend to
get higher interest rates and a slowing of the economy. With a
slowing of the economy you will always tend to have higher rates.
There are always costs involved. But are the costs worth it?
Mr. PATMAN. I understand if you expected the Fed to reduce
money supply you expect also higher interest rates. And that's exactly what everyone's view anticipates.
Mr. NAPOLI. Through tighter monetary policy, interest rates
would, hopefully, be reduced in the longer run.
Mr. PATMAN. Mr. Sprinkle notwithstanding tight money
policy
Mr. NAPOLI. Perception.
Mr. PATMAN [continuing]. Equals high interest.
Mr. NAPOLI. Perception of tight money would lead to higher interest rates.
Mr. TAYLOR. On a short-term basis.
Mr. BUNTING. The shortrun effect of the tight policy would be
somewhat higher interest rates. However, another contributor is
the demand for credit. Regardless of whether the Feds policy is
viewed as tight or loose, if the total demand for credit increases,
interest rates will rise. This is especially true when a great deal of
it is the Federal Government's financing.
Mr. PATMAN. That's something that worries me. At what point
do we lose entire control of the deficit, having risen so high?
Mr. BUNTING. I would say clearly the level of current interest
rates reflects, to a large degree, concern that we have lost or are
very close to losing the whole program.
Mr. PATMAN. The higher rate of interest the more out of control
it looks. Is that true?
Mr. BUNTING. I don't know what annual increase in interest expense is necessary trigger to the point. It clearly would be more
comfortable to have a lower level of interest rates to save Treasury
borrowing power for restructuring the debt. But the mismatch between monetary and fiscal policy as perceived by the market at
now is certainly a large influence on the level of interest rates
which, by inflation measures, should obviously be substantially
lower.
Mr. PATMAN. What results do you anticipate from the tax cuts
that are coming up in July? You think that's going to cause the
economy to go back up?
Mr. BUNTING. I am not an economist by background, but my surface judgment would be that it prevents the economy from falling
further and might tend to create an upward tilt, with higher consumer spending as they receive more money.
Mr. PATMAN. Any of you like to make further comments?
Mr. SMEAL. I would like to make one comment with respect to
techniques of Treasury debt management discussed by Mr. Napoli,
especially the subscription issue and the Dutch auction. Both are
controversial in the market. There are some of us who feel that
these are high-cost techniques. That the Dutch auction, especially,
which clears the market at the lowest price is one that has been
tried and at the moment rejected. Further, that the problems associated with subscription issues, which are efforts at some price to
raise a lot of money, is not generally achieved at costs that many
95-448 0 - 8 2 - 9



126
of us have found to be appropriate. We feel that prevailing yield
auction techniques are superior to either of those proposed by Mr.
Napoli. I think you need to know this is a controversial subject and
that we do not agree with Mr. Napoli's suggestion.
Mr. TAYLOR. That's what makes markets, different views.
Mr. PATMAN. And that's what gave birth to the money market
funds and so forth.
Mr. COYNE. I do happen to agree with others in the Treasury
who were arguing for the Dutch auction method. Unfortunately
yesterday we heard testimony from Mr. Stalnecker who said it has
been tried and in his opinion and their opinion, it failed.
I'd like to know if there are any arguments that you, who are
proponents of Dutch auction, may give me in support of that
method of sales. I would like to take back to the Treasury some
good arguments and perhaps persuade them that the current conditions of the marketplace should give rise to other experiments to
see if its current situation could be avoided or if maybe Treasury
could learn what we thought they would learn in the previous experiments. I was frustrated they didn't seem willing to try new
methods of financing especially in light of what seems to be very
different market conditions today. I believe they should try and
give it another shot.
Mr. NAPOLI. Well, as I said before we are certainly all advocates
of debt extension. As I mentioned, our analysis at Merrill Lynch
indicates that, in the financial futures market, 70 percent is in fact
public participation. I guess Merrill Lynch probably talks to more
doctors, dentists, and lawyers than anyone else. And they are in
fact a very large component in the long-term market via the futures market.
Right now, as I said, the futures long bond contract volume is
roughly 60 thousand contracts a day, which is about three times
the cash market. The conclusion is that there is certainly interest
in that long-term securities. And as we mentioned before a lot of
the problems that have developed in the long bond market revolve
around fear of volatility.
I think we're talking about people questioning whether the real
rate of return is acceptable. We presently have the best real rate of
return in history. The problem occurs when an investor buys a 14percent security and is afraid it's going to turn to 15-percent security. This premature judgment on his part when viewed versus a
competing portfolio across the street, could be detrimental to his
career. What we're talking about is trying to make a situation that
is already stressful a bit more comfortable.
As I pointed out the Dutch auction is of no benefit to the underwriting community. Many institutional accounts are not included
on a daily basis whereas the underwriting dealers have more expertise in the bidding process. By putting everyone on an equal
footing I think the auctions will attract a lot more bidders that
would normally be afraid to commit money it in fact he was afraid
he was going to bid too aggressively.
Mr. COYNE. I didn't mean to get back into the reasons for the
constant dollar debt instrument, but many of your points are intended to hold and bolster that argument. To relieve uncertainty
about future inflation rates, I believe we must preserve the long-




127
term market. The instability of the long-term market impacts
heavily upon the willingness of investors to provide the funds for
those sectors of our economy that are dependent on long-term
credit, especially housing and others. Of course, we are equally concerned about the inability of many of the new financial institutions
to provide long-term credit.
Many financial institutions are discouraged from moving their
assets into long-term instruments since they must compete with
other instruments, especially the market money funds, which are
invested, as you know, in maturities that bear out the best interest.
Do you feel that there are mechanisms by which we can open up
many of these new money market funds into long-term investments? This is obviously outside some of your expertise, but do you
feel that by authorizing money market funds to have longer maturing portfolios we can create a more balanced marketplace?
Mr. NAPOLI. A S you know the money funds in aggregate total
$190 billion, which is a large sum by any stretch of the imagination. And right now, the main reason for their growth and the
main reason why people are in that type of instrument is because
they're rewarded for doing so. The yield curve being what it is, due
to the current tight money situation, is creating an environment
that keeps the $190 billion exactly where it is—in short maturities.
If there is any alleviation in terms of monetary policy, and the
yield curve starts not to reward, but penalizes for being in the
short-term securities, you'll see a lot of money extend further out
into the longer maturities. Right now the risk of capital by extending maturities at this point in time is still high.
Mr. COYNE. YOU would prefer to leave the money markets as
short-term instruments and let people seeking longer term investments go into the exisiting long-term markets rather than let the
money markets invest in long-term bonds?
M r . NAPOLI. NO.
Mr. TAYLOR. There are
M r . NAPOLI. Y e s .
Mr. TAYLOR. Tell him.
Mr. NAPOLI. We have

long-term bond funds?

Government funds that attract enormous
amounts of money. But, of course, right now the vogue, because of
the current volatility, is certainly the short-term money fund.
Mr. COYNE. Let me ask another question which is a little bit outside of our expertise and the committee's—tax policy. Currently, of
course, we tax interest. We tax the full weight of the interest, and
of course do not give any credit to the person who withdraws his
$1,000 20 years after deposit for the fact that his $1,000 doesn't
have the purchasing power that it did when the man deposited the
$1,000. In a sense, the tax policy of our country really doubly penalizes people during times of inflation. To what extent do you feel
that our tax policy encourages the high interest rate? What recommendations would you make to fix this situation? For example,
some have proposed reducing the taxes on interest or raising the
thresholds upon which interest is taxed. Others have said there
should be a discount off of the interest earned to reflect inflation.
For example, if you're earning 14-percent interest and the inflation
rate is 10 percent then to make you pay tax on the whole 14 percent, when most of your principal has been eroded is unfair. I be-




128
lieve people should be allowed to get credit for the lost purchasing
power of their principal. Do you think it's all right to penalize the
interest receiver to the extent we do today?
Mr. NAPOLI. I'm curious, I know the Federal Reserve comes
under considerable criticism by many groups. I'm wondering how
many letters of thanks from the investor public have been received
for the 8-percent return over the current inflation rate. I think
that if we look at what's gone on in the last few years it's interesting. The investor no longer is content with a 5V2-percent savings
deposit return he has been receiving over the years considering
today's yields in the growing money funds. If any of you attend
cocktail parties you know that the conversation always seems to
arrive at current money fund yields.
Mr. COYNE. Now that inflation is abated it's no longer a problem.
Mr. NAPOLI. We're talking about real rates of interest that no
one has ever seen before.
Mr. COYNE. We still have an awful lot of investors holding 7-percent bank bonds or lower, who may be going to cocktail parties and
crying while listening to their more fortunate neighbor who did not
invest in bank bonds. Why should the investor be whipsawed like
that by the tax policy of the Government? Maybe my pleas are falling on deaf ears here. Isn't there any interest in seeing a change to
assure that tax rates are paid only on real income?
Mr. BUNTING. As dealers and investors
Mr. COYNE. It's irrelevant.
Mr. BUNTING. NO; the real rates of return have to be after tax.
Mr. COYNE. Certainly. So the tax policy seems to exacerbate the
problem, does it not?
Mr. BUNTING. The country has for many years, subsidized homeownership by the deductability of interest. You also allowed business borrowers to deduct their interest. Thus, there has been quite
a prejudice to encourage borrowing—excessive borrowing in retrospect and, very few incentives to invest unless the price is right
which it is now getting to be.
I don't know how the Government would solve the problem of
the lost revenues if Congress suddenly reduced the taxes on interest and dividends. It has always struck me, as a citizen and as a
professional, that it is wrong to have the tax on capital gains which
are supposed to reflect whatever inflation or increase in assets is
absorbed.
Mr. COYNE. But it is unfair in times of high nominal inflation.
Mr. BUNTING. It is very easy to rail against it. However, I don't
know how to substitute the billions of dollars that would be sacrificed. The recent reduction in capital gain rates and so forth are a
step in the right direction to be sure.
Mr. SMEAL. In answering that question, I think you are focusing
too much the role of the committee in managing the debt. I think,
on the tax and policy question, you ought to look at how the debt
was created rather than managed. This is one of the reasons that
the debt produces a high interest rate. However, we're still dealing
with the symptoms rather than substance in the cases. I would add
one point to what Mr. Bunting has said. There is one area in this
market in which many investors, on an after-tax-basis, can get a
reasonable rate of return. That is, to buy tax-exempt bonds of in-




129
vestment grade yielding 13 or 14 percent. This is historically a high
after-tax rate of return.
Mr. PATMAN. Just a brief question or two.
Mr. Bunting, when you were talking about 3 percent as the real
rate of interest, you weren't talking about after tax-return, were
you?
Mr. BUNTING. NO. That was the after inflation rate.
Mr. PATMAN. Yes. In your testimony you're talking about on
page 10 what the Treasury wants to know about the Federal and
the Fed wants to know the debt policy. What does the Treasury
want to know about the Fed policy? Plans and policies?
Mr. BUNTING. I would assume the Treasury would like to know if
the Fed were planning a major shift in policy during a financing
period. As I mentioned I have no way of knowing what kind of specific consultations may go on between those officials. But I certainly didn't mean to imply that they are coordinating or attempting
to. By the nature of the two institutions they can hardly bow down
for each other because they're both constantly active in the marketplace.
Mr. PATMAN. Thank you. Anybody else for closing statement
here? Comment? Mr. Coyne are you completed?
Mr. COYNE. I certainly am. Thank you.
Mr. PATMAN. Well, gentlemen, the subcommittee having concluded its business, will now stand recessed.
[The subcommittee was adjourned.]







A P P E N D I X E S
Appendix A: Letter sent to hearing witnesses and the responses of
the witnesses.
Appendix B: Statement of Treasury Assistant Secretary Roger W.
Mehle.
Appendix C: Debt financing: Graphics.
Appendix D: Notice of subcommittee hearing.
Appendix E: Miscellaneous material.




(131)

132
WALTER e. PAUNTROV. DC.. CHAIRMAN
PARREN J. MITCHELL. MO.
STEPHEN L. NEAL. N.C.
DOUG BARNARD. JR.. OA.
MENRV S. REUS*. WIS.
JAMES J. BLANCHARD. MICH.
CARROLL HUBBARD. JR.. KV.
•ILL PATMAN. TEX.

APPENDIX

A

u.s. house o f r e p r e s e n t a t i v e s

HZ-17*. ANNEX NO. 1
WASHINGTON. D.C. JOSH
(t02) MS-Tilt

BILL M. COI I.UM. TLA.
BILI. I Iiwr.RV. CALIP.
ED Wl HFR. OHIO
JAMI « K COVNC. PA.

SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
OF THE

COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
NINETY-SEVENTH CON&RESS

W A S H I N G T O N . D.C.

20515

April 1, 1982

Dear
Pursuant to the request of the Subcommittee made during your
appearance on Wednesday, March 24, 1982, I have enclosed additional
questions which I would like you to give such comments as you find to be
appropriate. If it is at all possible, I would very much like to receive
your responses within the next 15 days since publication of the hearing
record is scheduled to begin shortly thereafter. Your answers will
appear without further editing by the Subcommittee through inclusion
into the record by a photo reproduction process.
Your cooperation and assistance to the Subcommittee is deeply
appreciated. I look forward to hearing your views again in the near
future.




1.

The Treasury's receipts and spending estimates are usually on
the optimistic side, with little room for error—and in
reality results seldom come close to the projection in budget
documents. If this is a correct assumption and the deficit
for the next 2 years is closer to CBO's estimate, then net
marketable Treasury financing will be approximately $90
billion in the second half of this year. Given a task of
that magnitude, what mix would you suggest for the next two
quarterly refunding packages. How do you expect the market
to react to this level of financing over the remainder of the
year?

2.

In the next few years, because of large deficits, the
Treasury will be constantly coming into the market for new
funds in relatively large amounts, in addition to re-financings.
Will this create stiff competition for funds and thus increase
the volatility in interest rates?

133
3.

As you know, there has developed in the private market substantial
numbers of new and different kinds of instruments which are
variously pegged to Treasury instruments. Some of these are
even tax exempt, others are tax exempt and guaranteed by the
United States and are additionally backed by real property
while other are merely guaranteed. What is the impact of
these instruments on the ability of the Treasury to sell its
debt? What is the future impact?

4.

Can you estimate the extent to which the United States relies
on non-Americans for its financing? To what extent do foreign
nationals, foreign governments and central banks, and foreign
financial institutions hold United States debt? To what
extent has this changed over the past 10 years? To what
extent do you expect the Treasury to rely upon foreign purchases
to finance American debt in the future?

5.

The Treasury has used up its authority to issue long-term
marketable bonds above
percent, and must, therefore,
receive additional authority from Congress before it can
announce its next bond financing. Given the concern by many
in Congress, including myself, over the size of the deficit,
the high interest rates, and the "pricing out" or "crowding
out" of other issuers in the long market, do you think such a
request is practical? Should, instead of increasing the
sales authority, Congress authorize one marketable bond
financing per quarter without dollar limit.

6.

The 3-month T-bill rate averaged 10% in 1979, 11.5% in 1980,
and 14.1% in 1981. The Administration's forecast sees the
rate receding to 11.7% in 1982, 10.5% in 1983, and 9.5% in
1984. The CBO estimate is even less optimistic about these
rates--they are seen going higher, not steadily declining. I
believe that one of the main reasons for the differences of
these rates is the budget deficit projections. The Administration
projects $98.6 billion in FY 1982, $91.5 billion in FY 1983,
and $82.9 billion in FY 1984. The CBO estimate is considerably
higher, at $109 billion in FY 1982, $157 billion in FY 1983,
and $188 billion in FY 1984. How would debt management be
different if CBO's figures, at some point in the near future,
were to become reality? I am particularly interested in
sales techniques—not merely the problem that is on its face
obvious, namely the added burden of the sale of additional
debt.

7.

The quarterly refunding packages that have recently been
announced have often had an exaggerated market impact despite
their reduced relative importance as a means of raising
funds. Could you suggest some alternative financing plans,
such as more frequent financing with no more than say 2
issues sold at any one time? Would this allow the Treasury
to vary the amounts sold to make the individual issues smaller
if that seemed appropriate? On the other hand, would you
consider going to less frequent refundings with larger amounts
issued? Would the market absorb this less frequent borrowing
easier than if it were done quarterly.

8.

Do you agree with the Fed's monetary targets and more generally
their conduct of monetary policy?




Sincerely yours,

Walter E. Fauntroy
Chairman

134

THE

FIRST
MEMBER

BOSTON

NEW YORK

STOCK

CORPORATION
EXCHANGE.

INC.

p

CABLB ADDRESS
FIRSTCORP, NEW YORK

X R K

AVENUE

PLAZA

NEW YORK, N . Y . 1 0 0 5 5

April 8 , 1982

The Honorable Walter E. Fauntroy
Chairman
Subcommittee on Domestic Monetary P o l i c y
of the
Committee on Banking, Finance and Urban A f f a i r s
H2-179, Annex No. 2
Washington, D.C. 20515
Mr. Chairman:
Thank you f o r the opportunity to respond to your Subcommittee's further
questions concerning Treasury debt management problems. My comments, in the
sequence of your l e t t e r of April 1, are as f o l l o w s :
1. If the Treasury's cash r a i s i n g requirement in the second half of
calendar 1982 approaches the $90 b i l l i o n CBO estimate, the Treasury w i l l c l e a r l y
be f o r c e d to s e l l large amounts of debt both in new cash c y c l e i s s u e s and quarterly
refunding packages.
In a d d i t i o n , large a d d i t i o n s t o the weekly b i l l auctions would
be necessary. The e x i s t i n g schedule of s a l e s has shown the c a p a b i l i t y of r a i s i n g
l a r g e amounts of cash by regular a d d i t i o n s to the s i z e of the i n d i v i d u a l c y c l e s ,
but with the Treasury currently f o r e c l o s e d from the long term market, we can expect
correspondingly greater pressure on m a t u r i t i e s of ten years or l e s s . The prospect
of huge Treasury needs l a t e r t h i s year has already had the e f f e c t of keeping r a t e s
higher than might be considered "normal" at t h i s stage of the business c y c l e , and I
f e e l that rates are l i k e l y to stay high when the actual barrage of financing occurs
2. The Treasury can always compete s u c c e s s f u l l y in the marketplace, but
sometimes does so at the expense of other borrowers when funds f o r investment are
s c a r c e . The p r o j e c t i o n of chronic l a r g e Treasury requirements may tend to keep
r a t e s higher than would otherwise be the c a s e . However, the recent v o l a t i l i t y in
i n t e r e s t r a t e s appears to be more c l o s e l y r e l a t e d t o constantly s h i f t i n g p u b l i c
perceptions of the i n f l a t i o n r a t e , Fed p o l i c y , e t c . than to the s p e c i f i c burden of
large d e f i c i t f i n a n c i n g .
3. The development in recent years of various instruments pegged to
underlying Treasury s e c u r i t i e s primarily r e f l e c t s the d e s i r e of both i s s u e r s and
i n v e s t o r s to f i x q u a l i t y d i s t i n c t i o n s in term of y i e l d d i f f e r e n t i a l s .
By d i r e c t




135
inference, i f the yield spread is too narrow, the preferred investment i s the
Treasury security. As the prime credit of the country, the Treasury can always s e l l
i t s debt, but other issuers may occasionally view the yield spread "penalty" as too
large a price to pay. Those Issuers holding tax exempt or Federally guaranteed status
will naturally fare better in the market than issuers not so favored, but none of the
instruments mentioned here will impede the Treasury's a b i l i t y to s e l l i t s debt.
4. In the past ten years, foreign holdings of United States debt have
risen sharply, and now approximate 20% of the marketable debt outstanding. The major
factors contributing to this pattern include central bank operations to support the
values of various currencies, large demands f o r dollar-denominated assets from holders
of Eurodollars, investment of o i l revenues from some OPEC nations, and in recent years,
high U.S. interest rates versus those available in other countries. I f e e l i t i s
reasonable to assume that foreign purchases of U.S. debt w i l l continue at high l e v e l s
if the circumstances cited above remain intact.
5. The hhX c e i l i n g on long term bond issues i s an anachronism that should
be eliminated to provide the Treasury maximum f l e x i b i l i t y in financing the large cash
requirements ahead. M views on "crowding out" and financing long term at current
y
rates are contained in my testimony of March 24, but to emphasize the main point, I
f e e l strongly that r e s t r i c t i n g the Treasury to short maturity debt runs the risk of
increasing market congestion and causing substantially high interest costs on that
portion of the Treasury's requirements. The proposal of one unlimited bond financing
per quarter i s preferable to no authority at a l l , but might push the Treasury toward
outsized individual issues in attempt to take advantage of a limited opportunity.
Regardless of the form, Treasury access to the long term market i s desirable, given
the large cash needs of the future.
6. The question of how to s e l l the quantities of debt implicit in the CBO
d e f i c i t estimates is very d i f f i c u l t to assess. In a comparable previous period
(1975-76), the Treasury resorted to large subscription issues at the then-high rates
of 8% and attracted funds from the stock market and t h r i f t i n s t i t u t i o n s .
Subsequently,
the use of regular cycles of notes and bonds has proved able to generate large
amounts of cash, but not in the dimensions envisioned by the CBO estimates. A combination of the two techniques seems mostly l i k e l y to be used, but in any case, the
treasury w i l l be able to gather large amounts of cash only if the investing public
views the rates available as "high."
7. The Treasury does not have the luxury of timing their sales, given
current and projected levels of financing. However, from a trading and marketing point
of view, I would prefer to see large aggregate packages sold at more widely spaced
intervals, because large, "important" financings tend to attract and focus investor
interest more readily than a series of routine issues. Also, a greater time interval
between financings would allow f o r better distribution of the issues recently sold
and greater market preparation for subsequent large financings.
8. As I am not an economist, I cannot answer this question with confidence,
t strongly endorse the Fed's stated policy of r e s t r i c t i n g the growth of money and
credit for the purpose of reducing i n f l a t i o n . Unfortunately, the attention focused on
various narrow measures of monetary aggregates and their short-term fluctuations,
however they are viewed by the Fed, has had the e f f e c t of producing great v o l a t i l i t y
in the financial markets. I suspect that the d i f f i c u l t i e s even of defining "money"
and " c r e d i t " have made monetary targets hard to attain, and the resulting uncertainties have contributed to \ general feeling of financial i n s t a b i l i t y .




Sincerely yours,

David G. Bunting

J

136

Merrill Lynch
Pierce
Fanner 8 Smith Inc.
May 7, 1982

The Honorable Walter E. Fauntroy
Chairman, Subcommittee
on Domestic
Representatives
U.S. House of
Washington, D.C.
20515
Dear

Monetary

Policy

Sir:

This is in reply to your letter of April 1, 1982 addressed to Mr.
and Manager of Merrill Lynch Government
Securities.
Napoli, Vice-President
Your letter was forwarded to me for response and I hope that the following
on the Treasury's debt management will be of
comments and recommendations
subcommittee.
interest to you and the

D.

1.
With the CBO's having revised its baseline projections
for FY
1982 as well as outer years, the likelihood of net marketable debt of $90
billion for the second half of calendar year 1982 would seem very real, unless
some cuts are enacted o n the spending side and/or some increases on the
receipts side of the budget.
Given such staggering financing needs, the
Treasury would have to increase its debt issuance throughout the m a t u r i t y
An even heavier reliance on the notes and bonds sector would,
spectrum.
therefore, be necessary.
In order to raise as much new money as possible
through one issue, we would recommend an August refunding consisting of two
issues, a ten-year note that would be sold through a subscription
method and a
thirty-year bond.
The latter assumes that the present bond debt ceiling would
Since by then the Treasury would have refrained
from
be raised late July.
issuing a bond for six months, a $2.0 billion new issue in a thirty—year
For the ten-year
maturity should not encounter problems in being distributed.
issue, we would not limit the amount that could be raised.
The Treasury
should accept as much as it feels comfortable with, in our opinion at least
This $8 billion
$8.0 billion could be raised through such a subscription.
ten-year note, in addition to the $2.0 billion thirty-year bond would provide
An issue of $8.0 billion or
$5.7 billion of net new money for the Treasury.
larger would enable the Treasury to limit the additions it would have to make
to the weekly bill auctions.
This type of refunding package is recommended as
short-term
by issuing longer maturities some pressure would be lifted from
rates which in turn would allow the yield curve structure to become
positive.
For the November refunding, we would recommend a three pronged offering of
$10.5 billion, which would raise $5.9 billion new money.
Such a standard
refunding could consist of a three to three and a half year note of $5.5
billion, a ten-year note of $2.5 billion and a thirty-year bond of $2.5
billion.
Certainly, the markets can hardly respond positively to such a




137

supply of new debt, especially if facing the possibility of escalating deficits looming ahead.
With the economy not expected to recover
meaningfully
through the rest of the year, the key sectors will not be able to provide the
needed supply of funds to accommodate the Government's needs.
As a result,
unless there is an improved outlook for the budget deficit in the outer years,
some upward pressure on interest rates may
materialize.
2. The ever increasing Government needs for funds have in recent
years and will in the coming years continue to "squeeze out" other borrowers.
With interest rates having remained at all time highs both in nominal and real
terms, the corporate balance sheets have been under severe strain as corporate
needs have been heavily accommodated through short-term debt.
Presently, the
overall short-term to long-term debt ratio is slightly above the all time
Unless there is a
record of 42% reached in the fourth quarter of 1981.
meaningful decline in nominal interest rates, the current strain on corporate
These
balance sheets will persist through the early stages of the recovery.
strains combined with the heavy demand for funds from the Government sector
will add to the interest rates volatility that we have experienced in recent
years and as a result, will have a depressing impact on the economic
recovery.
3. Tax exempt securities and Government guaranteed
securities,
while a drain on Government revenues, have been a positive factor for those
sectors of the economy that have had access to these sources of funds.
Since
these instruments consist of only a fraction of those funds raised by the
Treasury, their impact on the Treasury's ability to smoothly finance its debt
is minimal.
To the extent that the relationship of taxable vis-e-vis nontaxable securities remains constant, it should not have a meaningful impact on
the Treasury's funding needs in the future.
4. Foreign investors have increasingly provided a steady flow of
While shifts during the last ten years have
funds to the U.S. Debt Markets.
occurred within the debt markets, these investors have impressively
increased
their holdings of Credit Market instruments from $53.0 billion to $197 billion
the end of 1981.
Additionally, corporate equities' holdings have risen from
$30.8 billion to $54.8 billion and direct investments have increased from
Of the $144 billion net increase in Credit
$13.9 billion to $77.9 billion.
Market instruments, the most remarkable change has been in holdings of U.S.
Government Securities which surged by $94 billion.
Currently, these holdings
have been on a declining trend, as the combination of higher domestic interest
rates and a stronger dollar have resulted in some selling of marketable debt.
While over the near-term, we expect this trend to continue as far as marketable U.S. Treasury Debt investments are concerned, overall foreign investors
should continue to be an important source of funds for the domestic
markets.
As the worldwide economies recover from the current weakness, we anticipate
these investors to increase their U.S. dollar denominated investments and to
take an increasing share of U.S. Government Debt issues.




138
5. The request by the Treasury for an increase in the authority to
issue marketable bonds in excess of 4k% is not only practical but necessary.
Since the 4k% limit has actually been absolete since April 18, 1963, the date
the last bond was issued with a coupon of 4k% or less, it would probably be
even more efficient to lift the bond authority ceiling altogether.
If a one
bond per quarter limit without a dollar limit would be placed on the Treasury,
instead of increasing the bond authority ceiling, Congress may force the
Treasury to lock in higher interest costs for a longer period than would be
the case if the Treasury had the flexibility to do more than one bond of a
different maturity, i.e., twenty and thirty years per quarter.
In order for
the Treasury's debt managers to raise the anticipated staggering amount of
funds with a minimal impact on the credit markets, we feel various methods
should be used in raising these funds.
Each of the methods used, of course,
has to properly fit into the market and economic environment at the time it is
used.
6. Since two-thirds of the Treasury's financing needs for FY 1982
has agreed with the
have already been accommodated and the administration
CBO's $119 billion deficit for FY 1982, we have answered this question on the
Therefore, if
basis of the revised CBO estimates for the outer years only.
the CBO's latest estimates for FY 1983 of $182 billion and FY 1984 of $216
billion were to materialize in the near future, some alternative methods for
As it was recommended in the
the Treasury to sell its debt would be needed.
testimony, first of all, we would suggest larger and less frequent
auctions.
Secondly, we suggest reviving, when appropriate, two auction techniques which
have been used in the past.
One of these techniques is the subscription
method whereby the Treasury sets a coupon and receives subscriptions at a
specific price pre-set by them.
The other technique which should be considered is the "Dutch Auction" method whereby all winning bidders of an issue
The latter would place all bidders
receive their awards at the lowest price.
on equal footing.
Therefore, most participants will bid more aggressively if
they know that their award will be received at the cheapest price.
The
details on how both of these techniques work were discussed in the testimony.
Both of these auction techniques can result in wide distribution, less fear
The third suggestion would be to
and substantial financing at market prices.
lower the minimum purchase price for the issues.
This would result in even
issues.
more public participation and wider distribution of Treasury
7. Alternative financing plans, such as the two auction
techniques
suggested in the previous answer, less issues at the refunding, i.e., two
instead of three and larger issues, would all allow the markets to absorb the
constant supply of Treasury issues with less volatility.
At the present time,
there are an average of about 104 Treasury auctions per year, less frequent
auctions would certainly have a positive impact on the tone of the markets.
It would give dealers more time to distribute the issues and would induce
those investors who hesitate to participate in the markets because they know
that a similar issue will shortly follow, not to step aside because the time
between similar issues would be longer.




139

8. The Fed's monetary targets and monetary policy are designed to
bring down the supply of money and the growth of inflation on a long-term
basis.
The Fed has been successful in the last two years in bringing down the
growth of money and making a dent on the inflationary front.
The imbalance
between a Fed policy geared to less money growth and a fiscal policy that has
been and continues to be expansionary has caused the real rate of interest to
remain high.
Unless the pace of Government spending diminishes, Fed policy
alone cannot carry the burden for relieving the pains in the economy.
In closing, we appreciate the opportunity to have participated
your hearings and look forward to being of any assistance to you in any
further pursuit of this issue.
Sincerely

yours,

c
. ///>/' >, •
MFR:lc

cc:

Mr. D. Napoli
& Manager
Vice-President
Government Securities
Trading




N

~
'

Maria Fiorini Ramirez
Vi ce-President
Senior Money Market Economist

in

140

CONTINENTAL B A N K
CONTINENTAL II LINOlS NATIONAL BANK AND TRUST COMPANY Oh CHICAGO • 231 SOUTH LASALLE STREET CHICAGO ILLINOIS 60693

April 7, 1982

DAVID G. TAYLOR
EXECUTIVE VICE PRESIDENT
312/828-4240

Mr. Walter E. Fauntroy
Chairman
U.S. House of Representatives
Subcommittee on Domestic Monetary Policy
of the Committee on Banking, Finance
and Urban Affairs
H2-179, Annex No. 2
Washington, D.C. 20515
Dear Mr. Fauntroy:
I appreciated your cordial letter of thanks concerning our recent appearance
before your Subcommittee. You are quite correct — appearances like that
are time consuming but nevertheless worthwhile if they lead to a better
understanding of Treasury debt management problems and solutions.
I a also in receipt of your letter of April 1, with its additional series
m
of questions concerning debt management. I a very sorry but I must respectm
fully decline your invitation to furnish additional comment on these matters.
Unfortunately, some extensive travel and other matters preclude the availability of time necessary to do justice to these subjects. I would hope,
however, that a reading of m testimony along with that of others during
y
your March hearings would provide general, if not specific, answers to the
questions. Attention to our commentary on the basic principles of debt
management in itself offers answers to many of the choices faced by Treasury
debt managers in the period ahead.
Our a d v i s o r y c o m m i t t e e also w i l l continue, at its officially convened
m e e t i n g s , to offer advice on these critical issues to Treasury o f f i c i a l s .

I might also suggest that you may wish to have your staff sit down with some
of us on these questions and would be happy to take some time and provide a
forum of our "experts" for them if they could come to Chicago. Alternatively,
I would be able to spend a couple of hours with you myself in Washington on
Wednesday morning, April 28, which will be at the time of our next quarterly
meeting with Treasury o f f i c i a l s .
The one question that I can comment on pertains to CommitLee membership.
Members are chosen by a caucus of past Chairmen of the Committee, plus
the current Chairman and Vice Chairman. Presently, this is a group of
five men. Members are chosen on the basis of individual qualifications
and no firm or bank has a "seat" on the Committee ever, though many firms
and banks have been represented continuously throughout the Committee's
history. Treasury formally and annually approves all members.
Kind regards.




WAI.TER E. FAUNTROV. D.C . CHAIRMAN
PARREN J. MITCHELL. MO
STEPHEN L. NEAL. N.C.
ooua BARNARD. JR.. OA.
HENRY S. REUSS. WIS.
JAMES J. BLANCHARD. MICH
CARROLL HUBBARD. JR KY
BILL PATMAN. TEX.
W/

10515

U.S. H O U S E O F R E P R E S E N T A T I V E S
SUBCOMMITTEE ON DOMESTIC MONETARY POLICY
OF THE
COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS
NINETY-SEVENTH CONGRESS

W A S H I N G T O N . D.C.

20515

May 5 . 1982

Nr. David G. T a y l o r
Executive V i c e - P r e s i d e n t
Continental I l l i n o i s National Bank
231 South L a S a l l e S t r e e t
Chicago, I l l i n o i s
60693
Dear David:
Thank you f o r your response o f A p r i l 7 , 1982, to n\y recent l e t t e r .
I am sorry t h a t our planned v i s i t on A p r i l 28th did not m a t e r i a l i z e . I
was very much looking forward t o seeing you and t o engaging f u r t h e r I n
the discussion o f the Issues o f debt management which we began a t the
hearing on March 2 4 t h .
You maty be I n t e r e s t e d to know. I n c i d e n t a l l y ,
a d i r e c t r e s u l t , I have scheduled hearings on H«y
business l i q u i d i t y conditions. I hppe t h a t these
I n t e r e s t i n g and Informative as those a t which you

t h a t w h i l e 1 t I s not
26 and 2 7 , 1982, on
hearings w i l l be as
testified.

While we were unable to meet during your l a s t v i s i t t o Washington,
I do very much want you to know t h a t I hope we can meet on your next
v i s i t , assuming t h a t our schedules can be made to mesh. I n the meantime,
would you be so kind as t o supply me w i t h a 11st o f the members composing
the caucus o f past chairmen which nominates members t o the Government
and Federal Agencies Securities Committee, as Indicated 1n your l e t t e r
o f A p r i l 7? I n a d d i t i o n , could you please Include a 11st o f the current
members o f the Committee and the length o f time each has served? Some
I n t e r e s t 1n the names and positions o f these Individuals has been
expressed by other Members.
With kindest regards, I am.
Sincerely yours

Walter E. Fauntroy
Cha1rrnan
WEF/hl,cm/jlt

95-448 0-82-10




142

CONTINENTAL B A N K
C O N T I N E N T A L ILLINOIS N A T I O N A I




BANK A N D T R U S T C O M P A N Y OF C H I C A G O • 231 S O U T H LA SAL I E STREET

May 17, 1982

CHICAGO

I L L I N O I S f>G'>93

DAVID Q. TAYLOR
EXECUTIVE VICE PRESIDENT
312/828-4240

Mr. Walter E. Fauntroy, Chairman
U.S. House of Representatives
Subcommittee on Domestic Monetary Policy
of the Committee on Banking, Finance & Urban Affairs
H2-179, Annex No. 2
Washington, D. C. 20515
Dear Walter:
In response to your letter of May 5, I am enclosing a l i s t of the
current members of the PSA Government and Federal Agencies Securities
Committee. As you requested, we have indicated next to each member's
name the year each began serving on the Committee. In some instances,
you will note this service precedes 1971.
In addition, following are the past chairmen who currently serve on the
Committee and who comprise the group that nominates members to the
Committee. Also noted are the years that each of these individuals
served as chairman.
Robert W. Stone
Daniel S. Ahearn
Frank P. Smeal
David G. Taylor

1976-1977
1978-1979
1980-1981
1982-1983

Jack Runnion, in his capacity as current vice chairman of the Committee
and the person who will succeed me as chairman in 1984, is also included
in the nominating group.
I hope that your hearings later this month on business liquidity are
fruitful. If I can be of any further assistance to you and your
Subcommittee, please let me know.
Kind regards.

D TE H
G:M
Enclosure

/
125th ANNIVERSARY 1857-1982

125
SUBSID-AHY CP CONTINENTAL li IINOIS CO-lPOf/'TlON

143
REVISED

1982
PUBLIC SECURITIES ASSOCIATION
G V R M N & FEDERAL AGENCIES SECURITIES COMMITTEE
OEN E T
Chairman
1974

David G. Taylor, Executive Vice President
Continental I l l i n o i s National Bank
and Trust Company of Chicago
231 South LaSalle Street
Chicago, IL 60693
Vice Chairman

Prior to 1971

H . Jack Runnion, Jr.
Executive Vice President
Wachovia Bank & Trust Company
P. 0. Box 3099
Winston-Salem, NC 27102

Prior Daniel S. Ahearn
to
Senior Vice President
197.1 Wellington Management Company
28 State Street
Boston, M 02109
A

1981

John B. Ford
President
Aubrey G. Lanston & Co., Inc.
20 Broad Street
New York, N
Y 10005

1978

James A. Brickley
Executive Vice President
First National Bank in Dallas
P. 0. Box 83754
Dallas, TX 75283

1981

1982

Robert C. Brown
Senior Vice President
Northwestern National Bank
Seventh & Marquette
Minneapolis, M 55479
N

George H. Grimm
Executive Vice President
& Managing Director
W . E. Pollock & Co., Inc.
m
160 Water Street
New York, N
Y 10038

1979

Gedale B. Horowitz
Managing Director
Salomon Brothers Inc
One New York Plaza
New York, N
Y 10004

- 1981 -

Larry F. Clyde
Executive Vice President
Crocker National Bank
Money Market Division-4th Fl.
1 Montgomery Street
San Francisco, CA 94104

1972

m. Dale Jackson
Senior Vice President
Security P a c i f i c National
Bank H12-4
P. 0. Box 92121
Los Angeles, CA 90009

Prior
G. Lamar Crittenden
12. ' Executive Vice President
19_ZJ. First National Bank of Boston
100 Federal Street
Boston, M 02110
A




1982

F . Kessenich, Jr.
Senior Vice President
Citibank, N.A.
55 Water Street
New York, N
Y 10043

Mark

144
PUBLIC SECURITIES ASSOCIATION
G V R M N & FEDERAL AGENCIES
OEN E T
SECURITIES COMMITTEE—1982
Page 2

Prior
to
1971

Edward R. McMillan
Senior Vice President
& chief Economist
Rainier National Bank
P. 0. Box 3966
S e a t t l e , W 98124
A

1981

Raiph

1977

Donald B. R i e f l e r , Chairman
Sources & Uses of Funds Committee
Morgan Guaranty Trust Company
23 Wall Street
New York, NY 10015

1975

Edward M. Roob
Senior Vice President
The First National Bank of Chicago
One First National Plaza
Chicago, IL 60670

1982

Wolfgang Schoellkopf
Executive Vice President
The Chase Manhattan Bank, N.A.
1 Chase Manhattan Plaza
New York, NY 10081

1977

Thomas N. Slonaker
Senior Vice President
Mellon Bank N.A.
Mellon Square
Pittsburgh, PA 15230

Peters
Chairman of the Board
Discount Corporation of New York
58 Pine Street
New York, N
Y 10005

1973

Frank P. Smeal
Partner
Goldman, Sachs & Co.
55 Broad Street
New York, N
Y 10004

1982

Morgan B. Stark
Senior Vice President
Chemical Bank
20 Pine Street
New York, NY 10015

F.




Prior Robert W. Stone
to
Executive Vice President
1971 Irving Trust Company
One Wall Street
New York, NY 10015
1974

H. James Toffey
Managing Director
The First Boston Corporation
Park Avenue Plaza
New York, N
Y 10055

1975

John Tritz
Senior Vice President
Bankers Trust Company
16 Wall Street
New York, NY 10015

1982

John R. Vella
Executive Vice President
Bank of America, NT & SA
World Banking Division-Financial
Services-#5030
555 California Street
San Francisco, CA 94104

145
APPENDIX B

FOR RELEASE ON DELIVERY
EXPECTED AT 10:00 a.m.
May 27, 1982

STATEMENT OF THE HONORABLE ROGER W. MEHLE
ASSISTANT SECRETARY OF THE TREASURY (DOMESTIC FINANCE)
BEFORE THE SUBCOMMITTEE ON TAXATION AND DEBT MANAGEMENT
OF THE SENATE COMMITTEE ON FINANCE

Mr. Chairman and Members of the Committee:
My purpose here today is to advise you of the need for
Congressional action to increase the public debt limit and to
repeal the interest rate ceilings on savings bonds and on Treasury
marketable bonds.
Debt Limit
The present temporary debt limit of $1,079.8 billion will
expire on September 30, 1982, and the debt limit will then revert
to the permanent ceiling of $400 billion.

Based on the Office of

Management and Budget's April estimates of FY 1982 and FY 1983
budget deficits of $100.5 billion and $101.9 billion, respectively,
and other transactions affecting debt subject to limit, the amount
of debt subject to limit outstanding on September 30, 1983 will
total $1,270 billion, assuming a $20 billion cash balance on that
date.

Given this projected debt level, and allowing a $5 billion

margin for contingencies, we now recommend and request that the debt
limit be increased to $1,275 billion through September 30, 1983.
R-806




146
We recognize that Congress has not yet completed action
on the first budget resolution for FY 1983 and that that resolution
may contain a different debt limit figure for FY 1983.

We do

expect however that, given the efforts in Congress to develop
a 1983 budget with a deficit close to $100 billion, any resultant
debt subject to limit amount will be in the same order of
magnitude as the amount we are requesting.

In that regard

we urge that any budget resolution debt limit figure incorporate
our recommended $5 billion margin for contingencies and our
assumption that the cash balance at the end of FY 1983 will be
$20 billion.
As to the timing of Congressional action on the debt limit
bill, our current estimates indicate that final action on the
bill will be needed by the third week of June.

This will give

the Treasury sufficient time to auction a new 4-year rote for
subsequent issuance on June 30 to refund maturing securities
and to raise the new cash needed at that time.

The issuance

of the 4-year note will cause the debt subject to limit to
rise above the present statutory ceiling of $1,079.8 billion.
Treasury's earlier projection that action would be needed late
in May has been changed due to a slightly lower estimate of
our borrowing needs through early June because of a combination
of higher receipts and lower outlays.
Timely action on the debt ceiling is require 1 to avoid a
repetition of past dislocations which have ha;.c?.v£d Treasury
financing operations.




In recent years, delays in action on

147
the debt limit have generated market uncertainty about Treasury
financing schedules and on several occasions emergency measures
have been undertaken, including suspension of savings bond
sales, cancellation of scheduled security auctions and failure
to fully invest trust funds.

A point may be reached at which

the President must consider which obligations should be paid

—

social security checks, payroll checks, unemployment checks,
defense contracts —

or, indeed, whether, for the first time

in history, the United States will default on its securities.
I hope we can avoid such problems this year.
Separate legislation for a statutory debt limit has not been
an effective way for Congress to control the debt.

The increase

in the debt each year is simply the result of earlieL decisions
by Congress on the amounts of Federal spending and taxation.
Consequently, the only way to control the debt is through firm
control over the Federal budget.

In this regard, the Congressional

Budget Act of 1974 greatly improved Congressional budget procedures
and provided- a more effective means of controlling the debt.
That Act requires Congressional concurrent resolutions on the
appropriate levels of budget outlays, receipts, and public debt.
This new budget process thus assures that Congress will face up
each year to the public debt consequences of its decisions on
taxes and expenditures.
The debt limit, act of September 29, 1979, also amended the
rules of the House of Representatives to t i e the establishment
of the debt limit to the Congressional budget process.




Under

148

the new House rules, upon adoption by the Congress o£ a budget
resolution, the vote by which the Rouse adopts the budget
resolution is deemed to be a vote in £avor of a joint resolution
changing the statutory debt limit to the amount specified in the
budget resolution.

The joint resolution on the debt limit is

then transmitted to the Senate for further legislative action.
No comparable procedure exists in the Senate.

The Senate must

still vote twice on the debt limit figure, in the budget resolution
and in the separate debt limit bill.
To summarize our debt limit request, Mr. Chairman, we urge
that legislation be enacted promptly to provide the requested
amount of increase in the debt limit to $1,275 billion, to be
effective upon the date of enactment and through the end of FY 1983.
Savings bonds
I would like to turn now to our proposal to repeal the
interest rate ceiling on savings bonds.

For most of the past

forty-five years, the savings bonds program has been a relatively
stable source of funds, financing a significant portion of the
public debt.

The program broadens the market for Government

securities, and the cash raised by savings bonds reduces the
amount of borrowing that the Treasury must undertake on a competitive
basis in the open market.

The relatively long maturity of savings

bonds helps with Treasury's current objective of achieving a
better maturity structure of the public debt.

Also, savings

bonds have proved to be a cost-effective means of financing the
debt, with ultimate savings to the American taxpayer.




149

The program generally has been popular with the American
peoplef has helped instill a habit of thrift among small savers,
and has received broad support from leaders of industry and finance.
Yet the future role of the savings bonds program in financing the
public debt will depend primarily on the interest rate on savings
bonds relative to rates on competing instruments.
Legislation enacted in October 1980 authorized Treasury to
increase the interest rate on savings bonds by up to one percent
during any six-month period.

Accordingly, Treasury increased

the maximum rate on savings bonds from 7 percent to 8 percent on
November 1, 1980 and to 9 percent on Hay 1, 1981.

Yet the maximum

rate increases permitted under existing law have not been sufficient
to stem the savings bond cash drain from the Treasury, because of
higher interest rates available from other market instruments.
Savings bond redemptions exceeded sales by over $5 billion in
1979, over $11 billion in 1980, nearly $9 billion in 1981, and
by $2-1/2 billion in the first 4 months of 1982 (See Chart 1).
This substantial cash drain from the savings bond program
over $28 billion since 1978 —

—

must be financed by other, more

expensive, Treasury borrowing, namely the issuance of additional
marketable securities at interest rates much higher than the
savings bond rate.

Interest rates on Treasury marketable inter-

mediate notes are currently around 13-3/4 percent, compared to
the current guaranteed rate of 9 percent paid to Series EE bond
holders after 8 years.




150

To stem the cash drain, Treasury must assure savings bond
investors that they will receive a fair rate of return throughout
their holding period.

Thus Treasury must be able to promise the

small saver that the rate on savings bonds will vary with market
rates of interest.

Large investors can achieve this assurance

through investment in short-term Treasury bills.
The alternative o£ raising the savings bond rate tor say,
10 percent now and possibly a higher rate later, under existing
legislation, was rejected by Treasury.

While such rate increases

might over time reduce the savings bond cash drain, they would be
relatively expensive over the long run if market rates of interest
declined.

In this regard, savings bonds differ from long-term

marketable debt.

Holders o£ marketable securities do not have the

option of redeeming their securities at par, and thus bear market
risk not borne by savings bond investors.

Also, there is no way

under existing legislation that Treasury could assure long-term
savers that the rate on savings bonds would continue to be competitive with current market rates.

The need is for a savings bond

rate that automatically increases, and decreases, with market rates,
and that is what we propose.

Simply stated, the major change will

be that people holding either new or old bonds for at least 5 years
from the beginning of the new program will be assured that their
return will be no less than 85 percent of the average return on 5-year
Treasury marketables during their holding period.

They will also

be guaranteed a minimum rate; so they will receive 85 percent of the
average market yield on 5-year Treasury securities over the holding




151
period, or the guaranteed minimum rate, whichever is higher.

Five-

year Treasury marketable securities currently are yielding about
13-3/4 percent.

If this rate prevailed over the holding period, the

savings bond rate would be about 11.7 percent.
The rate paid on savings bonds must be less than the marketable
rate for several reasons:

(1) savings bonds are available in smaller

minimum denominations and therefore entail higher administrative
costs; (2) savings bonds have tax deferral advantages which increase
their effective yield after taxes (relative to marketable securities);
and (3) savings bonds are redeemable at par, thereby eliminating the
risk of market value depreciation inherent in ownership of marketable
Treasury notes.

On this basis, a rate on savings bonds equal to

85 percent of the rate on marketable Treasury five-year notes is a
fair rate of return. A healthy savings bonds program is not only good for small
savers it is good for the Treasury too.

Even at the higher market-

related rates we propose to pay to savings bond holders the costs
to the Treasury will be less than the alternative cost of financing
this debt in the open market.

Thus the longer we delay the

introduction of the new variable rate savings bond the greater
the cost of financing the debt.
Long-Term Bonds
Finally, I would like to discuss our proposal to repeal the
interest ceiling on marketable Treasury bonds.




152

The maximum interest rate that the Treasury may pay on marketable bonds has long been limited by law to 4-1/4 percent.

This

limit did not become a serious obstacle to Treasury issues of new
bonds until the mid-1960*s.

At that time market rates of interest

rose above 4-1/4 percent and the Treasury was precluded from issuing
new bonds.

The average length of the privately-held marketable debt

of the Treasury declined steadily from 5-3/4 years in mid-1965 to
about 2-1/2 years in 1975, because of the heavy reliance by the
Treasury on short-term bill financing of the large budget deficits
during this period (See Chart 2)•
Congress first granted relief from the 4-1/4 percent ceiling
in 1967 when it redefined, from 5 to 7 years, the maximum maturity
of Treasury notes.

Since Treasury note issues are not subject to

the 4-1/4 percent ceiling on bonds, this permitted the Treasury to
issue securities in the 5 to 7 year maturity area without regard to
the interest rate ceiling.

In the debt limit act of March 15, 1976,

the maximum maturity on Treasury notes was increased from 7 to 10
years.

Today, therefore, the 4-1/4 percent ceiling applies only to

Treasury issues with maturities in excess of 10 years, and certain
amounts, such as bonds held by the Federal Reserve and Government
accounts, have been exempted from this ceiling.

In 1971, Congress

authorized the Treasury to issue up to $10 billion of bonds without
regard to the 4-1/4 percent ceiling.

In 1973 Congress relaxed the

$10 billion limit by applying it only to private holdings.

The dollar

limit since has been increased from time to time, most recently on
October 3, 1980, when the limit was raised to $70 billion to accommodate additional long-term financing (See Chart 3).




153

Since 1975 the Treasury's debt extension policies have moved
the average length of the marketable debt from 2 years, 5 months
in January 1976 to 4 years in March 1982, thus reducing the
administrative burden and the market-disrupting effects of frequent
Treasury operations to refund maturing issues.

Yet while the

Treasury has significantly improved the maturity structure of the
debt in recent years, almost one half of outstanding marketable debt
matures within one year (See Chart 4).

This refunding need must

be added to Treasury's new cash borrowing requirement to determine
gross Treasury issuance in the market.

Because of the short average

maturity of outstanding Treasury debt, long bond issuance must
remain an integral part of Treasury's debt management policy.
Some observers have suggested that Treasury should avoid the
sale of long-term securities when interest rates are "high", in order
to avoid locking in high interest costs.

However, any definition

of "high" interest rates is extremely subjective and carries with
it an implicit forecast of future interest rates.

If Treasury

"temporarily" withdrew from the bond market because it felt rates
were "high", market reaction to reentry in the long market could
well be that rates were "low".

Thus reentry could be interpreted

as a Government forecast of higher rates in the future.

Management

of the debt based on interest rate forecasts would create tremendous
uncertainty as to Treasury's financing schedule and, over the long
run, would result in higher costs to the Government by reducing
the market's willingness to bid in auctions.

Therefore, a consis-

tent policy of debt issuance across the maturity spectrum must be
maintained without regard to expected interest rate developments.




154
I would also note that, because of the large volume of maturing
obligations refinanced each year,

interest expense on the public

debt is extremely sensitive to interest rate movements.

This adds

volatility to the interest expense component o£ Federal outlays.
As interest rates move up and down, Treasury*s interest expense
also rises or falls.

As long as the debt outstanding retains this

short-term character, debt extension must be a part of our debt
operations.
At this point I would like to note that market uncertainty
has recently arisen because of Congressional inaction on Treasury's
request to repeal the 4-1/4 percent ceiling on long bonds.

As

mentioned earlier, the £ace amount of Treasury bonds held by the
public with interest rates in excess of 4-1/4 percent may not exceed
$70 billion.

Treasury has exhausted this authority (See Chart 3).

Unless Congress repeals the 4-1/4 percent ceiling, or grants additional issuing authority, no more bonds may be sold.

In fact,

Treasury was forced to cancel its regular auctions of 20-year bonds
in March and 30-year bonds in April.
result of Congressional inaction.

These cancellations are a

Inability to sell these securities

has created dislocations in the market and raised questions about
the Treasury's ability to carry out predictable, prudent debt management policies.

I urge Congress to expedite the long bond authority

legislation so thatr.this uncertainty can be resolved.




155

In conclusion Mr. Chairman, we face large borrowing requirements
ever t:he foreseeable future.

This Administration abhors interest

^ate ceilings as ineffective attempts to control prices and incompatible with our commitment to a free market pricing system.

We view

•-he interest rate ceilings or. savings bonds and raarketable bonds as
anachronisms which serve only to frustrate the efficient management
of Tihe public debt . A viab.le, modern savings bonds program and
ceiroval of the 4-1/4 percent ceilj.ng on Treasury marketable bonds
will help the Treasury mee--. these financing needs in an efficient,
cosr.-eIfective man net;.

Interest on the public debt is estimated

to total i record $116 billion in FY 19&2.

We i i s raake every
iut

effort to ceduce tr-i3 stance*. Lug cost to the taxpayer

^.specially

at tai? time of severe budget stringency, we must not ada to our
budget cosns by mismanaging the public debt.
That concludes a/ prepared statement, Mr. Chairman,
r- happy to respond to your ouestions.
.e




I will




Chart 1

CUMULATIVE N E T C A S H F L O W I N S A V I N G S BONDS 1 7

J/jCash sales l e w redemptions




Chart 1

A V E R A G E L E N G T H O F T H E M A R K E T A B L E DEBT
Privately Held




Chart 3

USE OF AUTHORITY TO ISSUE TREASURY BONDS
WITH INTEREST RATE OVER 4Va PERCENT
100

80

60

40
HOMMon

20

March 17,1871

1
1971 1972

OtaiCMMMfw

$10 blWon c«IHn0
lo private hHritngt
July 1,1973

Privately
Held

I
1973

1974

J
L
-L
J
I
Uo
1975 1976 1977 1978 1979 1980 1981
As of December 31




Chart 1

PRIVATE HOLDINGS O F TREASURY MARKETABLE DEBT
BY MATURITY
Coupons • over 10 yrs
1 - 2 yrs
• 2-10 yrs
ES11 yr & under

Bills

As of December 31

•

APPENDIX

INTEREST-BEARING

1000 -I

C

PUBLIC

DEBT

r IOOO

800 "

U
_

600

-600

600

<
o
z
o
H

CO
Z

o
M
TOTAL

400

400 -

/
MARKETABLE

'

^

"

0

1

56

I '
60

ZOO

^

I '
62

I '
64

I
66

1

'

I '
68

I
70

'

I
1Z

'

I
74

I

1

76

YEARLY AVERAGE OF MONTHLY DATA

Subcommittee on Domestic Monetary Potccy




^

NON-MARKETABLE

'

I
78

'

I
80

'
8Z

g




0>

YEARLY AVERAGE OF MONTHLY DATA

Subc.omnti£t&e. on Domestic

Mon&toAy

Poticy

12.5 n

COMPUTED

ANNUAL

INTEREST

RATE
ft\

THE
11 .2 -

INTEREST-BEARING
DEBT

PUBLIC

/
'

,

r 12.5

U
"

-11.2

-9.9

9.9 £
tu
O
QL

O
C
*

NON-MARKETABLE

£




S
6.6 -

8.6

7.3 -

7.3

6.9

6.0

1974 ' 1975 ' 1976 ' 1977 ' 1978 ' 1979 ' 1989 ' 1961 ' 1962
MONTHLY AVERAGE

SubcommMzz on Domestic. Mowtoiy Potiay

to

COMPUTED

ANNUAL

INTEREST

RATE

ON

12.0-1

THE

INTEREST-BEARING

r 12.8

PUBLIC

DEBT
10.8-

C D

IS INTEREST RATE ON TOTAL

- 10.8

77\ IS INTEREST RATE ON MARKETABLE
^

IS INTEREST RATE ON NON-MARKETABLE

0

9.6UJ

o
ckL
UI

(L

8.4-

0

7.2-

6.0

na
1974

1975

1976

m
1977

Subcommittee o Iowatic MoneXaAu PoU.c.y
n




I

1978

3

-9.6

z

UJ

k

-8.4

-7.2

1

1979

1980

i-

-6.0

1981

o
cz
UJ
iL




AVERAGE LENGTH O F T H E M A R K E T A B L E DEBT
Privately Held

January 26.1982-4




Subc.ommi££e.(L on PomeAtic Monttany Poticy




INTEREST

17 "i

RATES

r 17

ON

U. S.

TREASURY

B I L L S

14 -

- 14

11 -

- 11

UJ

o
QC

O
*

k
-

-6

5 -

-5

8

SOLID LINE IS 3-MONTH BILLS
DASHED LINE IS 6-MONTH BILLS
DASH-DOT LINE IS 1-YEAR BILLS

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

I

64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82
YEARLY AVERAGE OFMOIMTHLY DATA

Subcommittee, on JomeAtic MonetaAy Poticy




INTEREST

17 n

RATES

r 17

ON

U.S.

T R E A S U R Y

N O T E S

&

B O N D S

14

14 -

11

- 11

z

UJ

UJ

o

o
QC.
U
i
CL

QC

UI

a.

- 8

-5
SOLID
DASHED
DASH-DOT
DOTTED

LINE
LINE
LINE
LINE

IS 1 - Y E A R NOTES
IS 5-YEAR NOTES
IS 10-YEAR BONDS
IS 30"Y
-YEAR BONDS

n—i—i—i—i—i—i—i—i—i—i—i—i—i—i—i—r
64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 89 81 82
YEARLY YEARLYA V E R A G EOF M O N T H L Y
DATA

SabcurmlttdfL on Domdbtxc Monetwtij PotLcy

3




FEDERAL DEBT

Iri l ? r e t • • e r iria Puh 1 i c D b t Se(• • ir i. I, i.es 0utstaridiria (billions of $)
i
.
'
G s• • B a
e
li i tei-psl, -Bearii i<:i Marketable public Debt Securities O t,stand.intf
u
ITM
Per cei 1 u I T.i' l.e re*.»t--Bear n i.i Pub'!. . r S- cur :i. t : << which re Mr-V etab I.e (billions of $)
1
«i
i?
i •>
>
;
3) I M
T P
.
i 11
T r e a s r -.t B :i I I.s ( B : . . o n s o f $ >
4) BILLS
<
>
;
3) I II... L P Pei cen t of I nteresI. --Be.-^ i n4 Mari' e l-.«jbl e Publ ic Debt which is T-B i. 11 <
B
S
T r e a s u r v N o t e s (b i 11 :i. o 1 v, o f $ >
*
.
1 .
6) N T S
OE
Percent of I rite rest-Bear :i.ns* Marketable Public Debt, which is T -Notes
7) N T S
OEP
>1
;
«
>
3 > B N S T re a < 1 r vj B o n d; (b :i. 11 i o n s o f $ )
OD
!"' e r- c e r 1 i f" 11 1 e i • e s t • B e a r i. n M a r I- e t a b 1 e l:" ii b 1 :i. c D e b t w h :i. c h :i. s T •• B o n d s
1 > .1
•
".
.
i
•
•
9) B N S
O DP
I n t e r e s t, •• B e a r :i. n N o 1 m < r k e t a b . e P u b 1 i. c D e b I, S e c u r :i. I :i. e v 0 u t s t a 1 d .i. n < b :i. II :i. o r i s o 1
•
•
•
1 :
!
'I
.
>
:
1
'
10) I N
T
Percent of Interest-Bear i.ntf Public Debt Securities which are Nonmarketable
11> ITNP
1IM
P B T 1 1 S BT.I.I. S
NTS
OE
BNS
OD
IT
. . .
P
BNS
O DP
IN
T P
[M
T
NTS
OEP
ITN
luy
Date
(6)
mi
tsi
(?)
(7)
W
m
m
W
2:1., 97
2 4,
,66
14.,67
•
86,• / 5
51 <
. . 61
61 • 02
,
'!. 07• 37
38.98
1958
275 • 46 168 . 09
13.,07
63.• 99
35,• 53
1959
182 .37
19., 48
33..40
84,,63
284 . 98
46..41
1.02.62
36.01
18.,32
4 7 55'
2 5,35
<
82,,77
37,,92
20.• 21
>
44. 12
65,• 59
98 .43
34.41
I960
286 * 0 3 187 . 60
41 .. 5 7
40,,23
21 • 07
: .
66,• 13
61 • 2 6
.
32.,09
97 . 78
288 .71
79.,37
.93
190
• >, 8/
•/
)
1961
7/,• 35
67., 26
44,,28
61 .
22.,26
i 87
31., 11
96 .81
1962
295 • 7 2 198 .90
38. 89
3 2.74
204 * 55
67 ,82
,
49,,02
5 4> 19
,
23.,97
26.,49
40. 32
32. 18
3.963
82.• 48
97 .04
301 .59
67,>73
1964
53,,09
29.,40
308 • 37 208 . 86
25.• 42
92.• 41
32.27
61 • 40
•
44.
99 .51
67,,41
1965
56,,61
24.,73
26.• 74
52,.36
102.,75
32.59
314 • 08 211 .72
48..53
102 .36
67,, 16
59,,91
1966
27.• 96
49,• 06
2 2. 89 101 ,60
104 .77
32.84
•
47..42
319 .04
.
66,,37
1967
219 . 17
29.• 76
24., 16
97 ,62
,
330 »2 2
65.,23
52 .95
,
44. 54
111 .04
33.63
70,>71
71 .14
,
232 .34
66 ,57
<
1968
349 . 00
30.• 62
90,,49
38. 95
33.43
30.• 43
116 .66
77,• 97
1969
358 .81
234 .03
65,, 22
75;>95
32.• 45
80,. 11
34,• 23
124 . 78
34.78
33. 32
34.• 27
134 • 80
1970
373 • 61 238 . 80
63,,92
95,. 17
61 • 80
.
25. 88
36.08
,
39.• 85
811 8 4
89,,42
249 .68
21 ,36
40:1. .51
62,, 19
42.• 83
53.• 33
35.• 81 106,.94
1971
151 .83
37.81
44.• 10
•
39.24
60,,76
981 25
37.• 55 u:-.,.39
48,• 04
18.. 36
.1.972
430 • 65 261 . 68
168 .97
45.• 16
.
41 .74
266 . 62
58,,26
38.,74
120,• 42
42.• 91
16.. 09
.1.973
457 . 67
103.,30
191 .04
57,• 19 110.,27
1.27,.67
34,,34
203 .85
42.81
1974
272 .28
46.• 89
476 . 14
40.,50
12,.61
60,,45
39.55
41 ,. 91
1975
534 • 53 323 • 11
135.,42
15 ,23
.1 ,
36.,46
11 .28
211 .41
46.• 81
39,• 57
35.94
64,.06
,77
1 94,
9.,99
222 .28
396 .28
40.,82
,94
49 • 19
.
1976
618 .57
161.
438 • 48
64,,42
53.• 75
197?
680 .66
158.,83
235,,70
242 . 18
35.58
36., 22
43.• 96
10 .02
63,,85
264,,99
55.• 17
752 • 28 480 * 31
33., 55
54.,35
1.1. ..31
271 .97
36 . I 5
19 78
161,, .1.4
1979
>04
54.• 36
809 • 35 507 . 83
62,,74
32., :i. 3 2 7 6,
68.• 61
13. 5.1.
37*26
163., :l. 7
301 .53
300,,37
14..08
.25
• 2 2 194., 74
33,,79
52 • 13
<
81 • 14
.
307 .31
34/78
1980
883 • 56 576
65,
349 54
670 .45
33.r 84
52.• 14
94 • 03
.
31 .37
976 .93
68,• 63 226,,88
306 .47
1 4.02
1981
....
....
1982
198 C U
Rs
1) IT

I..I

*

Subcommittee on




i

:I.

Domestic Monttoiy Policy




I N T E R E S T

RATES




MONTHLY AVERAGE OF WEEKLY AUCTION AVERAGE




YEARLY AVERAGE OF MONTHLY

DATA




YEARLY AVERAGE OF MONTHLY

DATA




FEDERAL AND FEDERALLY-ASSISTED
B O R R O W I N G F R O M T H E PUBLIC
-200

150

100

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982e1983e
Fiscal Years
J / Adjusted for Federal and sponsored agency purchases of guaranteed obligations.
2 / C o n s i s t s largely of Federal Financing Bank borrowings from Treasury.
3/Adjusted for changes in cash balance and other means of financing.
e estimate

aPmi 27.19828




TREASURY FINANCING REQUIREMENTS
January - March 1982

Uses

52V4

l$Bil.

Sources

50
Coupon Maturities!

4 Coupon Refunding
^ State and Local

40

V4

Savings Bonds

11 Cash Deficit
Increase
in Cash
Balance

Ofhct at the Secretary oi Hit TrMMiry
Ofhct of Government Financing

Foreign Nonmarketables

30

20
Net Market Borrowing
10

April 27. 1982-20




TREASURY F I N A N C I N G REQUIREMENTS
$Bil.
40

April - June 1982

1

1

Uses

|

J

Sources

_37V4

1

30
Coupon Maturities

Coupon Refunding

20

10

Bonds
1 (Jov't Series^ W S g ^ T
Foreign \ pUbiiC Series
te^ElgB
Nonmarketables^^HB""
y4
State and Local
ICash Deficit

1/4

Net Market
Borrowing

. H H

Increase in Cash Balance
J / A s s u m e s $ 1 8 billion cash balance June 30, 1982.

OfKnoftheSecretaryofttwTrMMiryApril 27. 1982-6




NET MARKET BORROWING
April - June 1982

15V2

Total
Cash Management Bills:
April Issues
April Retirements
June Maturities
Net Borrowing

8
—10
—3
—5
»

Other Net Borrowing:
Done^
7 year note
2 year note
Regular bills

2 0 !/a

^

3%
1%
V2

Total
To Be Done

5
15 V2

J 7 Issued or announced through April 23, 1982.
OfKnoftheSecretaryofttwTrMMiryApril 27. 1982-6




TREASURY O P E R A T I N G C A S H B A L A N C E
Semi-Monthly

-15

Apr. May

Jun. Jul.

Aug. Sep.
1981

Oct. Nov. Dec. Jan.

u Assumes refunding of maturing issues with
the exception of cash management bills.

Feb. Mar. Apr
1982

May

Jun




T R E A S U R Y N E T M A R K E T BORROWING 1 7
Calendar Year Quarters

IV

I

II III
1979

IV

I

II III
1980

IV

I

II III
1981

IV

I
1982

-20

1/ Excludes Federal Reserve and Government Account Transactions.
Ai..- 27. 1982 5

T R E A S U R Y N E T B O R R O W I N G F R O M N O N M A R K E T A B L E ISSUES
$Bil.

10
H H Savings Bonds
Kgsa State & Local Series
• I Foreign Nonmarketables

8
6
4

2.2

2

-.9

-1.7 -1.4

-6.6
I

II

III

1978

IV

I

II

III

1979

IV

_L

I
6

OfKn of the Secretary ofttw TrMMiry




II

III

1980

IV

I

II

III

1981

IV

I lle
1982

estimate
April 27. 1982-6




QUARTERLY C H A N G E S IN F O R E I G N A N D I N T E R N A T I O N A L
H O L D I N G S O F PUBLIC DEBT S E C U R I T I E S

I

II

III

1978

IV
y

OKK* & the Secretary ol the Treasury

I

III

1979

IV

I

II

III

1980

IV

I

F.R.B. Purchases of marketable issues as agents for foreign
and international monetary authorities for new cash.

2/ Partly estimated.

II

III

1981

IV

12J

1982




S H O R T T E R M INTEREST RATES
Monthly Averages

Ofliot at ttw Secretary at ttw Treasury
Office of Government Financing

OfKnoftheSecretaryofttwTrMMiryApril 27. 1982-6




SHORT TERM INTEREST RATES
Weekly Averages

Oflice of the Secretary <* the Treasury
Office ol Government Financing

A-ir.i 27 1982 13




L O N G M A R K E T RATES
Monthly Averages

00

Treasury 20-Year
I
/
I
20-Year
••—•••• |
Municipal Bonds
T M I I I II 1 I 1 I I I II 1 II i i i I I II I i I I I I i I I i i I i I I i I M I i i i i I
1982
1981
1979
1980
1978
OfKnoftheSecretaryofttwTrMMiryApril 27. 1982-6




INTERMEDIATE AND LONG MARKET RATES
Weekly Averages

July

Office ol (he Secretary ol the Treasury
Office ol Government Financing

Aug

Sep
Oct
1981

Feb
Mar
1982
A.;ril 27. 1982 14




MARKET YIELDS O N G O V E R N M E N T S
Bid Yields

Years to Maturity
Office ol (he Secretary ol the Treasury
Office ol Government Financing

A.;ril 27. 1982 14




CUMULATIVE NET C A S H F L O W IN S A V I N G S BONDS 1 7

Ottice of the Secretary oI the Treasury

1/ Cash sales less redemptions
e April 1982 partly estimated




USE O F A U T H O R I T Y T O ISSUE T R E A S U R Y B O N D S
W I T H INTEREST R A T E O V E R 4Va P E R C E N T

Office ol (he Secretary ol the Treasury
Office ol Government Financing

A.;ril 27. 1982 14




AVERAGE L E N G T H O F T H E M A R K E T A B L E DEBT
Privately Held

Office ol (he Secretary ol the Treasury
Office ol Government Financing

A.;ril 27. 1982 14




PRIVATE HOLDINGS O F TREASURY M A R K E T A B L E DEBT
BY MATURITY

1971

1972

1973

1974

1975
1976
1977
As of December 31

1978

1979

1980

1981

O f h n ot ttw Sacrttary of tlw Traawiy
April 27. 1982-2




PRIVATE H O L D I N G S O F TREASURY M A R K E T A B L E DEBT
BY M A T U R I T Y
I

I Coupons [ J over 10 yrs ^ 1 - 2 yrs
12-10 yrs
Eg 1 yr & under

Bills •

11
m

llllll

H

1971 1972

Office ol (he Secretary ol the Treasury
Office ol Government Financing

1973 1974

1975 1976 1977 1978
As of December 31

26

1979

1980

1981 Mar 82

A.;ril 27. 1982 14

OWNERSHIP OF MATURING C O U P O N ISSUES
May 1 9 8 2 - S e p t e m b e r 19821/
(In Millions of Dollars)

Total
Privately Commercial
Banks
Held

Maturing Issues

7%
8%
9 1/4%
9 3/8%
8 1/4%
8 5/8%
8 7/8%
8 1/8%
9%
11 1/8%
8 3/8%
11 7/8%

Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.
Nt.

Savings Institutions
State &
Other
LongIntermediate- Local Corpora- Private Foreign
General tions Domestic
term 2/
term 2/
Funds
Holders
Investors
Investors

2547
1296
2515
3858
2475
4436
4213
1754
2513
4521
2423
4555

TOTAL
U

794
427
1097
1311
925
1057
1131
618
901
1918
1191
1417

65
19
23
13
7
15
52
96
27
61
7
112

353
207
138
280
188
301
274
206
282
519
228
338

225
48
66
191
151
411
760
194
142
574
220
368

402
2
*

37,106

5/15/82
5/15/82
5/15/82
5/31/82
6/30/82
6/30/82
7/31/82
8/15/82
8/15/82
8/31/82
9/30/82
9/30/82

12,787

497

3,314

3,350

141
14
108
261
55
5
44
150
76

262
586
856
1187
835
894
864
575
483
710
292
1095

446
7
335
735
355
1650
871
10
673
695
335
1149

1,258

8,639

7,261

Amounts for investor classes are based on the February 1982 Treasury Ownership Survey.

2/ Includes State and local pension funds and life insurance companies.
3/ Includes casualty and liability insurance companies, mutual savings banks, savings and loan
associations, and corporate pension trust funds.
Office of the Secretary of the Treasury
Office of Government Financing




*

|_eSS t h a n $ 5 0 0 t h o u s a n d .

.
, „ 1 Q _ , 1Q
April 2 7 , 1 9 8 2 - 1 8




TREASURY M A R K E T A B L E MATURITIES
Privately Held. Excluding Bills and Exchange Notes
$Bil

:

1987

f6
5.5

n
N

%

I

i.b

1988
->

I

4

•3 4

2.3

I

I

1989
3 3

J

3.8

C
C
C
C

2.2

1990

5.1
2.6

1.0

1991
2.5

2 4

• .
/

ffl

i

1992

2.7

2.5

I
J
H

F

M

A

M

J

J

Securities issued prior to 1980

{

S

O

N

D

j j ^ N e w issues calendar year 1981

New issues calendar year 1980

A

.1 Issued or announced through April 23, 1982

Alii.! 21. 1982 10




TREASURY M A R K E T A B L E M A T U R I T I E S
Privately H e l d , Excluding Bills a n d E x c h a n g e N o t e s
$Bil.
>—
2003
19 93
»

$Bil
4

2_
~

2.2
•

1.9

2004

2.9

1.4
•

_4

1.7

2005

1.4
•

2006
i

19 95

2.7

i

•

19 94

1
_

1

1.4
•

S3
H

t~

1.4

1

1996

—

I

-

•S
2.2

>

i

1

"

1

20 01
_

J

!
11

M

| |

4.5

!

l

20 12

2002

1.8

m
F M

I

if20

1.7

m

i

g

a

i

1.7

1.5

4.2

1.9

1.8

r

|

3.4

1

I
2.5

•

2 00 9

2010

3.9

!
•

.7

3.6
•

1.3
•

i

1998
I
1999
I
20 00

-

1.2
•

i

20 08

i

1997

—

2007

2.7

»

1

A

M

J
m

J

A

S

O

N

D

Securities issued prior to 1980

jjjjjjj New issues calendar year 1980

J

F

M

A

M

J

J

A

S

M f a New issues calendar year 1981
K ' v l Issued or announced through April 28. 1982

O

N

D




AGENCY MATURITIES^
Privately H e l d
SBil.r

.8 ^
• •

i l
1994

.8
•

J5

1995
.1

1998

1999

_1 JL iL _i
2002

1993

1992

1991

1990

J_

1997

1996

A±

A

2000

2004

2003

2001

2005
Oi

*

-1

2007

2006

2010

£

2008

A
—

_1

.2

2009
—

-3

2012

2011

A

2013

.4

I

il

III IV

I

II ill IV

I

II III IV

I

II III IV

2015

2014
I

II

III IV

I

II

III IV

2017

2016
I

II

III IV

I

II

III IV

Calendar Y e a r s Q u a r t e r l y
-u Securities issued through March 31, 1982
* Less than $50 million.
OfKnoftheSecretaryofttwTrMMiryApril 27. 1982-6




N E T N E W M O N E Y IN A G E N C Y F I N A N C E , Q U A R T E R L Y
Privately Held
$Bil.i—

FCA

4
3

kdulL

2-

GNMA

Mortgage Backed Securities

I

II III IV

1978

I

II III IV

1979

I

II III IV

1980

I

II III IV

1981

I

I

II III IV

1982

* L e s s than $ 5 0 million.

e

II III IV

1978

I

II III IV

1979

II III IV

1980

Partly estimated.

J / Includes F H L B discount notes, bonds, and F H L M C discount notes, debentures,
certificates, mortgage-backed bonds, and mortgage participation certificates.

I

II III IV |e II III IV

1981

1982

197

AI'I'KNDIX

WALTER E. FAUNTROV O.C.. CHAIR
PARREN J. MITCHELL. MO.
STEPHEN L. NEAL. N.C
DOUG BARNARD. JR . OA.
HENRY REUM. WIS
JAMES J. BLANCHARO. MICH.
CARROLL HUIIARO. JR.. KY.

1)

u.s. h o u s e o f r e p r e s e n t a t i v e s

HZ-17*. ANNEX NO. t
WASH I NOTON. D.C. I09IS
(Ml) tt»-71l9

GEOROE HANSEN. IDAHO
RON PAUL. TEX.
BILL McCOLLUM. FLA.
BILL LOWERY. CALIF.
EO WEBER. OHIO
JAMES K COYNE. PA

S U B C O M M I T T E E O N DOMESTIC M O N E T A R Y POLICY
OF THE

C O M M I T T E E ON BANKING. FINANCE AND URBAN AFFAIRS
NINETY-SEVENTH CONGRESS

WASHINGTON. D.C.

20515

MEMORANDUM
T1.1;

Members
S u b c o m m i t t e e on D o m e s t i c

FROM:

W a l t e r E.
Chairman,

Fauntroy
S u b c o m m i t t e e on D o m e s t i c M o n e t a r y

DATF :

Marc.fi 1 8 ,

19J7

SUBJECT:

D e b t Management by t i e D e p a r t m e n t o f T r e a s u r y
H e a r i n g s on T u e s d a y , M a r c h 2 3 , 1 9 8 2 - 1 0 : 0 0 a . m . ;
Wednesday, March 2 4 , 198? - 1 0 : 0 0 a.m.
2 2 2 2 RH0B

Monetary

Policy

Policy

INTRODUCTION
On M a r c h 9 , 1 9 8 2 , t h e o u t s t a n d i n g n a t i o n a l d e b t o f t h e U n i t e d
States totaled $1,046 t r i l l i o n .
The c u r r e n t t e m p o r a r y d e b t c e i l i n g i s
now $ 1 , 0 8 0 t r i l l i o n .
T n e r e a r e i n d i c a t i o n s t h a t t h e n a t i o n a l d e b t may
e x p a n d b y a n a d d i t i o n a l $ 5 5 4 b i l l i o n - - a 50% i n c r e a s e — b e t w e e n now and
1985.
T h a t e x p a n s i o n i . m o r e t n a n t h e t o t a l d e b t a c c u m u l a t e d b y the?
U n i t e d S t a t e s up t o 197-' .
A t t n a t t i m e , t h e n a t i o n a l d e b t was $ 5 3 4 . 5 3
billion.
From t h a t t i m e u n t i l 1 9 8 1 , t h e n a t i o n a l d e b t grew an a d d i t i o n a l
$442.40 B i l i i o r i for a t o t a l of $976.93 b i l l i o n in 1981.
This y e a r , the
d e b t i s e x p e c t e d t o grov^ a n a d d i t i o n a l $ 1 2 0 b i l l i o n .
W h a t e v e r o n e may b e l i e v e a b o u t , t h e i m p a c t t h a t a c u r r e n t d e f i c i t
may h a v e o n i n t e r e s t , r a r e s , e c o n o m i c a c t i v i t y , p o t e n t i a l b o r r o w e r s , o r
ur-on i n f l a t i o n s , o r r e c e s s i o n s , t h e r e a l i t y o f t h e n a t i o n a l d e b t c o m p e l s
o n e t o c o n s i d e r how i t i s t r e a t e d by t h e g o v e r n m e n t .
L i k e any d e b t , i t
hds a m a t u r i t y , i t has an i n t e r e s t r a t e , i t must be s o l d , r e g i s t e r e d ,
r e f i n a n c e d , and h e l d w i t h i n t h e e s t a b l i s h e d l i m i t s o f t h e law as t o
U n l i k e other debt, however, t h i s is the
a m o u n t , m a t u r i t y , and c . ; s t .
d e b t o f t h e U n i t e d S t a t e s . I t commands t h e h i g h e s t r a t i n g s , i t i s t h e
most, s e c u r e , a n d i t w i 1 : a l w a y s b e s o l d o v e r a n y o t h e r c o m p e t i t i o n i n
tne market.
Whether i t is s o l d a t t h e b e s t terms f o r t h e t a x p a y e r s of
t h e c o u n t r y i s v e r y g e n e r a l l y d i f f i c u l t t o a s c e r t a i n s i n c e i t h a s no
1, i t v .
p c n j d l m qua
M o r e i m p o r t a n t l y , no o n e e l s e b o r r o w s o n t h e same
< a 1 e.
F n e r e t o v e , m a n a g e m e n t o f t n e d e b t c a n h a v e p r o f o u n d e f f e c t s on
tne marketplace
One n e e d o n l y t o w a t c h t h e a n n o u n c e m e n t s o f T r e a s u r y
sales.
The t o t a l amount o f i n t e r e s t p a i d , and t h e t o t a l c o s t s i n p r o c e s s i n g
t n e s i i ; t • a n d a d e m p t i o n of t h e s e s e c u r i t i e s , h a s now become a m a j o r i t e m
o" t h e B u d g e t o : t n e Urn t e a S t a g e s a n d a m a j o r c o m p o n e n t o f t h e Gros::
Nation,-1 P r o f i t ' e q u a l i n g a p p r o x i m a t e l y 2.34': i n FY-1981 vs. *.4?:; i n

T h e two c a y s o f i . e a r i n g s a r e i n t e n d e d t o e x p l o r e some o f t h e
i s s u e s a s s o c i a t e d w i t h the management o f t h e d e b t .
Included in this
i n q u i r y a r e such m a t t e r s as t h e t i m i n g o f d e b t s a l e s , t h e m a t u r i t y o f
v a r i o u s i s s u e s and t h e r e a s o n s t h e r e f o r e , t h e use o r n o t o f v a r i o u s
k i n d s o f d e v i c e s such as c a l l s , coupons and v a r i a b l e r a t e s .
Ownership
o f t h e d e b t i s a l s o o f some c o n c e r n s i n c e r e l i a n c e o n f o r e i g n b u y e r s c a n
i r p i n g e ori t h e n a t i o n a l s e c u r i t y i n t e r e s t .
F i n a l l y , there is the r o l e
w n i c h v a r i o u s a d v i s o r y g r o u p s and d e a l e r s have on t h e d e c i s i o n s o f t h e
T r e a s u r y t h a t a r i s e fron- t h e i r a d v i c e .
No o n e h a s s u g g e s t e d t h a t t h e
a d v i c e p r o v i d e d by t h e s e g r o u p s i s f a u l t y o r t i n g e d i n any way.




198
Small mistakes, however, can be costly to all parties. There is very
little way of measuring the usefulness of their advice since the scale
is beyond the pale of any other borrower.

1

The Materials provided herein are intended only as a guide to
assist Members in fashioning their own lines of inquiry. They are not
complete nor are they definitive of the issue. There is a paucity of
published materials and suprisingly, there is little even in the way of
considered scholarly materials. It appears that those who are knowledgeable
in this field foresake writing about the subject to become participants
in what has been characterized as a most rewarding field of endeavor.
DISCUSSION OF TERMS USED
Throughout this inquiry, one will periodically find reference
made to various kinds of Treasury securities. References to various
securities are also noted on the attached graphs and tables. There are
essentially two kinds of securities: Marketable and Non-Marketable.
The differences turn, essentially, on whether or not the securities can
be resold into the secondary market. Within the category of Marketable
Securities, there are Treasury Bills, Coupon Issues (no longer issued),
Treasury Notes, and Bonds.
Marketable Treasury securities may be exchanged at any Federal Reserve
Bank or branch for an equal amount of any authorized denomination of the
same issue. Bearer bonds are interchangeable with registered bonds.
However, all Treasury bills and a large fraction of all other marketable
securities are now in "book entry" form. That is, they exist as computer
entries only and no paper securities are issued.
Marketable Treasury securities are acceptable to secure deposits
of public moneys. They are also acceptable as security for notes discounted
at Federal Reserve Banks. Income is subject to all Federal income
taxes, but is exempt from state, municipal, and local income taxes.
NONMARKETABLE SECURITIES
Non-marketable securities include: (1) United States Savings
Bonds, which are currently designated as EE and HH; (2) retirement plan
bonds, which have been issued by the Treasury since 1963; (3) individual
retirement bonds, which have been issued by the Treasury since 1975;
(4) government account series which are sold by the Treasury directly
to government agencies, trust funds and accounts; (5) depository bonds
which are no longer issued although $11 million were still outstanding
in late 1980; (6) state and local government series, which are issued
to state and local governments that wish to reinvest the proceeds of
advance refundings of their tax-exempt debt; and (7) the foreign series,
which are foreign-currency-denominated securities offered to residents
of foreign countries.
MARKETABLE SECURITIES
Treasury Bills
T-bills are issued on a discount basis. That is, they are sold
at a dollar price less than their redemption value at maturity, which is
the difference, or discount, constituting the payment of interest. When
T-bills are to be offered, the Treasury issues a notice with respect to
the new offering inviting tenders under competitive and non-competitive
bidding.




199
In the Lei: e of competitive tenders, the price must be expressed on the
basis of 100, with not more than 3 decimals (e.g. 95.615). Non-competitive
tenders without stated price are accepted in full at the average price
of accepted competitive bids. Since April 1974, the Federal Reserve has
been allowed to bid noncompetitive^ to "roll over" maturing bills owned
by itself or its governmental customers (mainly foreign monetary authorities).
Such holdings have averaged about $3 billion each week through 1979, a
sizable amount when measured against the total of nearly $7 billion of
bills offered each week in the 1979 auctions. In 1981, Fed purchases
increased to about $8 billion out of $20 billion of bills offered each week.
3-month
payment
earlier
late in

and 6-month Bills normally are auctioned weekly on Mondays, with
due the following Thursday when issues sold three and six months
mature. The amounts to be auctioned are ordinarily announced
the afternoon on the Tuesday preceeding the auction.

52-Week Bills are auctioned every 4 weeks, presently on a Wednesday with
payment due the following Tuesday when the issue sold 52 weeks earlier
matures. The size of the offering is usually announced in the late
afternoon on the Thursday preceeding the Wednesday auction.
Cash Management Bills are issued at irregular intervals with maturities
ranging from a few days to about 6 months. Typically they are issued
early in the month when government spending tends to be the heaviest,
and they usually mature shortly after one of the major mid-month tax
receipts dates in March, April, June, September, or December. Cash
management bills are used to raise new cash and are sold only in large
Dlocks, with minimum tenders of $10 million for the short-dated issues
and $1 million for bills with longer maturities. Cash management bills
are jsuai y announced only a few days before their sale.
COUPON ISSUES
Certificates, notes, and bonds may be offered to the public for
cash subscription or in exchange for outstanding or maturing securities.
Offerings are generally announced 1 to 3 weeks in advance of the issue
date. The announcement designates a deadline through which the books
are to be open for entry of subscriptions at the offering price set by
the Treasury or for the submission of bids if the price is to be set by
auction. Since over-subscriptions on fixed-price offerings are the
rule, allotments of securities are made on a percentage basis. The
Treasury may grant preferential or full allotments to certain investor
classes: this is generally done for the Federal Reserve and other
domestic ana foreign governmental subscribers.
Treasury Notes
Treasury notes may be issued with a maturity of not less than 1
year nor more than 10 years. The shorter notes are frequently purchased
by non-financial corporations. In recent years, all quarterly Treasury
refunding operations—in February, May, August, and November--have
included one or more note offerings
Two-Year Notes are auctioned a week or so before the end of each month.
They are dated and mature as of the month's end. The amount to be sold
usually is announced about a week before the auction.
Three-Year Notes are not issued in a regular cycle, but are frequently
included in the Treasury's regular quarterly refundings. These occur in




200
February, May, August, and November. The terms for these offerings are
usually announced on the last Wednesday of the preceeding month.
Four-Year Notes are offered for sale in the last month of each quarter
and are dated and mature at month's end.
Five-Year Notes were first offered on a more or less regular basis
beginning in 1976. They are usually offered in the first month of each
calendar quarter except January.
Seven- to Ten Year Notes are typically used as an option in the quarterly
refunding packages, along with a long-term bond and, for large offerings,
a note maturing in about 3 years. The Treasury selects the particular
maturity to accomodate requirements and policies at the time of refunding.
Treasury Bonds
Treasury bonds may be issued with any maturity but generally have
an original maturity of over 10 years. Recently the Treasury's quarterly
refundings have included auction sales of new bonds. Treasury bonds
outstanding and available in the market cover a wide range of maturities.
There have recently been issues with maturities of 15 or 30 years, and
in generally smaller amounts than notes. Since July 1978, 15-year bonds
maturing at mid-month have been offered for payment early in the first
month of each quarter. In addition, every recent quarterly refunding
has included a bond with a maturity up to 30 years, but callable 5 years
earlier.
OTHER SECURITIES
A third category of securities are those which are issued by
Agencies of the United States. These are not direct obligations of the
Treasury, but in one way or another involve federal sponsorship or
guarantees. These issues have continued to increase in recent years.
The enlarged supply has been absorbed readily by the investing public,
which recognizes the investment quality of these obligations and their
sizable secondary markets. The following is a list of some of the most
important agency securities currently issued to the public:
Ordinary Debt Issues:
Chrysler Corp. Loan Guarantee Board
Farm Credit System
Federal Home Loan Bank Board
Maritime Administration
World Bank
Mortgage-Backed Issues:
Federal Home Loan Mortgage Corp.
Government National Mortgage Assoc.
Tax-exempt Instruments:
Department of Housing and Urban Development project notes
Like Treasury obligations, these securities generally are issued under
the authority of an Act of Congress and are exempt from registration
with the SEC. A few are backed by the full faith and credit of the




201
United States, many are guaranteed by the Treasury or supported by the
issuing agency's right to borrow from the Treasury.
AUTHORITY FOR DEBT
Treasury securities are issued under authority of the Second
Liberty Bond Act of 1917, as amended. Section 21 of the Act limits to
$400 billion the outstanding total face amount of obligations issued
under authority of the Act or guaranteed as to principal and interest by
the United States. The $400 billion debt limit has been raised many
times, but historically Congress has made the increases temporary. The
ceiling reverts back to $400 billion after a certain date in the absence
of new legislation. The current "temporary" limit is $1,080 trillion. As
of March 9, 1982, outstanding debt subject to the limit totaled $1,046
trillion.
Under the Public Debt Act of 1942, the Treasury has wide discretion
in determining the terms on marketable securities. They may be sold on
a competitive or other basis, they may be issued on an interest-coupon
or discount basis, or in some combination, at whatever prices the Secretary
of the Treasury may prescribe. There is no statutory limit on the
coupon interest rate that may be paid on bills, certificates, or notes.
There is a long outstanding limit of 4%% on the coupon rate for Treasury
bonds, but Congress has provided certain exemptions from that limit in
recent years. Currently, the Treasury is allowed to have outstanding up
to $70 billion of publicly held bonds exempt from any coupon rate
limit. 0*" this authority, $69.97 billion was exercised as of March 8,

1982.

HISTORY OF THE DEBT
The first major growth of the U.S. Government debt occurred
during World War II. At the end of fiscal year 1941, the debt was $44
billion. In February 1946, it stood at $280 billion. Subsequent reductions
brought the figure down to $?51 billion in April 1949, but since then
the trend has been largely upward.
A sdrge volume of the debt issued during World War II was long
term. The average length of the marketable interest-bearing public debt
peaked at 10 years and 5 months in June 1947. From the end of the War
until 1953, financing operations involved only issues maturing in less
than 10 years. Thus by 1953. the average maturity was down to 6 years.
Several issues of bonds maturing in more than 10 years were offered from
1953 tnrouqh 1959, but the tctal sold was only $10 billion.
Although concentration of Treasury debt in short-term issues was
a matter c* concern, it proved difficult to achieve any major extension
into long-term securities. Funds for investment in long-term government
securities were available only in limited amounts, and economic and
market conditions generally were not favorable to large-scale sales of
long-term bonds for cash..
In the late 1950s and thereafter, moreover,
market yields moved above the the statutory limit of
coupon rate for
Treasury conds, confining the Treasury to the issuance of notes (then
subject to ; statutory maximum maturity of 5 years), certificates, and
;

bills

Although refusing to relax the 4^% ceiling, Congress did enact
legislation in 1959 that facilitated a series of advance refunding
offers by the Treasury beginning in 1960. In these refundings, the
Treasury offered holders of various issues, most of which still had
years to run until maturity, the opportunity to exchange their holdings




202
for longer-dated bonds at a higher rate of return. Thus massive amounts
of long-term obligations were created with a minimum impact upon market
prices through the use of an exchange instead of a conventional sale and
refunding. ? A total of $67.8 billion was placed in 11 such advance
re.fundings during the 1960-65 period, with $54.4 billion representing
issues with more than 5 years to.maturity. These operations brought a
significant lengthening of the average maturity of the marketable debt.
After mid-1965, however, market interest rates rose so far above the
coupon rate maximum that further long-term refunding became impossible.
In 1967, Congress lengthened the maximum maturity of notes from 5
years to 7 years. Since notes are not subject to the
ceiling, this
in effect permitted the Treasury to sell securities of up to 7 years
maturity freely, and it made active use of the privilege. The maximum
maturity of new notes was extended to 10 years by legislation enacted in
March 1976. However, for the 6h years between 1966 and 1971, the Treasury
could not issue any securities with a maturity of longer than 10 years.
In 1971, the Treasury was authorized to issue up to $10 billion in bonds
exempt from any coupon interest rate limitation. Thus the average
maturity of the privately held debt, which mainly shortened from 1967
until the end of 1975, when it reached a low of 2 years and 5 months
began to then rise until late in 1979. However, since that time, it has
been again contracting somewhat. The authority to issue bonds exempt
from the
ceiling has been increased a number of times since the
initial $10 billion in 1973. In 1976, it was increased to $12 billion.
In 1977, it was increased to $15 billion; in 1978 to $30 billion; in
mid-1979 it was increased to $40 billion and later to $50 billion. In
October, 1980, it was increased to its present level of $70 billion.




203
APPENDIX E

FEDERAL
RESERVE BANK OF
NEW YORK

THE DEALER MARKET FOR UNITED
STATES GOVERNMENT SECURITIES




REPRINTED FROM QUARTERLY REVIEW
WINTER 1977-78 VOLUME 2

204

The Dealer Market For United
States Government Securities
T h e market for United States G o v e r n m e n t securities
o c c u p i e s a c e n t r a l p o s i t i o n in t h e n a t i o n ' s f i n a n c i a l
system. T h e market helps the Treasury finance the
Government debt and provides the Federal Reserve
w i t h a n e f f e c t i v e m e a n s of i m p l e m e n t i n g m o n e t a r y p o l icy. W h i l e t h e s a f e t y of G o v e r n m e n t s e c u r i t i e s is a
f u n d a m e n t a l f e a t u r e , p e r h a p s t h e i r m o s t vital q u a l i t y
to i n v e s t o r s is t h e i r l i q u i d i t y — t h e a b i l i t y t o t r a n s f o r m
t h e m into c a s h q u i c k l y a n d a t l o w c o s t . T h e m a r k e t is
a n o v e r - t h e - t e l e p h o n e o n e in w h i c h d e a l e r f i r m s s t a n d
r e a d y t o b u y a n d s e l l f r o m a w i d e r a n g e of p u b l i c a n d
p r i v a t e p a r t i c i p a n t s . T h e d y n a m i c i n t e r a c t i o n of all
p a r t i c i p a n t s e n h a n c e s t h e a t t r a c t i v e n e s s of T r e a s u r y
s e c u r i t i e s a n d t h e i m p o r t a n c e of t h e m a r k e t itself.
T h e d e a l e r m a r k e t is a n e f f e c t i v e c o n d u i t for t h e
d i s t r i b u t i o n o f n e w G o v e r n m e n t s e c u r i t i e s to investors.
T r e a s u r y financing requirements h a v e g r o w n signifi c a n t l y in r e c e n t y e a r s , o w i n g t o a s e r i e s of i n c r e a s e d
G o v e r n m e n t d e f i c i t s a n d t o t h e n e e d for r e f i n a n c i n g
a h e a v y s c h e d u l e of m a t u r i t i e s . S i n c e 1 9 7 4 , d e a l e r s
h a v e initially b o u g h t slightly m o r e t h a n 4 0 p e r c e n t of
the securities competitively auctioned to the public by
the Treasury. Moreover, the active role that the dealers
h a v e t a k e n in m a k i n g a s e c o n d a r y m a r k e t , i.e., b u y i n g
a n d s e l l i n g o u t s t a n d i n g issues, h a s e n a b l e d i n v e s t o r s
t o u s e G o v e r n m e n t s e c u r i t i e s m o r e r e a d i l y in c a r r y i n g
out their portfolio strategies.
Federal Reserve open market operations are undert a k e n w i t h d e a l e r s in t h e m a r k e t t o i m p l e m e n t m o n e t a r y p o l i c y . T h e M a n a g e r of t h e S y s t e m O p e n M a r k e t
A c c o u n t buys a n d sells securities on a t e m p o r a r y or
o u t r i g h t b a s i s e i t h e r to a u g m e n t ( t h r o u g h p u r c h a s e s )
o r t o r e d u c e ( t h r o u g h s a l e s ) t h e r e s e r v e s a v a i l a b l e to
m e m b e r b a n k s . T h e s e o p e r a t i o n s , c o n d u c t e d at t h e
T r a d i n g D e s k of t h e F e d e r a l R e s e r v e B a n k of N e w




York (FRBNY), have an important bearing on overall
e c o n o m i c activity. T h e y h e l p to d e t e r m i n e t h e g r o w t h
of m o n e t a r y a g g r e g a t e s a n d t h e a v a i l a b i l i t y of c r e d i t ,
a n d t h e y i n f l u e n c e t h e t r e n d of i n t e r e s t rates.
O p e n m a r k e t o p e r a t i o n s a r e a l s o u s e d to c o u n t e r
s h a r p f l u c t u a t i o n s in b a n k r e s e r v e s , w h i c h a r i s e f r o m
s u c h f a c t o r s a s c h a n g e s i n t h e p u b l i c ' s d e m a n d for
c u r r e n c y or in t h e s i z e of T r e a s u r y c a s h b a l a n c e s
h e l d at F e d e r a l R e s e r v e B a n k s . T h e F e d e r a l R e s e r v e
s e r v e s a s t h e fiscal a g e n t f o r t h e T r e a s u r y a n d a s
a g e n t f o r G o v e r n m e n t a n d f o r e i g n o f f i c i a l institutions
in t h e m a r k e t , b u y i n g a n d s e l l i n g T r e a s u r y s e c u r i t i e s
for t h e m . A c t i v i t y a t t h e T r a d i n g D e s k h a s g r o w n s i g nificantly in r e c e n t y e a r s , m a i n l y in r e f l e c t i o n of
g r e a t e r f l u c t u a t i o n s in o t h e r f a c t o r s a f f e c t i n g r e s e r v e s
a n d t h e i n c r e a s e d p a r t i c i p a t i o n of f o r e i g n c e n t r a l
b a n k s in t h e m a r k e t . T h e e x p a n s i o n of t h i s a c t i v i t y
h a s a l s o c o n t r i b u t e d t o t h e g r o w t h a n d liquidity of t h e
secondary market.
T h e Treasury and the Federal Reserve closely
m o n i t o r d e v e l o p m e n t s in t h e m a r k e t . T h e T r a d i n g D e s k
at t h e F R B N Y c o n d u c t s r e g u l a r m e e t i n g s w i t h r e p r e s e n t a t i v e s of d e a l e r f i r m s a n d t h r o u g h o u t t h e d a y
r e m a i n s in t e l e p h o n e c o n t a c t w i t h t h e i r t r a d i n g r o o m s ,
r e c e i v i n g p r i c e q u o t a t i o n s a n d a s s e s s m e n t s of t h e
s t a t e of t h e m a r k e t . O f f i c i a l s of t h e T r e a s u r y a r e a l s o
in f r e q u e n t c o n t a c t w i t h t h e s e f i r m s a n d o f t e n solicit
their views on debt m a n a g e m e n t . T h e F R B N Y has rec e n t l y s t e p p e d u p its s u r v e i l l a n c e of d e a l e r firms. In
a d d i t i o n to o b t a i n i n g s t a t i s t i c a l r e p o r t s f r o m t h e m , it
visits t h e i n d i v i d u a l f i r m s t o g a i n f u r t h e r insight into
m a r k e t p r a c t i c e s a n d t o e v a l u a t e t h e a c t i v i t i e s of t h e
firms themselves.
T h e m a r k e t h a s e x p a n d e d s h a r p l y in t h e p a s t f e w
y e a r s , b o t h in o v e r a l l t r a d i n g a c t i v i t y a n d in t h e

F R B N Y Quarterly Review/Winter 1977-78

35

205
n u m b e r of d e a l e r firms. T h e g r o w t h of t r a d i n g , o u t r i g h t
b u y i n g a n d selling, r e f l e c t s t h e g r e a t e r s h o r t - r u n v a r i a t i o n in i n t e r e s t r a t e s in t h e 1 9 7 0 ' s a& w e d a s t h e l a r g e
i n c r e a s e in T r e a s u r y d e b t . T h e T r e a s u r y ' s d e b t m a n a g e m e n t p o l i c i e s , e s p e c i a l l y efforts t o e x t e n d t h e m a turity of t h e G o v e r n m e n t d e b t w h i l e m e e t i n g e n l a r g e d
b o r r o w i n g n e e d s , h a v e a l s o c o n t r i b u t e d to t h e m a r k e t ' s
development. There has also b e e n a growing willingn e s s o n t h e p a r t of p o r t f o l i o m a n a g e r s t o s e e k to a n t i c i p a t e interest r a t e m o v e m e n t s a n d t h u s to t r a d e m o r e
a c t i v e l y in t h e short run.
T h e e n t r y of a n u m b e r of n e w d e a l e r f i r m s into t h e
m a r k e t h a s s u b s t a n t i a l l y r e d u c e d t h e c o n c e n t r a t i o n of
t r a d i n g activity—i.e., t h e s h a r e of t r a d i n g activity a c c o u n t e d for b y t h e l a r g e s t f i r m s — a n d h a s to s o m e e x t e n t
altered the trading relationships a m o n g the dealer
firms. A m o r e i m p e r s o n a l a n d e v e n m o r e c o m p e t i t i v e
m a r k e t a t m o s p h e r e h a s d e v e l o p e d . At t i m e s , p a r t i c i p a n t s , in s e e k i n g g r e a t e r returns, m a y a l s o h a v e o v e r r e a c t e d to e v e n t s that c o u l d a f f e c t interest rates. This,
combined with the active trading, could have cont r i b u t e d to s h o r t - r u n volatility in interest rates.
Stock in trade: United States Treasury debt
T h e T r e a s u r y i n c r e a s e d its b o r r o w i n g s h a r p l y f o l l o w i n g
t h e o n s e t of t h e 1 9 7 3 - 7 5 r e c e s s i o n . T h i s m a i n l y r e f l e c t e d t h e l a r g e i n c r e a s e s in s p e n d i n g d u r i n g t h e
most s e v e r e b u s i n e s s d o w n t u r n in t h e p o s t - W o r l d
W a r II e r a . T h e p u b l i c t o o k o n a b o u t $ 1 3 0 billion net
of m a r k e t a b l e T r e a s u r y s e c u r i t i e s d u r i n g 1 9 7 5 a n d
1976, and the amount held outside the Federal Reserve
and United States G o v e r n m e n t accounts rose by app r o x i m a t e l y 7 0 p e r c e n t . T h e l a r g e i n c r e a s e s in t h e
d e b t in 1 9 7 5 a n d 1 9 7 6 c a u s e d t h e ratio of T r e a s u r y
d e b t to g r o s s n a t i o n a l p r o d u c t to e n d a l o n g d o w n w a r d
t r e n d a n d to rise for t h e first t i m e s i n c e 1958. Still, t h e
ratio of T r e a s u r y d e b t t o G N P in 1 9 7 6 w a s only a b o u t
o n e - t h i r d a s h i g h a s in t h e y e a r s f o l l o w i n g W o r l d
W a r II.
T h e T r e a s u r y w a s a b l e to float t h e b u l k of t h e
s i z a b l e i n c r e a s e s in its d e b t w i t h o u t m a j o r d i s r u p t i o n s
to t h e f i n a n c i a l m a r k e t s , p a r t l y b e c a u s e t h e e x p a n s i o n
of p r i v a t e c r e d i t d e m a n d s a n d i n f l a t i o n a r y e x p e c t a tions b o t h a b a t e d a m i d a m o r e m o d e r a t e p a c e of
e c o n o m i c g r o w t h . At t h e s a m e t i m e , t h e T r e a s u r y
a d o p t e d n e w t e c h n i q u e s to a i d its s a l e s efforts. Initially, it c o n c e n t r a t e d d e b t o f f e r i n g s in t h e m o s t liquid
a r e a s of t h e m a r k e t , raising a s u b s t a n t i a l a m o u n t of
n e w c a s h in bills d u r i n g 1975. ( F o r a d i s c u s s i o n of t h e
t y p e s a n d c h a r a c t e r i s t i c s of T r e a s u r y d e b t , s e e b o x o n
p a g e 3 7 . ) It t h e n t u r n e d h e a v i l y to t h e c o u p o n s e c t o r ,
p a r t i c u l a r l y t h e t w o - to f i v e - y e a r a r e a , a n d a l s o i s s u e d
l o n g - t e r m b o n d s a s t h ^ C o n g r e s s a c t e d to e a s e e x i s t i n g interest r a t e c o n s t r a i n t s o n n e w issues of t h e s e

36

F R B N Y Quarterly Review/Winter

95-448 o - 82 -




14

1977-78

securities. T h e greater reliance on the coupon sector
h e l p e d m a k e t h e s e s e c u r i t i e s m o r e liquid b y i n c r e a s ing t h e s i z e a n d n u m b e r of s e c u r i t i e s a v a i l a b l e for
trading.
T o f a c i l i t a t e its f i n a n c i n g o p e r a t i o n s , t h e T r e a s u r y
i n c r e a s e d t h e a m o u n t of i n f o r m a t i o n p r o v i d e d to t h e
p u b l i c o n t h e e x p e c t e d a m o u n t a n d c h a r a c t e r i s t i c s of
its f i n a n c i n g e a c h q u a r t e r . T h e T r e a s u r y b e g a n to e x p a n d t h e s c h e d u l e of r o u t i n e c o u p o n o f f e r i n g s so that
by 1 9 7 6 it w a s h o l d i n g m o n t h l y s a l e s of t w o - y e a r n o t e s
a n d q u a r t e r l y s a l e s of f o u r - a n d f i v e - y e a r notes.' M i d q u a r t e r r e f u n d i n g s of m a t u r i n g c o u p o n s e c u r i t i e s g e n e r a l l y c o n t a i n e d o f f e r i n g s of a t h r e e - y e a r note, a n
intermediate-term note, a n d a long-term bond. This
e v o l v i n g p a t t e r n h e l p e d to e x t e n d t h e m a t u r i t y of t h e
d e b t . S t a r t i n g in 1 9 7 0 , t h e T r e a s u r y c a m e to rely inc r e a s i n g l y o n a u c t i o n s to sell its c o u p o n issues, thus
letting t h e m a r k e t set t h e rate c o m p e t i t i v e l y . T h i s
t e c h n i q u e m a k e s p r i c i n g e a s i e r , b e c a u s e it a l l o w s
m a r k e t p a r t i c i p a n t s to a d j u s t t h e i r b i d d i n g to i n c o r p o r a t e e v a l u a t i o n s of l a s t - m i n u t e d e v e l o p m e n t s in t h e
c r e d i t m a r k e t s . N o t a b l e e x c e p t i o n s to this p o l i c y o c c u r r e d in 1 9 7 6 , w h e n o n t h r e e o c c a s i o n s t h e T r e a s u r y
used a fixed price and coupon subscription method
that l e d to s u c c e s s f u l s a l e s of v e r y l a r g e a m o u n t s of
seven- a n d ten-year notes.
Investors
T h e l a r g e s t i n v e s t o r s in G o v e r n m e n t s e c u r i t i e s a r e
f i n a n c i a l institutions w h o p r e f e r to h a v e v e r y liquid
a n d h i g h - q u a l i t y a s s e t s in their portfolios. D o m e s t i c
c o m m e r c i a l b a n k s o w n e d o v e r $ 1 0 0 b i l l i o n of G o v e r n m e n t s e c u r i t i e s in m i d - 1 9 7 7 ( T a b l e 1). B a n k s s h a p e
their p o r t f o l i o d e c i s i o n s in r e s p o n s e to p r o n o u n c e d
s e a s o n a l a n d c y c l i c a l f l o w s of f u n d s . For e x a m p l e , b a n k
h o l d i n g s of G o v e r n m e n t s e c u r i t i e s i n c r e a s e d s u b s t a n tially in 1 9 7 5 a n d 1 9 7 6 a s a n offset to c y c l i c a l l y w e a k
d e m a n d for l o a n s c a u s e d b y a r e s t r u c t u r i n g of b a l a n c e
s h e e t s o n t h e p a r t of b a n k c u s t o m e r s in t h e a f t e r m a t h
of t h e 1 9 7 3 - 7 5 r e c e s s i o n . T h e e x p a n s i o n in h o l d i n g s of
G o v e r n m e n t s e c u r i t i e s f o l l o w e d m a n y y e a r s of little or
no growth while customer loan d e m a n d w a s heavy.
O t h e r p r i v a t e f i n a n c i a l i n s t i t u t i o n s — s u c h a s thrift institutions, insurance c o m p a n i e s , a n d pension f u n d s — h o l d
s o m e w h a t less t h a n half t h e a m o u n t of G o v e r n m e n t
s e c u r i t i e s h e l d b y c o m m e r c i a l b a n k s . W h i l e they k e e p
T r e a s u r y issues in their s e c u r i t i e s portfolios, their
n e e d s for f u n d s a r e g e n e r a l l y m o r e p r e d i c t a b l e t h a n
t h o s e of c o m m e r c i a l b a n k s . T h e y t y p i c a l l y h o l d a l a r g e r
p r o p o r t i o n of m o r t g a g e s a n d o t h e r s e c u r i t i e s that offer
' In J u n e 1977 a n d aga<n in D e c e m b e r 1977. fifteen-year b o n d s
w e r e sold ralher t h a n live-year n o l e s T h e T r e a s u r y h a s
i n d i c a t e d that it will m a k e s u c h substitutions from time to l i m e

206
h i g h e r y i e l d s b u t a r e l e s s l i q u i d t h a n T r e a s u r y issues.
T h e F e d e r a l R e s e r v e S y s t e m ' s h o l d i n g s of G o v e r n m e n t s e c u r i t i e s rival t h e a m o u n t h e l d b y t h e c o m m e r c i a l
b a n k s . T h e s e i s s u e s c o n s t i t u t e t h e g r e a t b u l k of t h e
S y s t e m ' s a s s e t s a n d t h e y s u p p o r t Its liabilities, p r i m a r i l y
F e d e r a l R e s e r v e n o t e s w h i c h c o n s t i t u t e m o s t of t h e
n a t i o n ' s c u r r e n c y in c i r c u l a t i o n , m e m b e r b a n k r e serves, a n d Treasury deposits. T h e principal reason
f o r t h e g r o w t h of F e d e r a l R e s e r v e h o l d i n g s o f G o v e r n m e n t s e c u r i t i e s h a s b e e n t h e e x p a n s i o n of F e d e r a l
R e s e r v e n o t e s a n d , t o a l e s s e r e x t e n t , t h e i n c r e a s e s in

average Treasury cash balances at the Reserve Banks.
M e m b e r b a n k r e s e r v e s h a v e e x p a n d e d little in r e c e n t
y e a r s , s i n c e t h e g r o w t h of m e m b e r b a n k l i a b i l i t i e s s u b ject to reserve requirements has b e e n offset by red u c t i o n s in a v e r a g e r e q u i r e m e n t s .
O t h e r g o v e r n m e n t a l units, b o t h d o m e s t i c a n d f o r e i g n ,
h o l d s u b s t a n t i a l a m o u n t s of U n i t e d S t a t e s G o v e r n m e n t
securities because they are bound either by law or
custom to hold the safest a n d most liquid securities
available. Foreign a n d international investors, primarily
official institutions, h e l d a b o u t $ 6 5 b i l l i o n of m a r k e t a b l e

f l i f oHiHWcn of Tranwy StoufMu
The Treasury sells two different kinds of marketable
obligations: coupon-bearing securities and bills. The
Investor's return on a coupon-bearing security comes
from semiannual Interest payments plus any gain or
loss In the price of the security from the time of purChase to maturity or sale If It Is sold before It matures.
Coupon-bearing securities are either notes or bonds. By
law, notes have an original maturity of from one to ten
years. Securities designated as bonds are permitted to
have any maturity, but the Congress has restricted to
927 billion the amount of bonds In the hands of the
public that may bear coupons exceeding 41/k percent.
As of June 90, 1977, only $ 1 3 % billion of bonds with
coupons over 414 percent was In private hands, /.e.,
outside the Federal Reserve System and official United
States Government accounts. There Is no comparable
restriction on notes. In reoent years, most coupon securities have been Issued in minimum denominations
of $1,000, except for two- and three-year notes for
which $5,000 has been the minimum.
Coupon securities are usually sold through auctions
in which bidders submit competitive bids expressed as
annual yields to two decimal places—7.31 percent, for
example. Noncompetitive bidders may submit tenders
of up to $1 million. The Treasury allots to the noncompetitive bidders first and then allots competitive
bids, beginning with those at the lowest yield. When
the issue has been fully allotted, the Treasury calculates the weighted average of the yields It has
accepted and then establishes a fixed coupon to the
nearest eighth percent, so that the average price Is
usually at par or slightly below par. For example, a security sold with an average Issuing yield of 7.31 percent would have a 7 t t percent coupon and an average
price slightly below par. A security is sold at par when
the average yield is exactly equal to the coupon. All noncompetitive bidders pay the average Issuing price, and
competitive bidders pay the price associated with the




bids acoeptad by the Treasury.
Price quotations In the secondary market are expressed In points with par value equal to 100 points.
Fractions of a point are expressed in 32nds. Thus, the
price of a coupon security when It Is below par might
b e expressed as 9 9 10/32, /.e., $993.12 for a $1,000
bond. (When the price is above par, the quote might be
102 3 / 3 2 , /.e., $1,020.94 for a $1,000 bond.) T h e quoted
price does not Include any Interest that has accrued
on the security after the previous semiannual coupon
payment date. The accrued Interest Is added to the
quoted price the buyer agrees to pay the seller.
Bills do not carry coupons. They are initially sold
and subsequently trade at a discount from par value.
The Investor's return is derived from the increase in
value from the original discounted price at purchase to
the par value at maturity. The Treasury auctions threeand six-month bills every week and 52-week bills every
four weeks. Bills In the secondary market are quoted
in terms of benk discount rates: the dollar discount Is
expressed as a percentage of par value computed at
an annual rate until maturity (based on a 300-day year).
T h e minimum denomination for a bill is $10,000, and
noncompetitive tenders are allotted In full up to
$600,000 each at the average auction price.
Another characteristic of Treasury securities is
their marketability or nonmarketabllity. Marketable securities may be resold after Issue, while nonmarketable
securities are sold to designated purchasers who may
not sell them to others. Official United States Government accounts hold slightly more than half the Treasury's nonmarketable securities. Among the most important accounts are the Federal employee retirement
funds snd the Federal old-age and survivors insurance
trust fund. Savings bonds held by Individuals constitute
slightly less then one third of the nonmarketable debt.
Other Important holders of nonmerketable debt are foreign governments and state and local governments.

F R B N Y Quarterly Review/Winter 1977-78

37

207
Table 1

United States Treasury I
In billions of dollars

December 31,
i960

Amounts outstanding on
December 31.
Juna 30.
1975
1977

December 31,
1970

290
101
169*

321
106
215

389
140
248

577
213
363

674
242
431

39
51
80

Orasa pliMIe * M
Nortmarketabls dabt
MartcatatXa dabt

December 31.
1966

60
50
104

88
101
59

157
167
39

155
233
43

8
27
62
6
10
19
19
20
10
7

12
41
61
S
10
16
23
22
11
16

17
62
63
3
*
7
28
29
13
22

19
88
85
5
9
20
33
24
44
36

15
102
102
6
14
24
39
26
65
35

Msrtwtskto by ^fpt of HMri^fs
Bills
NotM.
Bond*

Federal Rasarva 8ystam
..
insurance companies
Other corporations
State and local governments
Individuals
Foreign and international
Other investors
Discrepancies fn totals are due to rounding
* includes $18 billion of certificates of indebtedness,
t Partially eetimated.
Source: Treasury Bulletin

Treasury issues in mid-1977.1 The growth of foreign
holdings of Treasury securities mainly reflected foreign
central bank investments of dollars obtained in exchange market operations as well as substantial acquisitions by oil-exporting nations. State and local governments invest in short-term Treasury securities to
bridge the gap between the timing of periodic tax receipts and Federal grants-in-aid and the more continuous flow of payments for goods and services.
Individuals hold a considerable volume of marketable Treasury issues even though there are several
factors tending to inhibit purchases by small investors.
The transactions costs for small purchases and sales,
the cost of custody, and large minimum denominations for shorter term issues have tended to restrain
purchases by individuals except in periods when market yields on Treasury securities moved substantially
above those on alternative liquid investments, mainly
thrift and savings deposits. (The major portion of the
Treasury debt held by individuals consists of savings
* Foreign <' vos!ois aiso held about $22 b'llion c< nonmarketabie
?r«M»suiy securities in mid-1977

38

FftBNY Quarterly Review/Winter




1977-73

bonds with small denominations. They are not marketable, but they are redeemable prior to maturity.)
The dealer market
The market for United States Government securities
centers on the dealers who report activity daily to the
FRBNY. The dealers buy and sell securities for their
own account, arrange transactions with both their
customers and other dealers, and also purchase debt
directly from the Treasury for resale to investors. In the
normal course of these activities, they hold a substantial amount of securities. In addition to the dealer firms,
there are brokers that specialize in matching buyers
and sellers among the dealers in the Government 'securities market.
The dealer firms include dealer departments of commercial banks (bank dealers) and all others (nonbank
dealers). Bank dealers call upon the custodial and
other facilities of the bank and frequently obtain a
portion of the financing of their securities holdings
from the bank. The bank dealer often acts to meet the
needs o* the correspondent banks of the parent. In

208
a d d i t i o n to t r a d i n g In G o v e r n m e n t securities, b a n k
d e a l e r s a r e g e n e r a l l y a c t i v e in o t h e r m o n e y m a r k e t
i n s t r u m e n t s a n d in t h e m a r k e t for t a x - e x e m p t g e n e r a l
o b l i g a t i o n s e c u r i t i e s of state a n d local g o v e r n m e n t s .
T h e y a r e , h o w e v e r , p r o s c r i b e d b y t h e B a n k i n g A c t of
1933 (Glass-Steagall) from trading corporate equities
a n d bonds, as well a s t a x - e x e m p t revenue issues. T h e
Glass-Steagall Act w a s intended to create a legal distinction b e t w e e n commercial banking and investment
banking. Nonbank dealers face no such proscription,
a n d m o s t of t h e m t r a d e in t h e s e o t h e r m a r k e t s , a l t h o u g h
a few firms concentrate their energies on Government
securities and money market instruments such as
bankers' acceptances, commercial paper, and large
n e g o t i a b l e b a n k certificates of deposit.
At the e n d of 1977, t h e r e w e r e thirty-six securities
dealers that reported their transactions, financing, and
inventories to the F R B N Y daily; twelve w e r e c o m m e r cial banks a n d twenty-four w e r e nonbank dealers. A
f i r m i s a d d e d t o t h e r e p o r t i n g list w h e n it d e m o n s t r a t e s
t h a t it c o n d u c t s a s i g n i f i c a n t a m o u n t o f b u s i n e s s w i t h
c u s t o m e r s a s w e l l a s w i t h o t h e r d e a l e r s , t h a t it o p e r a t e s in s i z e in t h e m a j o r m a t u r i t y a r e a s of t h e m a r k e t ,
a n d t h a t it i s a d e q u a t e l y c a p i t a l i z e d a n d m a n a g e d b y
r e s p o n s i b l e p e r s o n n e l . If a f i r m ' s p e r f o r m a n c e m e e t s
h i g h s t a n d a r d s in t h e s e r e s p e c t s for s o m e p e r i o d of
time, t h e M a n a g e r of the S y s t e m O p e n M a r k e t A c c o u n t
w i l l g e n e r a l l y e s t a b l i s h a t r a d i n g r e l a t i o n s h i p w i t h it.
T h u s , n o t a l l f i r m s o n t h e F R B N Y r e p o r t i n g list n e c e s sarily trade with the S y s t e m O p e n M a r k e t Account.
In 1944, the F e d e r a l O p e n M a r k e t C o m m i t t e e ( F O M C )
e n t e r e d into formal relationships with a limited g r o u p
o f d e a l e r s t o f a c i l i t a t e its o b j e c t i v e o f p e g g i n g i n t e r e s t
r a t e s d u r i n g W o r l d W a r II. T h e d e a l e r s , n u m b e r i n g
about a dozen, w e r e required to m a k e vigorous efforts
to find buyers for their e x c e s s securities b e f o r e selling
t h e m at t h e e s t a b l i s h e d p r i c e s to t h e S y s t e m O p e n
M a r k e t A c c o u n t . W h e n this basis for the special relationship e n d e d w i t h t h e d e m i s e of p e g g e d interest
rates in t h e e a r l y 1950's, a s u b c o m m i t t e e of t h e F O M C
a c k n o w l e d g e d the n e e d to develop specific standards
f o r i n c l u s i o n o n t h e list. A m o n g t h e c h a r a c t e r i s t i c s
noted at the time w e r e that dealers should m a k e m a r k e t s , t a k e p o s i t i o n s , a n d o p e r a t e i n v o l u m e in a l l
s e g m e n t s of the market.
F o r a t i m e t h e s i z e o f t h e list s h o w e d s o m e t e n d e n c y
to e x p a n d , a n d by 1960, w h e n the F R B N Y b e g a n receiving detailed statistical reports from dealers daily,
t h e list i n c l u d e d e i g h t e e n d e a l e r s . T h e n u m b e r h o v e r e d
a r o u n d twenty through the 1960's but has since exp a n d e d r a p i d l y t o its p r e s e n t s i z e , l a r g e l y b e c a u s e
investment b a n k i n g firms h a v e sought to e x p a n d the
r a n g e of their o p e r a t i o n s a s activity in t h e i n t e r m e d i a t e and long-term Treasury market grew.




Dealers trade actively among themselves as well as
with customers. Brokers facilitate this interdealer trading b e c a u s e they bring buyers a n d sellers together; the
interdealer brokers themselves d o not m a k e m a r k e t s
or h o l d s e c u r i t i e s for their o w n a c c o u n t . T h e y c h a r g e
a c o m m i s s i o n o n e a c h transaction, a m o u n t i n g to roughly $ 7 8 p e r $ 1 m i l l i o n of T r e a s u r y c o u p o n i s s u e s s o l d .
T h e c o m m i s s i o n o n T r e a s u r y b i l l t r a n s a c t i o n s is g e n e r a l l y c a l c u l a t e d in b a s i s p o i n t s : f o r e x a m p l e , t h e c o m m i s s i o n o n t h r e e - m o n t h b i l l s f r e q u e n t l y is h a l f of 1
basis point, approximately $ 6 2 o n a $5 million trade. (A
b a s i s p o i n t is 1 / 1 0 0 o f 1 p e r c e n t a g e p o i n t i n i n t e r e s t
rate terms.) In m a n y cases, b r o k e r s p r o v i d e their services by displaying participating dealers' bids a n d
offers o n c l o s e d circuit television s c r e e n s l o c a t e d in
the dealers' trading rooms. Other dealers then may
contact the broker, respond to the quoted price, and
complete the transaction. S o m e brokers
operate
c o m p l e t e l y by telephone, contacting d e a l e r s to p a s s
a l o n g bids a n d offers.
I n t h e d e a l e r m a r k e t , p r a c t i c a l l y a l l t r a d i n g is t r a n s a c t e d o v e r t h e t e l e p h o n e . T h e r e is n o f o r m a l c e n t r a l ized marketplace such as an exchange; instead, the
m a r k e t c o n s i s t s of a d e c e n t r a l i z e d g r o u p of firms, e a c h
w i l l i n g t o q u o t e p r i c e s f o r p u r c h a s e o r s a l e of T r e a s u r y
securities. E a c h firm's traders quote prices and buy
f r o m , a n d sell to, t h e i r c o u n t e r p a r t s at o t h e r d e a l e r
firms directly or w i t h brokers. T h e firm's sales p e r s o n nel use the telephone to contact customers to learn
their investment needs and to arrange trades with them.
T h e p r i c e f o r e a c h b l o c k o f s e c u r i t i e s t r a d e d is n e g o tiated, a n d m a n y c u s t o m e r s will typically c a n v a s s the
m a r k e t to find the dealer with the best price.
T h e o v e r - t h e - t e l e p h o n e o r g a n i z a t i o n of t h e G o v e r n m e n t s e c u r i t i e s m a r k e t p a r a l l e l s that of o t h e r f i x e d i n c o m e s e c u r i t i e s m a r k e t s . In c o n t r a s t , s t o c k e x c h a n g e s
largely rely o n b r o k e r s to funnel o r d e r s f r o m c u s t o m e r s
t o t h e f l o o r of a n e x c h a n g e . T h e r e , b r o k e r s c a l l e d s p e cialists attempt to m a t c h o r d e r s with d e s i g n a t e d prices
f r o m b u y e r s a n d s e l l e r s in a n a u c t i o n m a r k e t . A t t i m e s ,
the specialists are required to act as principals and to
b u y a n d s e l l s e c u r i t i e s , e s p e c i a l l y w h e n t h e r e is a n
i m b a l a n c e of b u y a n d sell orders.
F o r t h e m o s t part, t h e d e l i v e r y of T r e a s u r y bills t a k e s
place on the same business day (called "cash" delivery) w h i l e c o u p o n issues a r e generally d e l i v e r e d o n
the following business day (called "regular" delivery).
D e l i v e r y a n d s a f e k e e p i n g o f s e c u r i t i e s is i n l a r g e p a r t
handled by a book entry system provided by the
F e d e r a l R e s e r v e B a n k s . A t t h e b e g i n n i n g of 1977, four
fifths of t h e T r e a s u r y ' s m a r k e t a b l e d e b t w a s in t h e
form of b o o k k e e p i n g e n t r i e s o n c o m p u t e r s a t t h e F e d e r a l R e s e r v e B a n k s ; t h e r e m a i n d e r w a s in p a p e r c e r tificates. T h e c o m p u t e r i z e d s y s t e m eliminates physical

FRBNV

Quarterly Review/Winter 1977-78

39

209
handling of certificates, since the securities c a n b e
transferred electronically from sellers to buyers through
entries o n the safekeeping accounts of commcrcial
b a n k s t h a t a r e m e m b e r s of t h o F e d e r a l R e s e r v e S y s t e m
a n d w h o act as a g e n t for t h e s e transactions. W h e n
transactions are a r r a n g e d b e t w e e n participants in different R e s e r v e Districts, t h e securities transfer is carried over the Federal Reserve wire-transfer network.
B o o k entries and wire transfers facilitate rapid a n d low
c o s t t r a n s f e r s of s e c u r i t i e s , e s p e c i a l l y a m o n g d e a l e r s
and customers who are separated geographically.
The role of the dealer
T h e d e a l e r firm m a k e s markets by purchasing a n d selli n g s e c u r i t i e s f o r its o w n a c c o u n t . D e a l e r s d o n o t
typically charge commissions o n their trades. Rather
t h e y h o p e t o sell s e c u r i t i e s at p r i c e s a b o v e t h e o n e s a t
w h i c h thoy w e r e bought. Dealers also seek to h a v e a
positive " c a r r y " on the securities they h a v e in position,
/.e.( t h e y try to e a r n m o r e interest o n thoir inventory
than they must pay o n the funds raised to finance that
inventory.
Dealers attempt to establish positions in the various
m a t u r i t i e s of T r e a s u r y s e c u r i t i e s i n l i g h t of t h e i r e x p e c tations a b o u t interest rates a n d then t r a d e a r o u n d that
position. But the initiative often rests w i t h c u s t o m e r s
trying to undertake specific transactions, a n d the dealer
m u s t b e w i l l i n g to b i d o r o f f e r a t c o m p e t i t i v e p r i c e s t o
retain his customer base. W h e n traders q u o t e pricos
t o customers a n d to other dealers, they continuously
m a k e small adjustments in relation to p e r c e i v e d prices
e l s e w h e r o i n o r d e r t o m a i n t a i n t h e f i r m ' s p o s i t i o n , its
inventories of securities, within t h e limits laid d o w n by
the firm's management. T h e m a n a g e m e n t relies heavily
o n t h e t r a d e r s ' s k i l l s t o e n a b l e t h e f i r m t o c h a n g e its
position in various maturities whenever the outlook
c h a n g e s . A g o o d t r a d e r is a l s o e x p e c t e d t o m a k e
money from the spread between bid a n d offered prices
in a steady market.
T h e s p r e a d b e t w e e n b i d a n d o f f e r e d p r i c e s in g e n e r a l d e p e n d s o n a v a r i e t y of f a c t o r s . T w o b a s i c d e t e r m i n a n t s a r e t h o c u r r o n t s t a t o of m a r k e t a c t i v i t y a n d
t h e o u t l o o k for i n t o r e s t r a t e s . S p r e a d s a r e n a r r o w e r
for a c t i v e l y t r a d e d i s s u e s , b e c a u s e t h e d e a l e r is f a i r l y
certain about the price at w h i c h the issue c a n b e p u r c h a s e d or sold. S p r e a d s a r e narrowest of all o n T r e a s u r y bills, b e c a u s e t h e y a r e b o t h a c t i v e l y t r a d e d a n d
I n v o l v e l e s s risk of p r i c e l o s s t h a n l o n g e r t e r m s e c u r i ties. S p r e a d s f o r t h r e e - m o n t h b i l l s a r e o f t e n a s s m a l l
a s 2 b a s i s p o i n t s o n r e c e n t i s s u e s , /'.e.. $ 5 0 p e r $ 1
million. T h e spread on a n activoly traded c o u p o n issue
might b e 2 / 3 2 to 4 / 3 2 . o r S625 to $1,250 per $1 million
of s e c u r i t i e s . T h e s p r e a d is w i d e r t h e l o n g e r t h e t e r m
to maturity a n d the s m a l l e r t h o size of a requested

40

F R B N Y Quarterly Review/Winter




1977-78

transaction. Spreads also w i d e n — s o m e t i m e s dramatically—when new developments genorate caution or
uncertainty in the market.
A s u b s t a n t i a l i n c r e a s e in t h o s h o r t - r u n v o l a t i l i t y of
interest r a t e s — a n d thus securities p r i c e s — m the 1970's
has c a u s e d dealer firms to place great e m p h a s i s o n
position management. Sharp, unexpected price move*
m e n t s c a n l e a d t o p r o f i t s o r l o s s e s o n t h e i r net p o s i tion, gross long positions minus gross short positions,
l h a t c a n e a s i l y o u t w e i g h t h e g a i n s or l o s s e s a r i s i n g f r o m
other sourcos.1 Consequently, they m a n a g e their positions actively, frequently altering them in response to
changing economic news, tho perceived supply a n d
d e m a n d conditions for Government securities, a n d
o t h e r f a c t o r s a f f e c t i n g t h e o u t l o o k for t h o s e c u r i t i e s
markets. In the past, w h e n rates w e r e reasonably
stoady in t h e short run, dealers p l a c e d s o m e w h a t m o r o
e m p h a s i s o n structuring their inventories to meet customer needs.
Dealer inventories are highly leveraged. More than
9 5 p e r c e n t of t h e v a l u e of t h e i r h o l d i n g s is t y p i c a l l y
financed with borrowed money; the dealer's o w n capital
f u r n i s h e s t h e r e m a i n d e r . T h u s , t h e cost a n d a v a i l a b i l i t y
of f u n d s i s a n i m p o r t a n t c o n s i d e r a t i o n i n a d e a l e r ' s
willingness to hold securities. W h e n interest ratos o n
tho securities themselves a r e higher than tho cost of
t h e funds n e e d e d t o finance t h e position, there is a
" p o s i t i v e " c a r r y . A d e a l e r w i l l t e n d to h o l d a h i g h e r
inventory t h a n in t h e opposite c a s e w h e n "negativo"
c a r r y p r e v a i l s . I n a l l b u t a f e w p e r i o d s i n t h e last s e v eral years, interest rates h a v e generally b e e n higher
on longer maturities—i.e., the yield curve, the market
y i e l d a t a s p e c i f i c t i m e for o a c h a v a i l a b l e m a t u r i t y o u t s t a n d i n g . is u s u a l l y u p w a r d s l o p i n g . T n u s . t h e c o s t o f
d a y - t o - d a y f u n d s is u s u a l l y b e l o w t h e y i e l d o n all b u t
the shortest t e r m securities in the dealer's inventory.
H o w e v e r , t h e full risk o f a n y r i s e i n i n t e r e s t r a t e s f a l l s
o n t h e dealer. Carry profits c a n quickly vanish.' T h e

* A dealer firm hat a long position in a security when the firm
is an owner of the security. The t-m stands to ga'n rf the pr.ee ol
the security rises. A firm establishes a short position by selling
a security it does not own; it makes delivery to the buyer by
obtaining temporary possession of the security, tor eumpte.
by borrowing it from a third party. In this case, the firm
standi to gam if the price Cans because the firm can then purchase
me secunty to return it to me lender at a price lower than the
pnee at which it sold the security.
* Profits earned from positive carry can be rather small, compered
with those resulting from buying and seAng on the bid-asked
spread or the profits and losses stemming from price changes
For example, a change ol 1 basis point in the d-scount rate
on a bill due in slightly more than three months is equivalent
to tho carry profits earned in one day il lite tmaneng cost
of carrying the bid <s 100 basis p o r t s f i percentage ooml) louver
than the rate on the bill itself Moreover, positive cany
rarely reaches magnitudes of 1 percentage pomi while a daily
change ol at least I basis point in b<a rates is quite common.

210
a m o u n t of r i s k a d e a l e r Is w i l l i n g t o t a k e b y h o l d i n g a
l o n g e r t e r m p o r t f o l i o Is o n e o f t h e d i s t i n g u i s h i n g c h a r a c t e r i s t i c s of m a n a g e m e n t style.
S e a r c h i n g out a n d obtaining financing at the lowe s t c o s t is a v i t a l i n g r e d i e n t i n m a k i n g m a r k e t s a n d
t h e pursuit of profit. In d o i n g so, t h e d e a l e r s p r o v i d e
t e m p o r a r y i n v e s t m e n t outlets for m a r k e t p a r t i c i p a n t s
w i t h i d l e c a s h . I n a d d i t i o n , d e a l e r s t a k e in f u n d s t o
p r o v i d e t h e m to o t h e r s w h o a r e t e m p o r a r i l y short of
cash, in effect acting a s i n t e r m e d i a r i e s b e t w e e n shortterm lenders and borrowers. (See section on dealer
f i n a n c i n g a n d t h e g r o w t h of i n t e r m e d i a t i o n o n p a g e s
45-46.)
D e a l e r s also p r o v i d e a s e r v i c e to their c u s t o m e r s b y
giving their views about a n d advice on the market.
M a n y dealer firms distribute market letters about recent
a n d prospective m a r k e t developments. T h e letters often
contain assessments of Treasury financing needs, Federal R e s e r v e actions, a n d prospects for the e c o n o m y
a n d interest rates. S a l e s m e n discuss these subjects
directly w i t h participants a n d also s e e k to d e v e l o p a
familiarity with customers' investment objectives so
that the firm's traders c a n provide the customers with
buying a n d selling opportunities that m e s h with their
plans.

T h e g r o w t h of t r a d i n g activity
T r a d i n g activity h a s g r o w n sharply in t h e last f e w y e a r s
after m a n y y e a r s of m o r e m o d e s t e x p a n s i o n . Outright
trading, the total of p u r c h a s e s a n d sales, a m o u n t e d to
n e a r l y $ 1 0 V 2 b i l l i o n o n a d a i l y a v e r a g e b a s i s in 1 9 7 6 ,
r o u g h l y t h r e e t i m e s t h e l e v e l i n 1 9 7 4 ( T a b l e 2). I n p a r t ,
t h e g r o w t h of activity r e f l e c t e d t h e s u b s t a n t i a l o u t p o u r i n g of T r e a s u r y d e b t . B u t t h e e f f o r t s of a l l m a r k e t p a r t i c i p a n t s in s e e k i n g s u p e r i o r r e t u r n s o n their portfolios
have also b e e n a n important factor. M a n y investors,
d i s e n c h a n t e d by falling stock prices, h a v e sought to
obtain higher returns in t h e securities m a r k e t by buying a n d selling m o r e f r e q u e n t l y in r e s p o n s e to anticip a t e d s h o r t - r u n m o v e m e n t s in interest rates. Interd e a l e r activity h a s e x p a n d e d a s well, p a r t i c u l a r l y in
the brokers' market.
W h i l e t r a d i n g in bills h a s c o n t i n u e d to d o m i n a t e
activity in t h e d e a l e r m a r k e t , t r a d i n g in c o u p o n s e c u r i ties h a s g r o w n in r e l a t i v e i m p o r t a n c e . A s r e c e n t l y a s
1974, c o u p o n trading a c c o u n t e d for 2 9 p e r c e n t of total
a c t i v i t y , b u t b y 1 9 7 6 it h a d r e a c h e d 3 6 p e r c e n t . T h e
g r o w i n g s h a r e of c o u p o n s r e s u l t e d f r o m t h e m o r e r a p i d
g r o w t h of c o u p o n d e b t outstanding, a n d this g r o w t h in
turn led to a m o r e active s e c o n d a r y m a r k e t for t h e s e
issues. W h e n m e a s u r e d b y activity p e r dollar of d e b t

Table 2
Transactions In United States Government Securities by Dealers
Reporting to the Federal Reserve Bank of Now York
By maturity
(In millions of dollars, daif/ averages)
Due in one
Due within
one year*
year or more
Total
1960t
1965
1970
1971
1972
1973
1974
1975
1976
19771

994
2,032

2.800
6.886
7.061

379
346
481
VI2

1,373
1.827
2.513
2.700

071
796
779
1.015
3.565
3.877

2,930
3.439
3.579
6,027
10.449
10.938

By trading participant
(as a percentage of total)
Dealers
Commercial
a id brokers
banks
31.5
31.9
42.7
39.7
Dealers Brokers
24.8
140
19.3
23.1
18.2
27.0
14.7
29.0
13.0
32.6
11.'
34.1

All
others

44 0
41.4
37.0
35 7

24 5
26.7
20 3
24.6

34 1
31.8
27.9
24.1
23.2
22.0

27.2
25 8
26.9
32.2
31.2
32.2

Discrepancies in totals are oue to rounding.
* Includes a small volume of transactions In coupon securities with less than one year to maturity
t Average for last four months of the year,
t Average for first nine months of the year.
Source: Federal Reserve Bulletin. •




F R B N Y Quarterly Review/Winter

1977-78

41

211

Marketable Treasury Debt: Amount
Outstanding and Trading Activity
Billions ol dollars
1 8 0 Marketable securities'

T h e d e a l e r s ' c u s t o m e r s , w h o a c c o u n t for slightly
m o r e t h a n half of total d e a l e r t r a d i n g activity ( T a b l e 2),
h a v e e x p a n d e d their trading substantially. Portfolio
m a n a g e r s o f t e n s e e k t o a n t i c i p a t e m o v e m e n t s in I n t e r est rates a n d to lengthen or shorten the a v e r a g e m a t u r i t y o f t h e i r h o l d i n g s t o t a k e a d v a n t a g e of e x p e c t e d
r a t e c h a n g e s . C h a n g e s in t h e o u t l o o k for interest rates
over a day, week, or month now play an important role
in portfolio d e c i s i o n s . In t h e past, s u c h d e c i s i o n s w e r e
o f t e n t i e d t o t h e i n v e s t o r ' s e x p e c t a t i o n s of s h o r t - a n d
long-run n e e d s for liquidity. T h e profits g e n e r a t e d by
f a l l i n g i n t e r e s t r a t e s , i.e., r i s i n g p r i c e s , in 1 9 7 5 a n d
1 9 7 6 a l s o a c t e d a s a n i n d u c e m e n t to active trading.
T h e a n n u a l g r o w t h in trading activity m o d e r a t e d
t h r o u g h t h e first t h r e e q u a r t e r s o f 1 9 7 7 , c o m p a r e d w i t h
1 9 7 6 , a n d t r a d i n g p e r d o l l a r of d e b t d e c l i n e d s h a r p l y
f r o m t h e h i g h s p o s t e d a t t h e e n d of 1 9 7 6 , a s s h o r t - t e r m
interest rates rose a n d longer term rates fluctuated
irregularly o v e r a g o o d part of t h e year.

Percent

* Marketable debt not held by official Federal Qovernmer>t
accounts or the federal Reserve System

o u t s t a n d i n g in t h e h a n d s of t h e p u b l i c , t h e e x p a n s i o n
of t r a d i n g in l o n g e r t e r m s e c u r i t i e s f r o m 1 9 7 4 t o 1 9 7 6
e x c e e d e d t h a t for s h o r t e r t e r m s e c u r i t i e s ( c h a r t ) .
T h e g r o w i n g i m p o r t a n c e of t h e c o u p o n s e c t o r also
s t e m s f r o m the i n c r e a s e d liquidity of t h e s e issues. For
s e v e r a l reasons, p a r t i c i p a n t s c a n m a k e d e s i r e d portf o l i o c h a n g e s m o r e e a s i l y t h a n in t h e p a s t . T h e n u m b e r
of c o u p o n s e c u r i t i e s o u t s t a n d i n g h a s e x p a n d e d s h a r p l y ,
and by m i d - 1 9 7 7 there w e r e nearly 100 different c o u p o n
i s s u e s , o v e r 5 0 p e r c e n t m o r e t h a n in 1 9 7 4 . S e v e r a l
m a t u r i t y g a p s w e r e f i l l e d in. e s p e c i a l l y in t h e u r i d e r •ive-year area, thus facilitating a d j u s t m e n t s to the m a
turity distribution of portfolios. S e c o n d a r y m a r k e t activity h a s b e e n e n c o u r a g e d b y a n i n c r e a s e i n t h e a v e r a g e
s i z e of c o u p o n o f f e r i n g s f r o m a b o u t $ 1 5 b i l l i o n i n 1 9 7 4
t o a b o u t $ 2 . 8 b i l l i o n in 1 9 7 7 . T h u s , d e a l e r s a n d o t h e r
p a r t i c i p a n t s n o w h a v e a g r e a t e r v a r i e t y of f a i r l y s i z a b l e
i s s u e s a v a i l a b l e w i t h w h i c h t o e n g a g e in h e d g e o r
arbitrage operations. A dealer, for e x a m p l e , m a y h e d g e
t o a v o i d m a r k e t rink b y m a t c h i n g a s h o r t s a l e in o n e

42

F R B N Y Quarterly Review/Winter




i s s u e w i t h a p u r c h a s e of a s i m i l a r i s s u e w h o s e p r i c e is
e x p e c t e d to m o v e by about the s a m e a m o u n t as that
o n the security sold short. In a n arbitrage operation, a
p a r t i c i p a n t w o u l d a t t e m p t t o p r o f i t f r o m w h a t is e x p e c t e d to b e a t e m p o r a r y disparity in t h e m a r k e t ' s p r i c i n g
of t w o issues by selling o n e a n d buying the other. H e
w o u l d t h e n w a i t u n t i l t h e d i s p a r i t y is e l i m i n a t e d to r e v e r s e t h e t r a n s a c t i o n . If it is n o t e l i m i n a t e d , h e m i g h t
t a k e a loss o n t h e operation.

1977-78

C o m m e r c i a l b a n k s a c c o u n t f o r o v e r 4 0 p e r c e n t of
d e a l e r t r a d i n g w i t h n o n d e a l e r c u s t o m e r s . In r e c e n t
years, banks h a v e c o m e to rely on their securities holdings less a s a s e c o n d a r y s o u r c e of reserves, g i v e n their
e m p h a s i s o n liability m a n a g e m e n t , a n d to use securities
t r a d i n g m o r e a s a m e a n s of m a x i m i z i n g profits. T h e
m o r e active a p p r o a c h to asset m a n a g e m e n t has also
m e a n t g r e a t e r v a r i a b i l i t y i n b a n k h o l d i n g s of c o u p o n issues. B a n k s have not b e e n the only institutions
that have a d o p t e d a m o r e aggressive a p p r o a c h to
p o r t f o l i o m a n a g e m e n t a n d t r a d i n g . In f a c t , t h e a c t i v i t y
of o t h e r c u s t o m e r s , i n c l u d i n g s t a t e a n d l o c a l g o v e r n ments and nonfinancial corporations, has grown even
m o r e rapidly.1 A s a result, trading activity by d e a l e r s
with customers other than banks grew from 35 percent
t o 5 7 p e r c e n t of t o t a l t r a d i n g w i t h c u s t o m e r s b e t w e e n
1970 and 1976.
T r a d i n g w i t h i n t h e d e a l e r c o m m u n i t y itself is c o n d u c t e d either directly b e t w e e n the firms themselves or
indirectly t h r o u g h b r o k e r s . In t h e past f e w years, trading through brokers, w h o put together trades between
dealers, has c o m e to d o m i n a t e interdealer trading;
such b r o k e r i n g n o w a c c o u n t s for nearly three quarters
> Tne a v a i l a b l e statistics s e p a r a t e b a n k s Irorr. other customers
but d o not provide d a t a o n other c u s t o m e r s by category

212
of d e a l e r trading w i t h other dealers, c o m p a r e d w i t h
a b o u t o n e t h i r d i n 1 9 7 2 ( t h e first y e a r f o r w h i c h s e p a rate data on trading through brokers are available).
Using a broker provides anonymity and allows a dealer
to shield information about his activity a n d position
from other dealers and market participants. Another
f a c t o r c o n t r i b u t i n g t o t h e p o p u l a r i t y of t r a d i n g t h r o u g h
b r o k e r s is t h e r a p i d t r a n s m i s s i o n o f q u o t e s t o o t h e r
dealers, r e d u c i n g t h e costs of c a n v a s s i n g a l a r g e n u m b e r of d e a l e r s to c o l l e c t that i n f o r m a t i o n .
Still, d e a l e r s c o n t i n u e to a r r a n g e a p o r t i o n of their
trades, slightly m o r e t h a n 10 p e r c e n t of total activity,
directly with other dealers. T h i s activity reflects established interdealer trading relationships. A dealer firm
s p e c i a l i z i n g in o n e a r e a of t h e m a r k e t c a n s o m e t i m e s
m e e t customer n e e d s by dealing directly with a firm
p r i m a r i l y e n g a g e d in a n o t h e r a r e a of t h e m a r k e t .
T h e increased emphasis on position m a n a g e m e n t has
contributed to a t e n d e n c y for total interdealer trading
to a s s u m e a larger s h a r e of total activity, since d e a l e r s
w i l l t y p i c a l l y l o o k first t o o t h e r d e a l e r s t o f i n d b i d s o r
offers for issues they w a n t to sell or buy. S u c h t r a d i n g
h a s e x p a n d e d from a b o u t o n e t h i r d of t o t a l a c t i v i t y i n
the early 1960's to about 4 5 percent recently. T o s o m e
e x t e n t , this reflects a n i n c r e a s e in t h e n u m b e r of reporting dealers.4 But over the longer run the expansion
o f t h e r e p o r t i n g list h a s p r o b a b l y n o t s u b s t a n t i a l l y d i s t o r t e d t h e m e a s u r e m e n t of t h e rising t r e n d in activity.
M a n y of t h e n e w e n t r a n t s w e r e not a c t i v e in t h e T r e a sury m a r k e t for very long b e f o r e they b e c a m e reporting dealers, a n d their trading v o l u m e w a s essentially
nonexistent in t h e 1960's.
O n the other hand, m a n y of t h e n e w e r firms a r e relatively m o r e a c t i v e in i n t e r d e a l e r t r a d i n g a n d h a v e no
d o u b t c o n t r i b u t e d t o its m e a s u r e d rise. T h e y h a v e
u s e d t r a d i n g w i t h o t h e r d e a l e r s a s a w a y of b u i l d i n g
u p expertise a n d volume. ( T o m e e t the criteria for the
r e p o r t i n g list, h o w e v e r , a f i r m m u s t s h o w a s u b s t a n tial v o l u m e of t r a d i n g w i t h c u s t o m e r s . )
Dealers' positions
S e v e r a l important c h a n g e s in t h e m a r k e t h a v e e n a b l e d
d e a l e r s to c o n d u c t their operations with a lower level
of i n v e n t o r i e s in r e l a t i o n to t r a d i n g v o l u m e t h a n in t h e
1960's a n d early 1970's. W h i l e dealers have placed
greater e m p h a s i s o n m a n a g i n g their positions actively,
they c a n m e e t their customers' n e e d s with inventories
t h a t a r e l o w e r r e l a t i v e t o s a l e s t h a n in t h e p a s t . T h e
* A Wade between a reporting dealer and a newly report • dealer
.s an interdealer trade Belore the new dealer was added to the
reporting list, that trade was classified as a trade with a
cusiomer Also, because the new dealer is now a reporing
dealer as well, the trade is counted twice—as is true lor
all interdealer trades




w i d e r r a n g e of participants in the m a r k e t , t h e g r o w t h
in t h e activity of brokers, t h e g r e a t e r e a s e in c o v e r i n g
s h o r t p o s i t i o n s ( a s is d i s c u s s e d b e l o w ) , a n d p o s s i b l y
m o r e c a u t i o n in e x p o s i n g capital h a v e c o n t r i b u t e d to
this trend. Positions w e r e sharply cut b a c k — i n the
a g g r e g a t e a n d in relation to s a l e s — d u r i n g t h e 1 9 7 3 - 7 4
p e r i o d of s t e e p i n c r e a s e s in interest rates. W h e n m o n e y
market pressures later a b a t e d a n d rate expectations
changed, inventories e x p a n d e d threefold to $7Vi billion
b y 1 9 7 6 ( T a b l e 3), a b o u t t h e s a m e a s t h e e x p a n s i o n in
t r a d i n g activity. E v e n w i t h t h e e n l a r g e m e n t of i n v e n t o r y
positions, h o w e v e r , d e a l e r inventories w e r e l o w e r in relation to t r a d i n g activity in 1 9 7 6 t h a n t h e y h a d b e e n
d u r i n g t h e y e a r s b e f o r e t h e b e a r m a r k e t s in b o n d s in
1973-74. T h e ratio of inventories to activity c o n t i n u e d
to fall over 1 9 7 7 a s a w h o l e , w h e n positions d e c l i n e d
w h i l e g r o w t h of activity w a s rather m o d e s t .
T h e m o r e p e r f o r m a n c e - o r i e n t e d a p p r o a c h of cust o m e r s h a s g e n e r a t e d a higher turnover of their portf o l i o s . D e a l e r s n o w f i n d it e a s i e r t o o b t a i n i s s u e s t o
m e e t d e m a n d s , especially for c o u p o n issues. M o r e o v e r ,
t h e e x p a n s i o n of activity by b r o k e r s a n d t h e p r i c e q u o tations they provide almost continuously have probably
bolstered dealers' confidence that particular issues
can be found m o r e readily than before.
T h e g r o w t h of t h e m a r k e t for r e p u r c h a s e a g r e e m e n t s

Table 3
Inventories of United States Treasury
Securities Held by Dealers Reporting to the
Federal Reserve Bank of New York
In millions of dollars: dally averages

Year
I960*
1965
1970
1971
1972
1973
1974
1975
1976
1977t

Due within
one year

Due In one
year or more

Total

1.936
2.816
3.124
3,322
4.084
3.047
1.926
4,562
6.478
5.082

642
533
642
867
198
58
655
1.322
1.115
328

2.578
3.348
3.766
4.188
4.282
3,105
2.580
5.884
7.592
5.409

Discrepancies in totals are due to rounding.
' Average for last lour months of the year,
t Average for first nine months of the year.
Source- Federal Reserve Bulletin.

FRBNY Quarterly Review/Winter

1977-78

43

213
Table 4
Souroee of 8horl4*rm Financing of United States Government and Federally Sponsored
Agency Securities for Dealers Reporting to the Federal Reeerve Bank of Now York*
In millions of dollars: daily averages
Commercial
banks in
New York City

Tola1

rear
I960t

8,610

1965

Commercial
banks
el8ewhara

559

3,548

Corporations

684

1,061

782

956

Others

1.336

17
90

86
.5
6

1,098

1.072

1971

4,868

1,364

1972

4,201

1,292

1973

8,604

1,227

366
471

538

1.256

878

789

1.627

713

904

1.292

859

467

1.252

1974

3,977

1,032

1.064

459

1,423

1975

6,668

1,621

1.466

842

2.738

1976

8,716

1,898

1,860

1,479

3.681

1977*

9,947

1,412

1,982

2.233

4.320

Discrepancies In totals are due to rounding.
* includes both bank and nonbank dealers,
t Average for fast four months of the year.
* Average for first nine months of the year.
Source: Federal Reserve Bulletin.

Categories of Short-term Financing Arrangements by Nonbank Dealers
Reporting to t h e Federal Reeerve Bank of New York
in billions of dollars: dally averages

Veer

Collateral
loans
(1)

RPs
(2)

Reverse
RPs
(3)

Matched RPs
and reverse RPs
(matched transactions)
(4)

Funds provided
to others through
reverse RPs and
matched transactions
(3) + (4)

Funds
retained
(1) + (2) — (3)
2.0

1973

0.8

1.4

02

2.0

2.2

1974

08

1.6

08

2.5

3.3

1.6

1975

10

39

08

2.9

3.7

4 1

5 1

* 8

3.4

5.2

47

7.0

A9

48

97

38

'976
1977"

1.7

RPs = Repurchase agreements.
• First three quarters.

44

F R B N Y Quarterly




Review/Winter

1977-78

214
( R P s ) a n d r e v e r s e RPs 7 h a s f a c i l i t a t e d s h o r t s a l e s —
e i t h e r t o m e e t d e m a n d s of c u s t o m e r s or b e c a u s e of
i n t e r e s t r a t e e x p e c t a t i o n s . T h e a v a i l a b i l i t y of s e c u r i t i e s
in this m a r k e t h a s m a d e It e a s i e r for a d e a l e r t o l o c a t e
t h e p a r t i c u l a r Issue h e n e e d s t o d e l i v e r b y a c q u i r i n g
t h e s e c u r i t y u n d e r a r e v e r s e R P . In f a c t , a m a r k e t for
"specific issues", with the party obtaining the securities s p e c i f y i n g t h e p a r t i c u l a r issue, h a s d e v e l o p e d in
the RP and reverse RP markets and has b e c o m e an
a l t e r n a t i v e t o b o r r o w i n g s e c u r i t i e s . T h e o l d e r m e t h o d of
finding a holder willing to lend securities could be
m o r e c o s t l y a n d c u m b e r s o m e . It o f t e n m e a n t t h a t a
dealer's positioning m o v e b e c a m e obvious to others
a n d required the borrower to put up other securities a s
c o l l a t e r a l . T h e g r o w t h of R P m a r k e t s h a s e n a b l e d
dealers to t a k e larger short positions than they had
before during periods w h e n interest rates w e r e exp e c t e d t o rise. In o t h e r p e r i o d s , d e a l e r s o n a v e r a g e
h a v e not e n l a r g e d t h e i r l o n g p o s i t i o n s b y a s m u c h a s
they had previously.
Dealers may also have b e c o m e more cautious about
e x p o s i n g c a p i t a l b y a s s u m i n g l a r g e short o r l o n g p o s i tions. Y e a r - e n d c a p i t a l ' r e l a t i v e t o p o s i t i o n s in T r e a s u r y
s e c u r i t i e s at t h e n o n b a n k d e a l e r s h a s m o v e d s o m e w h a t
h i g h e r in r e c e n t y e a r s , c o m p a r e d w i t h t h e 1 9 6 0 ' s a n d
early 1970's. H o w e v e r , capital w h i c h has r e a c h e d the
i n d u s t r y in p a r t t h r o u g h t h e e n t r y of a d d i t i o n a l f i r m s
d i d not g r o w s o r a p i d l y a s t r a d i n g v o l u m e .
Dealer financing a n d the g r o w t h of intermediation
D e a l e r s h a v e b r o a d e n e d their s o u r c e s of f u n d s sign i f i c a n t l y in r e c e n t y e a r s . T h e i r g r e a t e r p a r t i c i p a t i o n
in t h e m o n e y m a r k e t h a s e n a b l e d t h e m to r e d u c e t h e i r
r e l i a n c e o n b o r r o w i n g f r o m b a n k s in m o n e y c e n t e r s .
T h e g r o w t h of t h e m a r k e t for R P s r e f l e c t s t h e c h a n g e s
in d e a l e r f i n a n c i n g p a t t e r n s a n d t h e i n c r e a s i n g l y s o phisticated cash management techniques used by
many money market participants. Dealers typically
r a i s e m o r e f u n d s t h a n t h e y n e e d to f i n a n c e t h e i r p o s i t i o n s in s e c u r i t i e s a n d h a v e b e c o m e i m p o r t a n t a s i n t e r m e d i a r i e s in t h e m o n e y m a r k e t .
' S e e " F e d e r a l F u n d s a n d R e p u r c h a s e A g r e e m e n t s " , this R e v i e w
( S u m m e r 1977). p a g e s 3 3 - 4 8 In a r e p u r c h a s e a g r e e m e n t ,
the owner of a security sells it outright to the provider ol funds
a n d a g r e e s to r e p u r c h a s e the issue at a s p e c i l i e d future d a : e
a n d price. In a reverse r e p u r c h a s e a g r e e m e n t , the provider of f u n d s
p u r c h a s e s a security a n d a g r e e s to sell it b a c k at a s p e c i f i e d
future d a t e a n d price T h e s e terms. R P s a n d reverse RPs. a - e
s o m e t i m e s i n t e r c h a n g e d in market p a r l a n c e , h o w e v e r , a n d
R P s are often u s e d to d e s c r i b e the usual transactions o! a r
institution m the m a r k e t — w h e t h e r it is a provider or user of funds.
• The capital a p p l i e d lo trading in G o v e r n m e n t securities represents
the s u m of e a c h n o n b a n k d e a l e r firm's e s t i m a t e d a l l o c a t i o n
of its net worth to its activities in that market. C a p i t a l d a t a e r e
only a n a p p r o x i m a t i o n of the c a p i t a l e m p l o y e d , b e c a u s e it is
likely that the v a r i o u s firms m a y u s e different a n d s o m e w n a t
arbitrary m e t h o d s of e s t i m a t i n g their a l l o c a t i o n of c a p i t a l




C o m m e r c i a l banks have remained the largest source
of f u n d s t o d e a l e r s , but b y 1 9 7 6 t h e s h a r e t h e y p r o vided had slipped to about 40 p e r c e n t from roughly
5 0 p e r c e n t in m o s t e a r l i e r y e a r s ( T a b l e 4 ) . L a r g e c o r p o r a t i o n s o n c e p r o v i d e d m o s t of t h e rest, b u t i n s u r a n c e c o m p a n i e s , s a v i n g s institutions. F e d e r a l l y s p o n sored agencies, and state a n d local governments have
b e c o m e relatively m o r e important. T h e Federal Reserve,
t h r o u g h t h e R P s a r r a n g e d b y its T r a d i n g D e s k , h a s a l s o
p l a y e d a l a r g e r r o l e in p r o v i d i n g f u n d s t o d e a l e r s for
s h o r t p e r i o d s of t i m e . T h e v o l u m e of R P s w i t h t h e
Federal Reserve has g r o w n substantially since mid1 9 7 4 , m a i n l y b e c a u s e of t h e n e e d t o c o u n t e r t h e e f f e c t
o n c o m m e r c i a l b a n k r e s e r v e s of e n l a r g e d f l u c t u a t i o n s
in T r e a s u r y c a s h b a l a n c e s a t t h e R e s e r v e B a n k s . A s a
result, t h e v o l u m e of f u n d s p r o v i d e d b y R P s w i t h t h e
F e d e r a l R e s e r v e r o s e t o a b o u t 1 5 t o 2 0 p e r c e n t of
d e a l e r f i n a n c i n g in 1 9 7 4 t h r o u g h 1 9 7 6 ; in m a n y e a r l i e r
y e a r s it w a s o n l y a r o u n d 5 p e r c e n t .
D e a l e r s e m p l o y t w o b a s i c m e t h o d s of f i n a n c i n g inv e n t o r i e s : e n t e r i n g into R P s o r f u r n i s h i n g s e c u r i t i e s a s
c o l l a t e r a l for a l o a n . T h e r a t e of r e t u r n o n o v e r n i g h t
R P s is r e l a t e d t o t h e F e d e r a l f u n d s r a t e b u t is t y p i c a l l y
b e l o w it, in p a r t b e c a u s e t h e a g r e e m e n t s a r e v i e w e d a s
s e c u r e d l o a n s by m a n y m a r k e t p a r t i c i p a n t s . T h e i n t e r est rate o n collateral loans to dealers by large b a n k s
in m o n e y c e n t e r s is u s u a l l y s o m e w h a t a b o v e t h e F e d e r a l f u n d s r a t e s i n c e t h e b a n k s v i e w t h e latter r a t e a s
t h e c o s t of f u n d i n g t h e l o a n .
Collateral loans have remained a significant source
of d e a l e r f i n a n c i n g d e s p i t e t h e i r h i g h e r c o s t . T h e b a n k s
a r e o f t e n r e s i d u a l s u p p l i e r s of f u n d s w h e n m o n e y
m a r k e t c o n d i t i o n s a r e tight a n d l i q u i d i t y is s c a r c e .
T h u s , c o l l a t e r a l l o a n s a m o u n t e d t o a b o u t o n e t h i r d of
nonbank dealers' financings through collateral loans
a n d R P s c o m b i n e d in 1 9 7 3 - 7 4 b u t t h a t p r o p o r t i o n d e c l i n e d s u b s t a n t i a l l y in 1 9 7 5 - 7 6 ( T a b l e 5). B a n k l o a n s
c a n b e o b t a i n e d l a t e in t h e d a y — a n d o f t e n a r e — a f t e r
d e a l e r s h a v e s e a r c h e d o u t o t h e r s o u r c e s of f u n d s .
They can be used w h e n a dealer agrees during the day
t o t a k e d e l i v e r y that s a m e d a y , s a y , in T r e a s u r y bills, or
e n d s u p w i t h s e c u r i t i e s t h a t w e r e e x p e c t e d to b e s o l d
but w e r e not. D e a l e r d e p a r t m e n t s of c o m m e r c i a l b a n k s
d o not u s e c o l l a t e r a l l o a n s . T h e y rely o n R P s a n d o n
o t h e r f o r m s of f i n a n c i n g a n d o f t e n o b t a i n f u n d s f r o m
their o w n banks.
D e a l e r s a l s o o b t a i n f u n d s to p r o v i d e t h e m t o o t h e r s .
A d e a l e r m a y r a i s e f u n d s t h r o u g h u s e of R P s a n d
provide t h e m to others by arranging a reverse RP.
T h e g r o w t h in h o l d i n g s o f G o v e r n m e n t s e c u r i t i e s b y
m a n y institutions o v e r t h e p a s t f e w y e a r s h a s e n a b l e d
t h e m to sell t h e i r h o l d i n g s t e m p o r a r i l y t h r o u g h R P s
to m e e t s h o r t - t e r m c a s h n e e d s a s a n a l t e r n a t i v e t o
r a i s i n g f u n d s in t h e c o m m e r c i a l p a p e r m a r k e t o r at

F R B N Y Quarterly

Review/Winter 1977-78

45

215
TaOlaS

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banks, in addition, c o r p o r a t i o n s a n d financial institutions h a v e also b e e n willing to invest t e m p o r a r y cash
surpluses in short-term R P s in p r e f e r e n c e to holding
d e m a n d deposits w h i c h p a y no interest.
Frequently the d e a l e r a c t s as a m i d d l e m a n in t h e s e
transactions, obtaining f u n d s f r o m o n e c u s t o m e r to
p r o v i d e t h e m to another. W h i l e the d e a l e r s a r e principals in the transactions, s o m e a r e essentially a c t i n g
as brokers b e c a u s e they " m a t c h " the maturities of
the R P a n d the reverse R P that t h e y a r r a n g e with
c u s t o m e r s . W h e n t h e maturities of such transactions
a r e not e x a c t l y m a t c h e d , the d e a l e r s h o u l d e r s s o m e
risk with respect to interest rates. T h e r e c a n also b e
s o m e risk in that t h e d e a l e r is d e p e n d e n t on the p e r f o r m a n c e of o n e c u s t o m e r in o r d e r to e n s u r e that he
c a n fulfill his obligation to a n o t h e r c u s t o m e r . D e a l e r s
a r e often willing to f i n a n c e t h e p l a c e m e n t of f u n d s
under reverse R P s t h r o u g h a series of R P s w i t h shorter
maturities. T h e u p w a r d s l o p e of the yield c u r v e over
t h e past few years has e n c o u r a g e d this pattern.
T h e s e m o n e y market activities of the d e a l e r s h a v e
g r o w n substantially in recent years. T h e dealers' role
as a financial i n t e r m e d i a r y rivals their use of the m a r ket to f i n a n c e inventories. In 1976, n o n b a n k d e a l e r s
p r o v i d e d $1.8 billion of funds (primarily raised t h r o u g h
RPs) to others t h t o u g h r e v e r s e R P s o n a daily a v e r a g e
basis. In addition, t h e y e n t e r e d into m a t c h e d transactions of $3.4 billion. T h e total, $5.2 billion, w a s s o m e w h a t m o r e than the $4.7 billion they r e t a i n e d for their
o w n u s e — c o l l a t e r a l loans plus R P s e x c l u d i n g r e v e r s e
RPs ( T a b l e 5). In 1 9 7 7 ; t h e intermediation function
c o n t i n u e d to grow w h i l e the v o l u m e of funds retained
d e c l i n e d as inventories fell.

46

F R B N V Quarterly Review/Winter




1977-78

T h e c h a n g i n g s t r u c t u r e of the m a r k e t
T h e structure of t h e m a r k e t has c h a n g e d significantly
s i n c e t h e early 1970's. At w o r k h a v e b e e n a sharp inc r e a s e in trading activity, the c l o s e r trading relationships that h a v e d e v e l o p e d b e t w e e n t h e G o v e r n m e n t
c o u p o n a n d other c a p i t a l markets, a n d n e w entrants.
T h e n e w entrants h a v e b e e n a b l e to take on a significant portion of overall t r a d i n g activity d e s p i t e their
recent entry. A n i n c r e a s e in c o m p e t i t i o n has led to
n a r r o w e r s p r e a d s b e t w e e n bid a n d offered p r i c e s —
particularly for c o u p o n i s s u e s — a n d it has r e d u c e d
m a r k e t c o n c e n t r a t i o n to s o m e extent.
E l e v e n firms w e r e a d d e d to the reporting list f r o m
early 1974 t h r o u g h 1976, including t w o firms that left
the m a r k e t in 1973 a n d 1974 but r e t u r n e d in 1976. T e n
of t h e n e w entrants w e r e n o n b a n k dealers, m a n y of
w h o m w e r e a l r e a d y active e l s e w h e r e in t h e capital
market. T h e y w e r e a t t r a c t e d by t h e e x p a n s i o n of t r a d ing in the T r e a s u r y c o u p o n s e c t o r a n d the opportunity
t o p r o v i d e alternative investment outlets for their customers. T h e lackluster p e r f o r m a n c e of the equities
m a r k e t w a s a n a d d e d factor. A s a group, t h e n e w e n trants h a v e c o n c e n t r a t e d m o r e of their trading in the
c o u p o n sector, with 41 p e r c e n t of their activity in the
m o r e - t h a n - o n e - y e a r maturity a r e a c o m p a r e d with 3 6
p e r c e n t for the o l d e r n o n b a n k firms in 1976 ( T a b l e 6).
T h e n o n b a n k e n t r a n t s a p p e a r to h a v e p l a c e d m o r e
e m p h a s i s on position m a n a g e m e n t a n d arbitrage, in
that t h e y hold lower net positions in relation to t r a d i n g
v o l u m e than o l d e r active n o n b a n k firms. In addition,
they d o not s e e m to have d e v e l o p e d c u s t o m e r relationships to the s a m e extent as the firms active earlier. In
1976 about 50 p e r c e n t of their trading w a s with cus-

216
t o m e r s , c o m p a r e d w i t h 5 9 p e r c e n t for f i r m s in t h e
m a r k e t prior to 1974. S o m e of t h e s e c h a r a c t e r i s t i c s
w e r e h i g h l i g h t e d in e a r l y 1 9 7 7 w h e n t r a d i n g v o l u m e
s a g g e d a s p r i c e s d e c l i n e d . T r a d i n g a c t i v i t y at t h e n e w
n o n b a n k d e a l e r s fell b y r o u g h l y 2 0 p e r c e n t :n e a c h of
the trading participant categories. T h e older nonbank
f i r m s e x p e r i e n c e d a 1 2 p e r c e n t d e c l i n e o v e r a l l , but t h e i r
t r a d i n g in t h e b r o k e r s ' m a r k e t fell b y s o m e w h a t m o r e
t h a n t h e i r t r a d i n g in t h o s e a r e a s i n v o l v i n g e s t a b l i s h e d
customer relationships (direct trading with other deale r s , w i t h c o m m e r c i a l b a n k s , a n d w i t h all o t h e r c u s tomers).
T h e s i z a b l e g r o w t h in t h e n u m b e r of r e p o r t i n g d e a l e r s
h a s c o n t r i b u t e d to a s u b s t a n t i a l d e c l i n e in t h e c o n c e n t r a t i o n of t r a d i n g a c t i v i t y . In t h e l a t e 1 9 6 0 ' s a n d e a r l y
1 9 7 0 ' s , t h e five m o s t a c t i v e f i r m s a c c o u n t e d for a b o u t
half of t o t a l t r a d i n g activity, b u t b y 1 9 7 6 t h e s h a r e of
t h e t o p five f i r m s h a d f a l l e n to slightly m o r e t h a n o n e
third. C o n c e n t r a t i o n of t r a d i n g a c t i v i t y h a d b e g u n to
d i m i n i s h slightly in t h e e a r l y 1 9 7 0 ' s w h e n p a r t i c i p a t i o n in
t h e m a r k e t b e g a n to e x p a n d . E v e n so, t h e s a m e f i r m s
h a v e t e n d e d to r e m a i n in t h e m o s t a c t i v e g r o u p o v e r
the past ten years. O v e r the interval, four firms w e r e
a l w a y s a m o n g t h e five m o s t a c t i v e f i r m s e a c h y e a r , a n d
f o u r o t h e r s w e r e i n c l u d e d at v a r i o u s t i m e s .
E v e n t h o u g h t h e i r s h a r e of a c t i v i t y fell, t h e five m o s t
a c t i v e f i r m s c o n t i n u e d t o a c c o u n t f o r a b o u t half of
dealers' net positions, o n average. Their positions
m a y h a v e r e m a i n e d h i g h e r b e c a u s e of t h e firms' o r i e n tation toward meeting investor demands. About 60
p e r c e n t of t h e t r a d i n g a c t i v i t y b y t h e five m o s t a c t i v e
d e a l e r s w a s d i r e c t l y w i t h c u s t o m e r s , w h i l e for o t h e r
d e a l e r s it w a s a b o u t o n e half ( T a b l e 6).
G r o w t h in t h e n u m b e r of d e a l e r s in r e c e n t y e a r s m a y
h a v e b e e n s t i m u l a t e d in p a r t b y h i g h profits e a r n e d in
t h e i n d u s t r y in 1 9 7 5 a n d 1 9 7 6 , a l t h o u g h d e a l e r r a n k s
h a v e a l s o i n c r e a s e d in 1 9 7 7 w h e n t h e profit p i c t u r e w a s
far l e s s f a v o r a b l e . T h e y e a r s 1 9 7 5 a n d 1 9 7 6 w e r e t w o
of t h e m o s t p r o f i t a b l e e v e r for d e a l e r s , rivaling 1 9 7 0
a n d 1 9 7 1 . T h e T r e a s u r y ' s l a r g e o u t p o u r i n g of d e b t , t h e
l a r g e r t h a n e x p e c t e d d e c l i n e s in i n t e r e s t r a t e s f r o m
record highs, a n d positive carry contributed importantly
to t h e u p s w i n g of t o t a l profits.* In 1 9 7 7 , a g a i n s t a b a c k ' T h e profits r e p o r t e d by the lirms to the F R B N Y s h o u l d b e v i e w e d
a s a n indicator of the g e n e r a l trend rather than a p r e c i s e
m e a s u r e of levels, a s i n e r e a r e several c o n c e p t u a l p r o b l e m s in
c a l c u l a t i n g the firms' profits o n trading in T r e a s u r y a n d F e d e r a l
a g e n c y securities A m o n g the p r o b l e m s a r e the s e p a r a t i o n
ol o v e r h e a d a n d c a p i t a l costs for firms that o p e r a t e in o t h e r m a r k e t s
a n d the c a l c u l a t i o n , for bank d e a l e r s , of the cost of fund::
o b i a i n e d I r o m the parent bank




g r o u n d of f l u c t u a t i n g i n t e r e s t r a t e s , m a r k e t a c t i v i t y
l e v e l e d off a n d p r o f i t s s h r a n k . T h e risks i n h e r e n t in t h e
b u s i n e s s a r e d e m o n s t r a t e d b y t h e profit r e s u l t s f r o m
1 9 6 7 to 1 9 7 4 , for in t h r e e of t h o s e y e a r s d e a l e r s a s a
g r o u p r e p o r t e d b e f o r e - t a x l o s s e s in t h e i r o p e r a t i o n s in
United States Government and Federally sponsored
agency securities.
Conclusions
R e c e n t y e a r s h a v e w i t n e s s e d s u b s t a n t i a l g r o w t h in t h e
G o v e r n m e n t s e c u r i t i e s m a r k e t , b o t h in t e r m s of a c t i v i t y
a n d in t h e n u m b e r of d e a l e r firms. T h e m a r k e t h a s r e s p o n d e d w e l l to s i z a b l e i n c r e a s e s in T r e a s u r y f i n a n c i n g
r e q u i r e m e n t s a n d in F e d e r a l R e s e r v e o p e n m a r k e t o p e r a t i o n s . T h e l i q u i d i t y of G o v e r n m e n t s e c u r i t i e s , p a r t i c u larly c o u p o n i s s u e s — t h e f a c t t h a t t h e y c a n b e c o n v e r t e d into c a s h m o r e q u i c k l y t h a n o t h e r a s s e t s of
s i m i l a r m a t u r i t y — h a s b e e n e n h a n c e d in t h e p r o c e s s .
Consequently, participants c a n carry out investment
d e c i s i o n s r e a d i l y at c o m p e t i t i v e p r i c e s .
I n c r e a s e d a c t i v i t y h a s b o t h c o n t r i b u t e d to a n d r e sulted from the greater efficiency and competitiveness
of t h e m a r k e t . T h e m a r k e t ' s c a p a c i t y t o h a n d l e l a r g e
Treasury financings and Federal Reserve operations
s m o o t h l y h a s e x p a n d e d in r e c e n t y e a r s . T h e m a r k e t is
a l s o b e t t e r a b l e t o w e a t h e r s u r g e s in t r a d i n g a c t i v i t y
p r e c i p i t a t e d b y s h i f t s in p a r t i c i p a n t s ' p e r c e p t i o n s of
the economic outlook. T h e s e e x p a n d e d capabilities are
d u e in p a r t t o t h e i n c r e a s e in t h e n u m b e r of a v a i l a b l e
m a t u r i t i e s , t h e e n h a n c e d a b i l i t y to e s t a b l i s h l o n g or
s h o r t p o s i t i o n s , a n d t h e w i d e r v a r i e t y of i n d e p e n d e n t
d e c i s i o n m a k e r s a c t i v e in t h e m a r k e t . C o m p e t i t i o n h a s
b e e n s t r e n g t h e n e d t h r o u g h t h e l a r g e i n c r e a s e in t h e
n u m b e r of d e a l e r s a n d t h e r e s u l t i n g r e d u c t i o n in m a r ket concentration.
T h e e x p a n s i o n in t h e m a r k e t a n d in a c t i v i t y h a s not
been an unmixed benefit, however. Trading has taken
o n s p e c u l a t i v e o v e r t o n e s at t i m e s , w h i c h m a y w e l l h a v e
e x a c e r b a t e d t h e volatility of p r i c e s . P a r t i c i p a n t s — i n
s e a r c h i n g for i n f o r m a t i o n a b o u t t h e p r o b a b l e c o u r s e of
interest r a t e s — h a v e i n c r e a s e d their focus on. a n d rea c t e d m o r e to, t e m p o r a r y p h e n o m e n a . T h e e m p h a s i s
o n t r a d i n g a n d p e r f o r m a n c e m a y not a l w a y s h a v e b e e n
a c c o m p a n i e d b y a d e q u a t e a p p r e c i a t i o n of t h e inc r e a s e d p o s i t i o n a n d c r e d i t risks t h a t d e r i v e f r o m t h i s
a p p r o a c h . E x p e r i e n c e in 1 9 7 7 s e e m s t o h a v e s e r v e d a s
a p e r t i n e n t r e m i n d e r of t h e s e risks. T h e d e a l e r s in
the market confront a n e w challenge to d e v e l o p a n d
m a i n t a i n a c t i v i t y in t h e m o r e c a u t i o u s but i n c r e a s i n g l y
competitive market environment with which 1978 begins.

Christopher J. M c C u r d y

FRBNY Quarterly Review/Winter 1977-78

47

217
FEDERAL RESERVE BANK OF PHILADELPHIA

Federal Deficits:

A Faulty Gauge
of Government's Impact
on Financial Markets
by Brian Horrigan andAris

Protopapadakis*

In the ongoing debute ubow ;/i< impii; t of government b o r r o w i n g on f inancial markets, the
focus usually renters on the
nf Federal budget deficits. In the following article, the authors
argue that l o o k i n g only at the deficit can 'nuke for misleading conclusions about government's
influen-.e on ihe credit markiMs. They p r o p o s e a more comprehensive measure which often

behaver differently than the Fcdeial deficit The views expressed here are those of the authors

and should not be identified <is rl'licial v i r u s of the Federal Reserve Rank of Philadelphia o r t h e

Federn! !<es* rve System. - Don ild I. Mi-lliueaux. Senior Vice President and Chief Economist,
Federal Reserve Bank of PhiJn lelphia
Newspapers and magazines frequently
warn about the dangers of big Federal budget
deficits, claiming that the recent large deficits
have pushed interest rates to record highs.
The continuing debate over tax and expenditure cuts illustrates the importance many
people attach to Federal budget deficits.
Projections of large deficits appear to have
prompted the Administration tt; request

"Briar. Horrigan received his P h . D . from the University of California at Los A n g e l e s and joined the I'hila
delphia Fed in 19ft0. H e specializes ir< monetary and
financial e c o n o m i c s . Arts P r o t o p a p a d a k . s is Research
O f f i c e r and E c o n o m i s t at the Philadelphia Fed. H e
received I:is Ph ) f r o m th»-University if < ihicago.




more expenditure cuts for 1982, and these
projections have sparked a lively debate
within the Administration on whether to
propose sizable tax increases for 1983. Some
members of Congress continue to advocate
rolling back recent tax cuts or increasing
other taxes in order to reduce the deficit.
People are concerned about budget deficits
because they equate them with increased
government borrowing from the private sector and increased government competition
with private investors. They fear that when
the U.S. Treasury borrows more, fewer
funds will be available for private investment and interest rates will rise. But does a
bigger budget deficit necessarily mean that

207
Table 1
U n i t e d States Treasury Dabt
In billions of doflare
Amounts outstanding on
December 31.
June 30,
1975
1977

December 31.
1966

Grata

nubile debt
Nortmarketabte debt . . . . . . .
Marketable debt

290
101
189*

'

Marketable by type ol eecurHy:
Bills
Notes.
Bonds
Marketable by type of hoWent
united States Government accounts
Federal Reserve System
Commercial banks
Mutual savings banks
insurance companies
Other corporations
State and local governments
Individuals
Foreign and International
Other investors

—
,
...

321
106
215

369
140
248

213
363

674
242
431

39
51
80

.

December 31,
1970

60
50
104

88
101
59

157
167
39

155
233
43

8
27
62
6
10
19
19
20
10
7

12
41
61
8
10
16
23
22
11
16

M
62
63
3

19
88
85
5
9
20
33
24
44
36

15
102
102
6
14
24
39
28
65
35

7

7
28
29
13
22

57
7

Discrepancies in totals are due to rounding
* Includes $18 billion of certificates of indebtedness,
t Partially estimated.
Source: Treasury Bulletin

T r e a s u r y i s s u e s in m i d - 1 9 7 7 . 1 T h e g r o w t h of f o r e i g n
h o l d i n g s of T r e a s u r y s e c u r i t i e s m a i n l y r e f l e c t e d f o r e i g n
c e n t r a l b a n k i n v e s t m e n t s o f d o l l a r s o b t a i n e d in e x c h a n g e market operations as well as substantial acquisitions by oil-exporting nations. State a n d local gove r n m e n t s i n v e s t in s h o r t - t e r m T r e a s u r y s e c u r i t i e s t o
b r i d g e t h e g a p b e t w e e n t h e t i m i n g of p e r i o d i c t a x r e ceipts and Federal grants-in-aid and the more continuous flow of p a y m e n t s for g o o d s a n d services.
I n d i v i d u a l s h o l d a c o n s i d e r a b l e v o l u m e of m a r k e t able Treasury issues even though there are several
factors tending to inhibit p u r c h a s e s by small investors.
T h e transactions costs for small purchases a n d sales,
the cost of custody, a n d large m i n i m u m d e n o m i n a tions for shorter t e r m issues h a v e t e n d e d to restrain
p u r c h a s e s b y i n d i v i d u a l s e x c e p t in p e r i o d s w h e n m a r ket yields o n T r e a s u r y securities m o v e d substantially
a b o v e those on alternative liquid investments, mainly
t h r i f t a n d s a v i n g s d e p o s i t s . ( T h e m a j o r p o r t i o n of t h e
T r e a s u r y d e b t h e l d by individuals consists of s a v i n g s
}

Fcresgr .f ^osiois aiso held about $22 b'llior- c* nonmarketabie
"refsuiy ser;uri!'es i mid-197n
38

FrtBNY Quarterly Review/Winter




1977-73

b o n d s with small denominations. T h e y a r e not m a r k e t able, but they are r e d e e m a b l e prior to maturity.)
The dealer market
T h e m a r k e t for United States G o v e r n m e n t securities
centers o n the d e a l e r s w h o report activity daily to t h e
F R B N Y . T h e d e a l e r s buy a n d sell securities for their
o w n account, arrange transactions with both their
customers a n d other dealers, and also purchase debt
d i r e c t l y f r o m t h e T r e a s u r y for r e s a l e to investors. In t h e
n o r m a l c o u r s e of t h e s e activities, they h o l d a s u b s t a n tial a m o u n t of securities. In a d d i t i o n to t h e d e a l e r firms,
t h e r e a r e b r o k e r s t h a t s p e c i a l i z e in m a t c h i n g b u y e r s
a n d s e l l e r s a m o n g t h e d e a l e r s in t h e G o v e r n m e n t s e curities market.
T h e d e a l e r f i r m s i n c i u d e d e a l e r d e p a r t m e n t s of c o m m e r c i a l b a n k s ( b a n k d e a l e r s ) a n d all o t h e r s ( n o n b a n k
dealers). Bank dealers call upon the custodial and
o t h e r facilities of t h e b a n k a n d f r e q u e n t l y o b t a i n a
portion of t h e f i n a n c i n g of their securities h o l d i n g s
f r o m the bank. T h e bank dealer often acts to m e e t the
n e e d s o * t h e c o r r e s p o n d e n t b a n k s of t h e p a r e n t . I n

218
BUSINESS REVIEW

the government sector is a bigger drain on
credit markets? We argue that the deficit is not
a reliable indicator of government's drain on
credit markets. The Federal deficit is an
incomplete measure of government borrowing
because it does not include all government
borrowing. More importantly, all government borrowing must be adjusted for inflation
before it can be used as a gauge of government's competition with private borrowers.
An alternative measure which we call "government net borrowing" accounts for all
government borrowing and is adjusted for
inflation to do a better job of gauging government's drain on the credit markets.
GOVERNMENT GROSS BORROWING
So far as the credit markets are concerned,
what matters is how much the government
sector borrows from the public. The Federal
budget deficit measures only part of the
government sector's borrowing activity.
Other government units and related b o d i e s such as off-budget Federal agencies and state
and local governments—also compete for
funds in the credit markets by issuing their
own debt, and these agencies often lend
funds to the Treasury as well. To obtain the
right total, the borrowing of all government
units has to be added together and what they
lend to each other has to be subtracted out.
W e label the resulting magnitude "government gross borrowing." Government gross
borrowing measures the amount of money
the government sector borrows from the
public.
Off-Budget Agencies Borrow, Too, . . .
The Federal government borrows funds that
do not appear in the Federal budget. Federally
owned agencies, such as the Postal Service
and the Tennessee Valley Authority, have
the authority to borrow in the credit markets,
but their activity does not explicitly appear
anywhere in the unified Federal budget.
Also, some Federally sponsored agencies,
such as the Farmers' Home Administration
and the Rural Electrification Administration,




MARCH/APRIL 1 9 8 2

can borrow directly from the Treasury via the
Federal Financing Bank.1 The Treasury lends
to these agencies and to the Federal Financing
Bank by borrowing directly from the public. 2
This kind of Treasury borrowing also does
not appear in the unified Federal budget.
Thus, even if the unified budget is balanced,
gross borrowing from the public can be large.
The annual increase in total Federal debt
includes all Federal borrowing, whether the
Treasury is involved in it or not. 3 Column 1 in
Figure 1 gives the Federal budget deficits as
reported by the Treasury while column 2 in
Figure 1 gives total Federal borrowing. The
data show that in some years total Federal
borrowing was over $20 billion more than the
Federal budget deficit.
In addition to off-budget borrowing, there
are other government obligations that should
be taken into account in a comprehensive
measure of the debt (see W H A T IS FEDERAL
DEBT? overleaf). Since it is not possible to
measure these obligations accurately, we do
not include them in the calculations that
follow. Adding accurate estimates of these
obligations to the measures of borrowing
developed here could change some of the
conclusions.
1 F o r a detailed analysis of the Federal government's
o f f - b u d g e t a c t i v i t i e s , see D a v i d R e s l e r a n d R i c h a r d L a n g ,
"Federal A g e n c y Debt: A n o t h e r Side o f Federal Borr o w i n g , " Review, F e d e r a l R e s e r v e B a n k o f S t . L o u i s ,
N o v e m b e r 1 9 7 9 . A l s o see John F i a l k a , " G r o w i n g G i a n t :
U . S . Lender, Bigger T h a n Citibank," T h e W a l l Street
Journal, D e c e m b e r 1 5 , 1 9 8 1 ; a n d H . L e o n a r d a n d E .
Rhyne, "Federal Credit and the 'Shadow Budget'," T h e
Public interest, F a l l 1981.
2 F o r e x a m p l e , as o f the e n d o f June 1981, the Student
Loan Marketing A s s o c i a t i o n ( S L M A ) o w n e d $ 3 . 4 billion
o f Federally guaranteed student loans. T h e S L M A purchased the loans by issuing debt. T h e Federal F i n a n c i n g
B a n k ( F F B ) p u r c h a s e d t h e S L M A d e b t b y i s s u i n g its o w n
debt, a n d the T r e a s u r y in turn purchased the F F B debt.
I n effect, the Treasury borrowed m o n e y f r o m the public
to l e n d to students.
3 A m o r e precise calculation w o u l d involve using the
m a r k e t v a l u e o f t h e n e w T r e a s u r y issues r a t h e r t h a n
their par value. H o w e v e r , the differences between par
and m a r k e t vaiue are small.

219
FEDERAL RESERVE BANK OF PHILADELPHIA

FIGURE 1

ANNUAL INCREASES
IN TOTAL GOVERNMENT DEBT HELD BY THE PUBLIC
CAN BE QUITE DIFFERENT FROM THE BUDGET DEFICIT*
(1)

(2)

(3)

(4)

Year

Reported
Federal
Budget
Deficits

Increases in
Total
Federal Debt

Increases
In Total
Government
Debt

Increases in
Privately Held Total
Government Debt
(Gross Borrowing)

1981

61.6t

98. Ot

119.3t

89. Ot

1960

61.2

64.5

108.9

90.3

1979

14.8

54.5

72.7

43.4

1978

29.2

68.5

90.9

60.2

1977

46.4

63.7

80.9

53.2

1976

53.1

77.9

91.0

63.0

1975

69.3

63.6

97.2

83.3

1974

11.5

23.3

38.1

24.7

1973

5.6

20.4

33.3

11.9

1972

16.8

25.1

39.3

26.0

•In billions of dollars. All figures are reported on a calendar year basis.
tPreliminary estimates.
SOURCES:
Federal deficits are from the Economic Report of the President 1082. Deficits are calculated by the NIP A
method, which is based on accrual, unlike the unified budget deficit, which is based on cash flow.
For 1972-78. Federal debt outstanding, Federal debt held by agencies, Federal debt held by state and local
governments, and Federal debt held by the Federal Reserve are taken from the Annual Statistical Digest (19701979J. After 1976, these data are taken from the Federal Reserve Bulletin, January 1982.
State and local government data are taken from the Flow of Funds Outstanding, September 1981. State and
local debt outstanding data are from p.39, line2, while internal holdings of state and local debt and holdings of the
retirement funds are from p. 39, lines 9 and 15 respectively.




220
B U S I N E S S REVIEW

MARCH/APRIL 1 9 8 2

WHAT IS FEDERAL DEBT?
In this article, we define the Federal debt as the sum of all the notes, bonds, and bills issued by the
Treasury and other Federally owned agencies. But is this all the Federal debt? Debt is nothing more
than an obligation, and the Federal government has many obligations that do not take the form of
Treasury debt. An important example of obligations not included in the Federal debt is the Federal
program of loan guarantees for private debt. The Federal government guarantees hundreds of
billions of dollars of private loans against default risk, and it also has assumed hundreds of billions of
dollars' worth of insurance commitments. According to the Treasury (as reported by U. S. News and
World Report, May 4,1981), Federally guaranteed private loans were $323.6 billion in 1980, and
Federal insurance commitments were $2,217.4 billion.
The majority of the loan guarantees are for mortgages and housing loans ($219.7 billion). It would
be absurd to add private mortgages to the national debt just because the Federal government
guarantees the mortgages. If, by chance, none of the mortgages defaulted, the guarantees would cost
the Treasury nothing. But if all of the mortgages defaulted, the Treasury would be stuck with having
to pay off all of the mortgages. It would also end up owning the housing behind these mortgages. A
sound strategy for the Treasury is not to include loan guarantees in the Federal debt; instead it could
create a sinking fund to cover loan defaults, and make a fixed payment into the sinking fund every
year. The annual payment would have to be large enough to keep the fund liquid and should be
adjusted with the default experience. That way, the cost of these guarantees would appear in the
budget, and Congress and the public would be forced to recognize and deal with the cost of loan
guarantees. The same principle applies to insurance commitments.
Another serious problem with measuring the Federal debt concerns the actuarial deficits of the
retirement and compensation programs of the Federal government. The Federal government
obligates itself to pay retirement benefits to members of the armed forces and the Civil Service. It
cannot morally renege on those obligations. If the government does not fund the retirement programs (as
private pension and life insurance programs dc), then the debt of the Federal government increases—
that is, the government has committed itself to pay benefits for which it doesn't have funds. In 1980,
the actuarial deficit of retirement and compensation programs (military, Civil Service, veterans,
railroad, Foreign Service, Public Health Service) was estimated at $631 billion. These liabilities are
part of the Federal debt and should be included in it. If the government commits itself to funding
these liabilities fully, then it should create an asset position that exactly offsets its total pension
liabilities. We have not included unfunded pension liabilities in the estimates of government net
borrowing only because the estimates of the actuarial deficits are unreliable.
The above principle does not apply to Social Security. Social Security benefits and taxes are set by
Congress and may be changed at any time. The $l,464-billion actuarial deficit of the Social Security
trust funds in 1980 only indicates that Social Security needs reform, not that the Federal debt is
mismeasured. Changes in the law could easily eliminate the entire actuarial deficit of the Social
Security Administration.

. . . As Do State and Local Governments. Even adding in the off-budget Federal
agencies doesn't give a complete picture of
government borrowing. A large portion of
government financing activity occurs at the
state and local levels. It does not matter to
private borrowers whether the Federal, state,
or local government competes with them for




available funds. Therefore, from the viewpoint of the private credit markets, the correct
measure of government borrowing must
include Federal, state, and local government
borrowing, not Federal borrowing alone.
Column 3 in Figure 1 shows the annual
borrowing of the combined Federal, state,
and local governments for the past decade.

FEDERAL RESERVE BANK OF PHILADELPHIA

The consolidated government borrowing is
always larger than Federal borrowing alone,
and it is much larger than the Federal deficits.
For instance, though the 1979 Federal deficit
was less than $15 billion, total government
borrowing was almost $73 billion. But not all
of the increases in the Federal, state, and
local debt represent a drain on private credit
markets; some of this debt is purchased by
Federal agencies, by the Federal Reserve
System, and by state and local governments.
Not All Government Debt Is Held by the
Public. A sizable portion of Federal debt is
currently owned by Federal agencies,
primarily the Social Security Administration.
Since Social Security receipts almost always
exceed outlays (they have in 9 of the last 10
years), the Social Security Administration
purchases more Federal debt each year. Debt
issued by the Treasury doesn't affect the
credit markets if it is purchased by a Federal
agency such as the Social Security Administration. Thus, increases in debt holdings of
Federal agencies must be subtracted from the
total increase in Federal debt. Increases in
the Federal Reserve System holdings of
Treasury debt must be subtracted for the
same reason. *

in the credit markets, increases in state and
local government debt holdings must be subtracted from the total increase in government
debt as well.
The calculations for 1980 illustrate the
magnitude of the adjustments discussed
above. In 1980, Federal debt increased by
$84.5 billion while the state and local debt
increased $24.4 billion, for a total increase of
$108.9 billion. Of this increase, the Fed
purchased $3.8 billion, Federal agencies
purchased $5.4 billion, and state and local
governments purchased an additional $9.4
billion. Thus, only the remaining $90.3 billion
of government debt was available for purchase by the public.

And so must holdings of state and local
governments. These governments typically
are prohibited by their constitutions from
running current account deficits. On average,
they run surpluses which they often use to
purchase their own debt and Treasury debt.
To gauge the impact of government borrowing

Column 4 in Figure 1 shows the increases
in the consolidated government debt held by
the public—government gross borrowing.
This borrowing is always larger than the
reported Federal budget deficit, but in some
cases it is smaller than the increases in total
Federal debt. Gross borrowing is smaller
than increases in the Federal debt whenever
agencies, the Federal Reserve, and state and
local governments buy back more debt than
they issue.
Gross borrowing is an accurate measure of
the money government borrows from the
public to finance its expenditures. Compared to
this measure, Federal deficits understate the
amount of money government borrows. But
even gross borrowing may be an inadequate
and misleading measure of the government
sector's impact on credit markets, because

4 The case for subtracting debt held by the Federal
Reserve is less clear cut than that for Federal agencies
and state and local governments. The Federal Reserve
annually purchases a certain amount of Treasury debt,
and in that respect it acts just like a Federal agency. It
purchases this debt, however, by selling new reserves to
the banking system. One could argue that the Federal
Reserve is only converting interest-bearing Treasury
debt to non-interest-beartng Federal Reserve debt, and
that this debt represents as much of a demand on the
credit markets as Treasury debt. Those who believe that
government borrowing can crowd out private invest-

ment assume that consumers consider purchases of
government debt and private corporate debt equivalent.
Consumers do not realize that excess government debt
may mean increased future taxes. There is not much
disagreement, however, that individuals do not view
purchases of bonds (government or private) and money
as being equivalent. Thus the response of the financial
markets to increases in the supply of reserves (and
consequently money) will be different than their
response to increases in the supply of government
bonds, so that reserves and government debt should not
be added together.

O - B? - ! =
>




B U S I N E S S REVIEW

gross borrowing greatly depends on the inflation rate. Gross borrowing seriously overstates government's impact on credit markets
when prices are rising, because inflation
increases the interest rate government must
pay on its debt while it reduces the real value
of government bonds held by the public.
GOVERNMENT BORROWING
A N D CREDIT MARKETS:
W H A T ' S THE CONNECTION?
A higher inflation rate automatically results
in larger government gross borrowing,
because interest rates are higher when inflation is higher. But does an inflation-induced
rise in government borrowing mean that the
government is competing for more funds in
the credit markets? Only when gross borrowing rises more rapidly than prices is
government a drain on the credit markets.
Therefore, gross borrowing figures need to
be adjusted for the effect of inflation to get a
good measure of government's impact on
credit markets.
A s inflation increases, the interest that
government pays on its debt rises. 5 The
higher interest compensates bondholders for
the inflation-caused erosion of the real value
of their bonds (see I N F L A T I O N A N D
INTEREST RATES). If these people are to
restore the purchasing power of their bondholdings, they must use the portion of the
interest payment that compensates them for
inflation—the inflation premium—to purchase additional bonds. Therefore, increases
in government debt that keep the real value
of the debt constant don't add to government's
claims on the financial resources available
for private investment.
Inflation causes government borrowing
requirements to increase. But this increased
demand for funds can be met by the private
5 The Federal government alone has accumulated a
large debt ($1 trillion), and a significant part of its budget
goes to interest payments on this debt (almost $96 billion
in fiscal 1981).




MARCH/APRIL 1 9 8 2

sector without affecting consumption and
investment, because the inflation premium
makes enough funds available to finance the
additional borrowing. Therefore, judging the
impact of government borrowing in the credit
markets without accounting for the effect of
inflation is highly misleading. In fact, two
economies can be identical in real terms, but
if they experience different inflation rates,
the government deficits and the amounts of
new debt the two governments must issue
can behave very differently.
Figure 2 gives an example of two such
hypothetical economies. Transylvania and

INFLATION
AND INTEREST RATES
Interest rates, including those on government debt, are influenced by inflation because
interest involves payment in the future, and
tomorrow's dollars may be worth far less in
terms of goods and services than are today's
dollars. For example, if a $100 loan today is
repaid with $102 a year from now, the nominal
interestrateon that loan is 2 percent. If there
is no inflation, the 2 percent is also the real
interest rate—real because $102 buys 2 percent more goods than $100 does. But if there is
inflation, the real interest rate differs from
the nominal interest rate. Inflation causes the
purchasing power of the dollar to depreciate;
future dollars buy fewer goods than current
dollars. Lenders want compensation for any
expected depreciation of their dollars caused
by inflation. If anticipated inflation rises
from zero to 10 percent, for instance, the
nominal interest rate must increase by 10
percentage points (to 12 percent) just to hold
the purchasing power of the principal
constant. Only in this way will the real interest
rate remain at 2 percent; 12 percent more
dollars ($112) buys 2 percent more goods after
the price level rises by 10 percent. The
additional $10 of interest payment (the
inflation premium) doesn't represent real
income, because it only offsets the lost purchasing power of the $100 principal.

223
FEDERAL RESERVE BANK O F PHILADELPHIA

Ruthenia have the same unchanging real
(inflation-adjusted) consumption and investment, real interest rates, real government
purchases and taxes, and real national debt.
The two economies have different rates of
inflation, though. Transylvania has no inflation, while Ruthenia maintains a steady
10-percent rate of inflation. Every year,
Ruthenia's nominal consumption and investment, nominal government purchases and
taxes, and nominal debt rise by 10 percent,
but in real terms nothing changes. Transyl-

vania has a balanced budget, while Ruthenia
has an ever increasing budget deficit and
increasing gross borrowing. Yet this budget
deficit (or gross borrowing) has no impact on
the Ruthenian economy because the real value
of government debt does not change. The
budget deficit (100 billion Ruthenian dollars
in the first year) is exactly equal to the inflation
premium the government pays on its debt,
and it serves to keep the real value of the debt
constant.
The quantity that correctly measures the

VIGURE2

INFLATION MEANS THAT TWO ECONOMIES
CAN BE IDENTICAL IN REAL TERMS,
BUT HAVE VERY DIFFERENT BUDGET DEFICITS*

j£s£

(1)
(2)
m
(4)
(5)
(6)
(7)
(8)
Govern- GovernGovernment
ment
ment
Expenditures
Gross
Net
Private
for Goods
Interest
Budget Government Borrow- Borrow- Consumption
* Services Payments Taxes Deficit
Debt
lag
Ing ft Investment

iPSANSYLVANIA
Inflation 0%, Nominal ft Real Interest Rate 2%
1
2
;9

600
600
600

20
20
20

620
620
620

0
0
0

1,000
1,000
1,000

0
0
0

0
0
0

2,400
2,400
2,400

ftUTHENIA
Inflation 10%, Nominal Interest Rate 12%. Real Interet Rate 2%
(real values in parentheses)
1
2
S

600(600)
660(600)
726(600)

120
132
145.2

620
682
750.2

100
110
121

1,000(1,000)
1,100(1,000)
1,210(1,000)

*t& billions of Transylvanian and Ruthenian dollars.




100
110
121

0
0
0

2,400(2,400)
2,640(2,400)
2,904(2,400)

224
B U S I N E S S REVIEW

MARCH/APRIL 1 9 8 2

impact of government borrowing on the credit
markets of both economies is government
net borrowing, shown in column 7, Figure 2.
Government net borrowing is the change in
the real value of the government debt,
expressed in current dollars. While gross
borrowing is very different for the two
countries, net borrowing is the same, reflecting
the fact that the two economies are identical
except for inflation.
But how is Ruthenia's inflation-induced
government gross borrowing financed without causing a drain on the credit markets?
The households in Ruthenia provide the
funds by saving the inflation premium
component of the interest payments on
government debt. This is the only saving
strategy that allows them to maintain both
the real value of their consumption and the
real value of their wealth in the face of rising
prices. Thus the increase in the dollar savings

of the households is just equal to the dollar
increase in government borrowing, leaving
both real savings and real investment unchanged. A numerical example of a typical
Ruthenian household may serve to illustrate
the case.
Consider a family with wage income of
$25,000 and accumulated savings of $20,000,
all invested in one-year government bonds.
Suppose there is no inflation and the interest
rate is 2 percent, resulting in $400 of interest
payments. To simplify the example assume
that this family consumes all its wage and
interest income—it undertakes no new saving.
Over time, its assets (bonds) remain at
$20,000 and its consumption at $25,400
(Figure 3, panel a).
If inflation suddenly increases to 10 percent and is expected to stay there, the interest
rate rises to 12 percent (fully reflecting
inflation), and the family's wages rise at the

FIGURE 3

TO KEEP REAL CONSUMPTION CONSTANT,
HOUSEHOLDS MUST SAVE MORE
WHEN THERE IS INFLATION

i

PI
(2)
(3)
(4)
(5)
Current
Current
Wage Interest Total
Value of
Value of
Tftwr Income Income Income Consumption Saving

(6)
(7)
(8)
Current
Real Value of Value Real Value
Consumption of Assets of Assets

(a) Inflation 0%, Interest Rate 2%
1
4
8

2*.000
19,000
91.000

400
400
400

25,400
25.400
25.400

25.400
25.400
25.400

0
0
0

25.400
25.400
25.400

20,000
20,000
20.000

20.000
20,000
20,000

20,000
22,000
24.200

20,000
20.000
20.000

(b) Inflation 10%, Interest Rate 12%
\
I
l

v.

l
*
f.,

25,900
£7,200
00,1159




2,400
2.040
2.904

27,400
80.140
48.154

25,400
27.040
20.784

2.000
2,200
2,420

25.400
25,400
25.400

225
FEDERAL RESERVE BANK OF PHILADELPHIA

10-percent inflation rate (Figure 3, panel b).
For the first year, the family's total income is
higher because of the higher interest rates.
Can this family still consume all its income
and maintain the purchasing power (real
value) of its assets? Obviously not, because
inflation erodes the purchasing power of its
bonds. If this family consumed all its new
income, by the end of the third year its assets
would be worth only $16,529 in today's
Ruthenian dollars. Instead, it must save the
inflation premium built into the nominal
interest rate and buy more government bonds
with that money. Only this behavior will
allow the family's real consumption and its
real assets to remain the same as before.

to increases in net borrowing and therefore
would not represent a drain on credit markets.
Net borrowing is the correct gauge of any
potential crowding out of private borrowers
from the credit markets. 7
The argument so far is made as if inflation
is fully anticipated. But, realistically, inflation
is never fully anticipated, and forecasts of
inflation are often far off the mark. Under
these circumstances, is government net borrowing still the correct measure of the government's impact on the credit markets? A s
discussed in detail in the Appendix, government net borrowing is a correct measure
even when inflation is not fully anticipated.

Figure 3 (panel b) shows the details of the
family's new saving strategy. The key point
is that the inflation premium built into interest rates is not truly income. Rather, it
compensates investors for the loss of the
purchasing power of their nominal investments (bonds). The family in the example
must save all of the inflation premium component of the interest payments to keep its
real wealth constant. In dollar terms (though
not in real terms), this family is saving more
than it used to, making more funds available to
buy government bonds.

IS GOVERNMENT A NET BORROWER?
With an inflation-adjusted measure of
government borrowing, it is possible to find
out whether the government sector might be
crowding out private investment by calculating the net borrowing of government. 8
Columns 1 and 2, Figure 4 (overleaf), show
Federal net borrowing and total net borrowing, respectively. These figures show
that government net borrowing has been far
smaller than the Federal deficit or gross

The examples about government and household finances show that inflation causes
budget deficits and government gross borrowing to increase. But this increase can be
exactly met by an equal increase in the dollar
savings of the households. 6 Thus, though
such inflation-induced deficits may seem
alarmingly large, they are not due necessarily

simplifies that task, without changing the conclusion.

6 T h e e x a m p l e s in the text and in the a p p e n d i x assume
that inflation is n e u t r a l — t h a t is, real G N P , the real rate
of interest, and real investment are not a f f e c t e d by inflation. G i v e n the current structure o f tax l a w s it is highly
u n l i k e l y that i n f l a t i o n is n e u t r a l i n the U . S . H o w e v e r ,
though inflation m a y cause some real variables to change
at the same time as it increases deficits, w e try to focus
o n the deficits a n d t h e i r i m p a c t , l e a v i n g out the effects of
i n f l a t i o n o n the e c o n o m y . A s s u m i n g neutrality greatly




Another feature of our example is the absence of taxes
on interest income. That omission is readily remedied by
thinking about these rates of interest as after-tax rates.
7 S e e G . V . Jump, "Interest Rates, I n f l a t i o n E x p e c tations, and Spurious Elements in M e a s u r e d Real Income
and Savings," American E c o n o m i c Review, D e c e m b e r
1980, a n d J. Siegel, " I n f l a t i o n - I n d u c e d Distortions in
G o v e r n m e n t a n d P r i v a t e S a v i n g Statistics," R e v i e w o f
E c o n o m i c s and Statistics, F e b r u a r y 1 9 7 9 f o r a similar
analysis. T h e E c o n o m i c Report o f the President 1982
also adjusts deficits f o r inflation. See C h a p t e r 4,
Appendix.
8 T o c o m p u t e net b o r r o w i n g , w e use a price index to
deflate the end-of-year gross debt. T h i s procedure gives
an estimate of real debt. T h e a n n u a l change in real debt
gives real net b o r r o w i n g ; m u l t i p l y i n g that by the price
index gives net b o r r o w i n g in current dollars. T h e price
index is the geometric average o f the G N P deflators f o r
the last quarter o f the year and the first quarter o f the
f o l l o w i n g year.

226
BUSINESS REVIEW

MARCH/APRIL 1982

FIGURE 4

NET BORROWING GENERALLY HAS BEEN SMALL
RELATIVE TO INVESTMENT*
(1)

(3)

(4)

Federal
Nat Borrowing
1981
80
1979
78
77
76
75
74
73
72

(2)
Total
Government
Net Borrowing

Net Private
Investment

Total
Net Government
Investment

23.2t
19.7
-12.9
1.3
13.8
37.7
56.0
-15.6
-16.5
1.4

19.0t
16.2
-14.6
3.0
17.0
36.8
52.8
-20.0
-18.2
9.5

130.2t
132.6
193.5
186.6
154.5
119.0
89.2
105.4
145.6
115.5

26.5
32.9
23.7
17.4
12.0
15.5
18.2
18.6
16.4
16.3

"Billions of dollars.
tBased on most recently available estimates.
SOURCE: Survey of Currant Business. Net real government Investment is the annual change in the net physical
capital stock owned by the government sector as reported In the National Income and Product Accounts. This
capital stock includes all equipment and structures owned by Federal, state, and local government and government-owned enterprises. Net private investment, column 3, is calculated by adding the net private investment
shown in the National Income and Product Accounts (Gross Investment minus capital consumption allowances)
to net consumption of durable goods. Net consumption of durables is calculated by applying a 20-percent
depreciation rate to the stock of durables and subtracting that from durables consumption in the National Income
and Product Accounts.
borrowing figures would suggest. Often net
borrowing is negative: the public reduced its
real holdings of government debt in those
years. When net borrowing is negative,
government in effect supplements savings
available for private investment. 9
The figures show that government net

borrowing was substantial only during the
1975 recession and the ensuing recovery.
There is some government net borrowing
also in 1980, the year of a sharp, but shortlived, downturn. It is not surprising that net
borrowing, especially Federal net borrowing,
rises during recessions; the increase in bor-

9 T O the extent that inflation is fully anticipated,
negative net borrowing implies a flow of funds to the
public. I f inflation is completely unanticipated, there is
no actual flow of funds. However, the unanticipated

capital loss on government bonds will cause households
to save more out of their income to rebuild their wealth
position. Thus negative government net borrowing in
effect increases the supply of private savings.




227
FEDERAL RESERVE BANK OF PHILADELPHIA

rowing coincides with the recession-induced
decline in tax revenues. 10
One way to assess the potential impact of
government net borrowing on the credit
markets is to compare it to net private investment (see column 3, Figure 4). The data
show that net government borrowing was
very small relative to net private investment
in the last decade. Thus the potential drain of
government on the credit markets has been
relatively small. For instance, in 1980 net
government borrowing was only 12 percent
of net investment and in 1978 it was less than
2 percent. Only during the 1975 recession
was government borrowing large relative to
private investment, and that was a result
mainly of the recession.
Another way to gauge the significance of
government net borrowing is to compare it to
government net investment. Net government
investment measures the net addition to the
physical capital stock (items such as buildings,
bridges, highways, and defense installations)
owned by the Federal, state, and local governments. These data are shown in column 4,
Figure 4. Government net borrowing is
considerably smaller than government net
investment, except during periods of recession.
Government has been collecting more taxes
than it needs in order to finance its current
expenditures. All of net borrowing and some
lax revenues go to finance government investment projects—a situation which raises
policy issues (see SHOULD GOVERNMENT
INVESTMENT PROJECTS BE FINANCED
WITH TAXES? overleaf).
The results of our analysis show that the
size of government net borrowing usually
has been small compared to the amount of

1 0 I f t h e g o v e r n m e n t w e r e t o t r y t o h o l d d o w n its n e t
b o r r o w i n g b y r e d u c i n g its e x p e n d i t u r e s a n d r a i s i n g
t a x e s d u r i n g a r e c e s s i o n , it w o u l d d e s t a b i l i z e t h e
e c o n o m y unnecessarily, a n d a deeper recession could
result. T h e potential i m p a c t o f net g o v e r n m e n t b o r r o w i n g
must be evaluated over the business cycle and not year
by year.




either private investment or government
investment. It is difficult to see how these
relatively small amounts of net borrowing
could have caused the record high interest
rates experienced recently.
Using the concept of government net borrowing can help put the projected budget
deficits in perspective. The Administration's
most recent forecast is a $97-billion deficit
for calendar 1982. This deficit is by far the
largest ever. Nonetheless, this large deficit
represents only about $46 billion in Federal
net borrowing according to our estimates.11
By historic standards $46 billion of net borrowing is large, but it is much less (47-percent
less in real terms) than Federal net borrowing
was in 1975—another recession year. Such
large net borrowing—and a budget deficitwould only be a problem if it persists after the
economy comes out of the recession.
CONCLUSION
Many people are concerned that large
Federal deficits cause high interest rates and
crowd out private investment. Whatever the
validity of the crowding-out hypothesis, the
unified Federal budget deficit simply is not
the appropriate measure of government's
drain on credit markets. The unified Federal
budget deficit does not include the borrowing
of off-budget Federal agencies and of state
and local governments, nor does it exclude
the debt purchased by government agencies,
by state and local governments, and by the
Federal Reserve System. Most importantly,
the meaning of the Federal deficit is distorted

^ P r o j e c t i o n s of Federal b o r r o w i n g for 1982 are f r o m
Borrowing a n d Debt S p e c i a l A n a l y s i s E , r e l e a s e d b y t h e
Office of M a n a g e m e n t and Budget. Since detailed 1982
estimates o f F e d e r a l Reserve, state, a n d local holdings
o f Federal debt are not available, w e assume that these
i n s t i t u t i o n s w i l l b e h a v e a s t h e y d i d i n 1 9 8 1 . T h u s , as a
result of a projected increase in F e d e r a l debt o f $ 1 3 1 . 3
billion, p u b l i c holdings h a v e to rise b y $ 9 0 . 8 billion. W e
also adopt the consensus forecast that the G N P deflator
w i l l g r o w by 7.3 percent in 1982.

228
B U S I N E S S REVIEW

MARCH/APRIL 1 9 8 2

SHOULD GOVERNMENT INVESTMENT PROJECTS
BE FINANCED WITH TAXES?
When a private firm undertakes an investment project, It does Dot usually suspend dividends and
try to finance the project internally. If the firm's credit standing Is good and tbo proposed project Is
expected to he profitable, it borrows in the market or IssuM new equity: the new Investment
generates new cash flows sufficient to pay the additional dividends and Interest.
Investment projects, whether private or public, are undertaken because they are expected to yield
benefits that exceed the cost of building and maintaining them. The difference between private and
public investment projects is that while private projects will be undertaken only when their financial
benefits exceed their cost, this rule need not hold for public Investment. For example, a local
government may decide to build a bridge to alleviate traffic congestion. The local government couUI
finance the bridge from additional tax revenues. But the a ppropriate financing strategy Is to borrow
the initial cost of the project and plan to pay for the real portion of the Interest charges, for
maintenance, and for depreciation with future taxes or to lis. The project will eventually be paid for
in either case, but debt finance matches the tax payments the community makes to the benefits ft
receives more closely than Immediate tax finance.
The reason that the government should not finance Investment projects with current taxes lies In
the role taxes play in the economy. While taxes raise revenues for the government, they also effect
the decisions individuals make about labor supply and saving. Evidence suggests that an Increase la
income and profits taxes decreases saving and labor supply moderately.* Financing Investment
projects from Current taxes means that tax rates are higher than they need be. unnecessarily reducing
incentives to produce and save.
The Department of Commerce has estimated the net investment of the Federal, state, and local
governments.t Column 4 In Figure 4 shows that government net Investment substantially exceods
government net borrowing except during the 1975 recession and the 1960 downturn. For the last ten
years government net borrowing has covered only part of new government Investment. The sum of
government net borrowing from the private sectorfrom1972 through 1979 amounts to 149 hflfltm fin
1972 dollars), while the sum of government net investme nt Is SI38 billion (In 1972 dollars). Thus a
large part of these investments has been and is continuing to be financed by currant taxes. Tills has
meant higher taxes and higher taxratesthan necessary.* The economy could benefit from lower tax
rates that would result from financing government Investments through borrowing from the
public.

"See Arte Protopapadakls, "Supply-Side Economics: What Chant e for Summtf?" RiisinsM Rrvfcmr. Mara!
Reserve Bank of Philadelphia, May/June 1981.
tThe Department of Commerce provides estimates only of the j >hy*foi/caplfal stock owned hy the government.
These estimates do not include financial assets purchased by the government This rxclualnn It parilefllaity
important for our estimates, because our net borrowing Includes off-burtgrt agencies. Rome of these uerifthttfltalr
instance the SLMA) purchase financial assets. However, It Is very difficult to estimate the market varae of these
assets and we do not Include them In our net investment figure s.
•We do not argue here that die taxes collected should always IN; equal to current expenditures and tniksftm.
Whether optimalrevenueraising involves budget deficits or Surplusestanot known, because the bifMltBW
necessary to decide that Issue is very difficult to And. We only argtie that paying for capital project* with Mrttttt
taxes Is not an optimal strategy. Furthermore, it Is generally agreed that the government should ntftffljustHi
taxes and expenditures every year so as to keep Its net borrowing constant every year. Rather, (he goWriunsrfi
Should allow net borrowing to rise and fall over (he business cycle




229
FEDERAL RESERVE B A N K O F PHILADELPHIA

by inflation. The inflation of the last decade
caused interest rates to rise and therefore
caused budget deficits to balloon. These large
deficits do not represent necessarily a drain
on the credit markets.
Government net borrowing is a better
measure of the government sector's impact
on credit markets. The net borrowing figures




show that government has not been a significant drain on the credit markets. Looking to
the future, it is clear that as long as inflation
persists, government can run substantial
budget deficits without crowding out private
investment. But as inflation and inflationary
expectations fall, budget deficits will fall without any expenditure cuts or tax increases.

A P P E N D I X . .

.

230

. . . APPENDIX
THE CASE
OF UNANTICIPATED INFLATION
The examples in the main text on the relationship between inflation, interest rates, and government budget deficits assume that inflation is always fully anticipated. But a 10-percentage-point rise
in the inflation rate raises the nominal interest rate from 2 percent to 12 percent only if the public fully
anticipates the inflation, and then only if inflation is neutral. If increases in inflation are not fully
anticipated, the reported budget deficits will not rise sufficiently to hold the real national debt
constant. At the same time, an unanticipated increase in the price level imposes a windfall loss on
bondholders.*
The wealth loss imposed on holders of government bonds by unanticipated inflation is a wealth
gain for the government. An inflation-induced drop in the real value of government bonds is
equivalent to an increase in the taxes of the bondholders. The real value of the outstanding debt falls,
but the interest rate is not high enough to compensate the bondholders for this loss.
The thesis of our article—that the proper measure of the impact of government borrowing is given
by the change in the real value of total government debt—does not depend on whether or not inflation
is unanticipated. It is easiest to see why by considering again the inflationary economy of our
example, Ruthenia.
If the Ruthenian inflation is anticipated, the additional financing needs of the government equal
the inflation premium of the interest payment—$100 billion. But what if the inflation is not
anticipated at all? As long as the government takes no action, there would be no budget deficit and
the net borrowing would be -$100 billion. This sum is the same as the purchasing power loss suffered
by the bondholders. If the government uses net borrowing as a guide for its fiscal policy and tries to
keep net borrowing constant, it would attempt to return to its original net borrowing, $0 in this
example. It can do so by either increasing transfer payments or cutting taxes and running a $100billion budget deficit. If it cuts taxes by $100 billion, individuals in the economy who suffered capital
losses on their bondholdings will use these unanticipated taxes to restore their portfolio without
changing their consumption or saving plans (taxes are unanticipated because the inflation was
unanticipated.) But since the government, by running a $100-bill ion deficit, is providing the right
quantity of bonds the public needs for the rebuilding of portfolios, consumption and investment will
remain the same, whether or not the inflation is anticipated.
To the extent that each individual is different, the capital losses on bonds will not be exactly offset
by the tax breaks or by the increases in transfer payments for each individual. Thus, any government
action to offset the impact of unanticipated inflation will alter the distribution of wealth and
probably the value of the real variables in the economy, which may be legitimate cause for concern.
Under these circumstances, government net borrowing may not be the only information necessary to
gauge government's impact on the credit markets.

"If, for example, bondholders require a 2-percent real return on their investment and they expect a 6-percent
inflation rate, the nominal interest rate would be 8 percent. Should the actual inflation rate turn out to be 10
percent, the bondholders realize a real return on their investment of -2 percent.




231
li&ss&aiirck I3>«p«.rtovSirii4

Bsuftk

©2

May 7,1982

Financing the Deficit
According to Congressional Budget Office
estimates. Federal budget deficits in fiscal
years 1982 and 1983 could reach $119
billion and $182 billion, respectively—
several times the size of any previous budget
deficit—in the absence of any revenue or
expenditure changes. These deficits must be
financed by Treasury sales of bills, notes and
bonds. Some of this new debt will be purchased by the Federal Reserve System, but
the vast amount—perhaps 95 percent on the
basis of the last two years' experience—will
be purchased by private investors.
Also, in view of the increased strength of the
dollar, foreign official institutions probably
will not purchase as much of the new debt as
they formerly did, when they were able to
purchase Treasury securities with funds
obtained from buying cheap dollars in the
exchange markets. For example, foreign purchases of new privately-held public debt
dropped from 29.2 to 19.8 percent between
the June 1976-June 1980 period, when the
dollar was weak, and the June 1980-June
1981 period, when the dollar was much
stronger. This means that the burden of a
larger deficit will affect domestic financial
markets more than it did previously.
Large Treasury financing needs coupled with
high interest rates portend high interest costs
for the Treasury. These interest costs have
more than doubled in recent years, from
$29.1 billion in 1977 to $73.3 billion in
1981. As a percentage of total Federal expenditures, interest payments thus rose from 7
percent to more than 10 percent over that
period (Figure 1). In light of President
Reagan's call for reducing the cost of government, the question of how to minimize the
interest cost of the new debt becomes
especially important.
Minimizing cost
The Treasury could attempt to minimize costs
by affecting either the supply of or the de-




mand for its securities. The amount of cash
needed by the Treasury in any fiscal year is
given by the size of the deficit, so the Treasury
cannot choose the total supply of securities it
will issue. It can, however, vary the composition and maturity distribution of its supply of
bills, notes, and bonds, and this choice could
affect the current and future interest costs of
the new debt. Alternatively, the Treasury
could minimize costs by increasing the demand for its securities, specifically by issuing
more attractive types of securities.
O n the supply side, the Treasury could limit
the transaction costs that arise every time it
issues new debt. For example, it could issue
longer-term debt that would require fewer
refinancings. More importantly, it could try to
minimize interest costs. This can be done
specifically by "playing the term structure."
That is, the Treasury could issue debt based
on what it believes to be the future course of
short- and long-term interest rates, and minimize its interest costs according to these
expectations.
Most theoretical work on the term structure
of interest rates follows the expectations
hypothesis, which states that in a world of
certainty the yield on a multi-period security
(where the number of periods equals " n " )
equals the yield that could be attained by
holding a series of one-period securities over
" n " periods. The term structure of interest
rates therefore would provide predictions of
the future course of shorter-term interest
rates. For example, a positively-sloped term
structure—with long rates higher than short
rates—would imply an expectation of a future rise in short-term rates.
According to the expectations hypothesis,
securities of different maturities are highly
substitutable by both sides of the debt
contract. Given such substitutability in an
efficient capital market, the term structure
should not, in the long run, be greatly affected

232

B&mk

©ff

Fmimose©

O p i n i o n s e x p r e s s e d i n this n e w s l e t t e r d o n o i
necessarily reflect t h e views of the m a n a g e m e n t
o f t h e Federal Reserve Bank of San hrancisro.
o r of t h e Board of G o v e r n o r s of the Federal
Reserve Svstem.
by an increase in the supply of bonds of any
particular maturity. If, overtime, long-term
rates approximated the average of current
and realized future short-term rates, the
maturity distribution of new Treasury debt
makes little difference in cost. O n e could
argue that the government faced a rule analogous to the "Modigliani-Miller t h e o r e m " —
that the average cost of long-term financing to
a firm is independent of the debt-equity mix.
O n e might then argue that, with efficient capital markets, the government has no optimal
long-term/short-term debt mixture. In the
short run, however, this need not necessarily
be so. By appropriately altering the supply of
debt of different maturities, the Treasury
could potentially reduce its costs, just as private corporations do by funding short-term
when long-term interests rates rise above
what appear to be suitable levels.

A constant-purchasing-power bond would
induce lenders who fear inflation to purchase
the Treasury securities rather than real assets
such as gold. Furthermore, such a bond
would restore the role of Treasury securities
as "riskless assets," since both default and
inflation risk would be absent. Given the
enormous new supply of Treasury securities
overhanging the markets in the next two
years, this increased demand would be welcome. Finally, tying the interest cost of the
debt to the inflation rate would force the Federal government to take stronger measures to
reduce the inflation rate. Issuing a constantpurchasing-power bond would appear to be
a positive step toward reducing the nominal
interest cost, especially if inflation were to
decelerate faster than expected by private
investors.

Increasing demand
The Treasury could also reduce interest costs
by increasing the demand for Treasury securities. It might be able to do this by issuing a
new, more attractive type of security rather
than by relying on the traditional bills, notes,
and bonds. In 1941, George L. Bach and
Richard A. Musgrave proposed just such an
innovation — a bond redeemable not for a
constant amount of dollars, but for an amount
of dollars representing a constant amount of
purchasing power. The coupon on this bond
would be similarly adjusted. The real value of
a "constant purchasing power" bond would
not be affected by inflation, as traditional
security prices are.

With a large deficit, Treasury financing operations can exert a severe impact on the financial markets. By issuing securities with a
broad range of maturities, the Treasury could
minimize its distortion of the term structure of
interest rates determined by the market—
although as discussed earlier, there may be
little distortion in any event. Most empirical
work indicates that Treasury financing operations only temporarily affect the structure of
interest rates, with the effect largely disappearing within a month's time.

Recent Treasury behavior

In recent years, the Treasury has issued debt
in various maturities, generally emphasizing
consistency rather than innovation. Recently,
therefore, it has issued no new types of securities. Also, the Treasury has issued securities
of particular maturities on regular schedules,
apparently with the aim of increasing the
overall maturity of its debt outstanding (Figure 2). As a result, the average maturity of
private holdings of marketable interest-bearing public debt increased from two years
seven months in June 1976 to four years in
September 1981.

This type of bond has several advantages. It
would eliminate the inflation-uncertainty
premium which some economists claim is
the cause of high real interest rates, since
inflation would not reduce the value of the
bond. This approach would immediately
reduce the nominal interest cost of the new
debt. Such a bond would place the inflation
risk on the borrower rather than (as at present)
on the lender, much as variable-rate mortgages do.




Again, there is no overwhelming evidence
that the Treasury's actions affect the general

2

233

level of interest rates. To some extent, however, the Treasury may be "crowding out"
long-term corporate financing. The debt
structure of corporations increasingly has
become skewed toward short-term obligations (Figure 3). Many corporations would
like to correct this imbalance, but do not want
to pay the current high long-term rates. If the
Treasury wanted to minimize the impact of
its' financing operations on corporate operations, it might not issue long-term debt. Instead, it could leave that segment of the
financial market to corporations, thereby
permitting them to restructure their balance
sheets and finance more investment. Why,
then, has the Treasury been lengthening the
overall maturity of its debt? Perhaps the idea

is to reduce transaction costs by decreasing
the number of times required to refinance its
debt. Still, given the high interest costs associated with this strategy, the approach may
cost the Treasury more than it saves.
Treasury debt management has not been a
" h o t " issue lately in academic discussions,
possibly because of a belief that Treasury
actions do not affect the term structure of
interest rates. However, the government's
financing requirements will be very large for
at least the next few years, and will thus impose a heavy burden on domestic financial
markets. Given this fact, the issue of Treasury
debt management deserves more attention.
Joseph Bisignano and Brian Dvorak

S O U R C E : Federal Reserve Board of Governors

Maturity lin y*aral
S O U R C E : Treasury Bulletin, various issues




F'ow of Funds Accounts

3

234

BANKOF AMERICA

J O H N R. V E L L A

Septenber

Executive Vice President

H o n o r a b l e Walter E . F a u n t r o y
Chairman
Subcommittee on Domestic Monetary
House of Representatives
H2-109, House Annex 2
Washington, D . C .
20515
Dear Congressman

2,

1982

Policy

Fauntroy:

I am p l e a s e d at t h e o p p o r t u n i t y t o e f f e r t h e f o l l o w i n g c o m m e n t s in r e s p o n s e
to y o u r recent request to a d d r e s s certain issues as y o u p r e p a r e f o r y o u r h e a r i n g s on d e b t management b y the Department of the T r e a s u r y .
1.

Issue:
T h e role of the financial f u t u r e s market on the ability of the T r e a s u r y to
m a r k e t i t s d e b t in t h e a f t e r m a t h o f t h e c o l l a p s e o f a g o v e r n m e n t s e c u r i t y
firm.
Response:
T h e a d v e n t o f the f u t u r e s market h a s a p o s i t i v e impact on T r e a s u r y d e b t
issuance.
It h a s e x p a n d e d t h e n u m b e r o f p a r t i c i p a n t s a n d i n c r e a s e d m a r ket e f f i c i e n c y .
T h e c o n t i n u e d g r o w t h of this market h a s also p r o m p t e d
t h e r e g u l a r i s s u a n c e o f T r e a s u r y s e c u r i t i e s vith 10 a n d 20 y e a r m a t u r i ties.
T h e a v a i l a b i l i t y o f f u t u r e s a s an o f f s e t t o c a s h i n s t r u m e n t s p r o v i d e s
l i q u i d i t y , a s well a s h e d g e a n d a r b i t r a g e o p p o r t u n i t i e s a s d e a l e r s p r e p a r e
for Treasury auctions.
T o the e x t e n t that l i q u i d i t y is i m p r o v e d , i n t e r e s t
rates are typically lower.
T h e f u t u r e s m a r k e t r o l e in t e r m s o f T r e a s u r y
d e b t issuance has not b e e n altered as a result of D r y s d a l e .

2.

Issue:
Y o u r perception of the actions taken b y the Federal R e s e r v e System
immediately f o l l o w i n g t h e c o l l a p s e o f t h e D r y s d a l e f i r m .
What o t h e r
a c t i o n s , if a n y , s h o u l d t h e F e d h a v e t a k e n ?
Response:
T h e v i s i b l e a c t i o n s t a k e n b y t h e F e d e r a l R e s e r v e S y s t e m w e r e , in o u r
j u d g m e n t , o n e s that w e r e a p p r o p r i a t e to a s s u r e the c o n t i n u e d viability o f
the market p l a c e .
When o n e e x a m i n e s t h e r o l e o f t h e F e d ' s t r a d i n g d e s k
in a d d i t i o n t o c a l l i n g o u t m o n e t a r y p o l i c y , i . e . , i n f o r m a t i o n g a t h e r i n g o n
p r i c e s , interest r a t e s , volume of a c t i v i t y , p o s i t i o n s , and its informal
s u r v e i l l a n c e r o l e o v e r t h e p r i m a r y d e a l e r s , it a p p e a r s t h e a c t i o n s t a k e n
k e p t m a r k e t d i s r u p t i o n t o a minimum.




235
Issue:
The effect of recent Federal Reserve actions in its conduct of monetary
policy on Treasury financing and the likely impact of financial markets
in the remainder of this year of heavy Treasury borrowings in light of
these actions.
Response:
In our judgment the Federal Reserve provided the necessary liquidity
and these additional reserves had a favorable impact on financial markets. However, the effect was short term in nature, did not cause a
major market disruption and should not for the remainder of the year,
notwithstanding the amount of Treasury financing in the second half
of this year.
Issue:
The impact on the market when dealers with underwriting responsibilities are left with higher than normal amounts of new issues. What is
the effect of such an event on the cost of future Treasury financing
operations before and after the Drysdale collapse? What is the effect
of such an event on dealer participations at future auctions?
Response:
Generally speaking when dealers with underwriting responsibilities are
confronted with bigger positions under the circumstances described,
prices would decline and yields would rise. However, the level of
economic activity, price level expectations and other factors also must
be considered by dealers when they decide on the extent of their participation in Treasury auctions. The "Drysdale collapse" w l not have
il
any impact on the financing operations of the U.S. Treasury-in the
market place.
Issue:
Whether the new rules adopted by the Fed and the dealer associations
would have been adequate to prevent the collapse of a government
securities firm i they had been in force? Are other actions by either
f
the Fed or the dealer organizations necessary?
Response:
Although additional capital requirements and clearly defined business
standards may be helpful, these actions alone would not have prevented
the collapse of a government securities firm in the past and they cannot
be expected to do so in the future.
Issue:
How the financial community has coped with the collapse of a government
securities firm. Whether this or any other recent financial failures have
increased interest in government securities and the impact such increased
interest might have upon Treasury financing operations.




BANK. O F - A M E R I C A NATIONAL T R U S T A N D S A V I N G S ASSOCIATION*

236
6.

Response:
T h e financial community and the market place a r e extremely resilient
a n d h a v e c o p e d well d u r i n g p a s t c r i s e s p e r i o d s .
During periods of
financial uncertainty the government markets has a t e n d e n c y to b e n e f i t a s i n v e s t o r s t e n d t o c o n c e n t r a t e m o r e f u n d s in s h o r t t e r m U . S .
Treasury instruments.
T o t h e e x t e n t that t h e T r e a s u r y i s r a i s i n g
f u n d s d u r i n g such a period they would benefit through lower interest
costs.

7.

Issue:
Please comment u p o n the view e x p r e s s e d b y some a n a l y s t s that the
collapse of a g o v e r n m e n t s e c u r i t i e s firm was " i n e v i t a b l e " a n d that
the quality of internal credit c o n t r o l s and credit decisions of l a r g e
m a g n i t u d e s a r e o f t e n n o t well c o n s i d e r e d .
Response:
We d o n o t s h a r e t h e v i e w t h a t a c o l l a p s e w a s i n e v i t a b l e .
T o the e x t e n t t h a t a p a r t i c u l a r f i r m may c h o o s e t o m a n a g e i t s r i s k in a m o r e
a g g r e s s i v e fashion to enhance p r o f i t s the possibility of failure e x i s t s .
It i s n o t , h o w e v e r , n e c e s s a r i l y i n e v i t a b l e .
Credit controls and decisions a r e only as g o o d as the management r e s p o n s i b l e .
T h e lack of
c r e d i t d i s c i p l i n e o n t h e p a r t o f some p a r t i c i p a n t s in t h e m a r k e t a l l o w e d
e x c e s s leverage to o c c u r .
H o w e v e r , this is not a situation which is
solely related to securities transactions.

Again,




thank y o u f o r the opportunity

t o o f f e r my v i e w s o n t h i s
Sincerely

o

B A N K OF : A M E R I C A N A T I O N A L T R U S T A N D S A V N G S

ASSOCIATION

subject.