Treasury Auctions at Risk from Debt Ceiling Impasse

Treasury Auctions at Risk from Debt Ceiling Impasse


Despite the political deadlock over raising the federal government’s debt limit, the Treasury Department continues to have no trouble finding buyers for a swelling mountain of securities to finance the government’s debt.

This year the Treasury has to sell nearly $8 trillion worth of bills, notes and bonds to the public in order to repay owners of more than $6.4 trillion worth of maturing debt and to finance the current budget deficit, according to analyst Nancy Vanden Houten of Stone & McCarthy Research Associates.

Remarkably, buyers are willing to purchase those securities at such low yields that the government’s net interest cost on publicly held debt this year and next is estimated to be only a little more than $200 billion — around 1 percent of the gross domestic product. Furthermore, the auctions are run so efficiently by the Federal Reserve on behalf of the Treasury that their cost was a scant $30 million, according to the Federal Reserve Board’s 2009 annual report.

The size of these auctions dwarfs those of any other government in the world. They are successful, Vanden Houten and analysts say, because investors generally regard Treasurys as among the safest in the world, and they know that the market for the securities is so deep that they can always be sold at a moment’s notice. For most investors they are virtually as liquid as cash.

This whole edifice could be jeopardized, however, if by early August Congress hasn’t raised the $14.3 trillion limit on the combined debt held by the public and various federal trust funds, including the Social Security system. Treasury has already taken some actions, including delaying investing some money contributed by government workers in their personal retirement accounts.

“It’s a pretty efficient system,” said economist Thomas Simons, a vice president at Jeffries & Co., one of the 20 so-called primary dealers that are among the most important bidders at Treasury auctions. If the government was unable to pay interest or repay principal on Treasury securities because of the debt limit clash, “in the short run it would do a lot of damage, and to some degree it would be permanent damage,” he said.

“If it became a rolling issue for months and months” — if there were a series of short-term debt limit increases — “it would have an impact on interest rates. Liquidity would suffer and there would be an element of uncertainty about auctions,” Simons said.

In other words, a default could undo a lot of Treasury’s efforts over many years to set up a system for raising money that minimizes costs. The debt is big enough that even a small increase in interest rates would be expensive.

Anyone who wants to buy Treasurys knows that every week there is an auction of short-term securities known as bills that mature in four, 13 or 26 weeks, and once a month, a 52-week issue. Once a month notes maturing in two, three, five, seven and 10 years are sold, as is an issue of 30-year bonds. Finally, once each month inflation-protected securities known as TIPS are sold. There are three sales a year of five- and 30-year TIPS and six times a year sales of 30-year TIPS.

That adds up to 262 auctions at which investors will commit close to $8 trillion.

The whole process is electronic. The bill auctions occur at 11:30 a.m. and the others at 1:00 p.m. In order to reduce the risk to bidders, the time between the moment of the auction and the announcement of the results has been shaved to about a minute and a half.

Brian Brennan, a vice president at T. Rowe Price who helps manage about $30 billion in assets invested in Treasurys, said the U.S. system “is the strongest in the world for debt management.”

In Europe, Brennan said, auctions of government securities often “fail” — that is, bidders aren’t willing to buy all that the government wants to sell. That’s never happened in this country.

Moreover, there are auction rules that have made the system “more effective and more transparent,” he said. After attempts years ago by one company to try to corner the market in particular Treasury issues, no bidder can get more than 35 percent of any issue at an auction. And the auctions are so-called Dutch auctions in which every bidder ends up paying the same price. That price is equal to the highest interest rate Treasury has to accept in order to sell all the securities it is offering.

Individuals and firms other than primary dealers can also bid at the auctions. Most do place non-competitive bids, indicating they are will to accept whatever the yield turns out to be. Most of those bids are placed using the Treasury Direct process.

“The primary dealer system is what makes it work,” Brennan said. “There’s a very effective give-and-take process between Treasury and the primary dealers, which are expected to participate in all the auctions.” T. Rowe Price itself acquires the Treasury securities it needs through the dealers, he added.

That give-and-take is a constant process, with people in the Markets Group at the New York Federal Reserve Bank and others at Treasury constantly on the phone inquiring about what is going on in the money markets.
In addition, every three months a group known as the Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association meets at the Treasury Department in Washington. It is briefed my Treasury officials on the economic outlook and the borrowing needs, and after a discussion, gives Treasury its recommendation on any changes in auction schedules and other issues it has considered. All this is made public.

Many members of Congress seem not to understand the great value of the carefully constructed process, or the potentially very high cost of undermining it for the sake of a temporary political advantage.

All those in the money markets are assuming the debt limit will be increased, said T. Rowe Price’s Brennan. “But it’s a line that goes up if you don’t have a surplus. You have to raise the limit. That’s the bottom line.”

Related Links:
Social Security and the Debt Limit (Angry Bear)
T-Bills Stay Hot Despite Low Yield (The Wall Street Journal)