Presentation to the Treasury Borrowing Advisory Committee · 03-11-2009 · FY 2009 FY 2010 Note:...

Presentation to the Treasury Borrowing Advisory Committee

U.S. Department of the TreasuryOffi f D bt M tOffice of Debt Management

November 3, 2009

Federal Budget Deficits FY2007 to FY2009

600%-1,600

$ Billions

Fiscal Year to Date Deficits(monthly data)

2007 Y-O-Y % Change20092008

-1,086

-1,267

-1,378-1,417

400%

500%-1,400

-1,200

20092008

-765

-957

-802

-992

1,086

300%

-1,000

-800

-311 -319269

-371

-483-455

-402

-485

-569

100%

200%

-600

-400

-49-122

-80-42

-162

-258

-81-148

-121-157

-274

-163

-56-154-106-88

-263311

-152

319-269-237

-100%

0%-200

0

Office of Debt Management2

Oct

-06

Nov

-06

Dec

-06

Jan-

07Fe

b-07

Mar

-07

Apr

-07

May

-07

Jun-

07Ju

l-07

Aug

-07

Sep

-07

Oct

-07

Nov

-07

Dec

-07

Jan-

08Fe

b-08

Mar

-08

Apr

-08

May

-08

Jun-

08Ju

l-08

Aug

-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09Fe

b-09

Mar

-09

Apr

-09

May

-09

Jun-

09Ju

l-09

Aug

-09

Sep

-09

Federal Outlays and Receipts

O tl

-500

01-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

Outlays

FY07 FY08 FY09

-2,000

-1,500

-1,000

$ B

illio

n

-3,500

-3,000

-2,500

Outlays were up $558 B YoY

2,500

3,000

Receipts

FY07 FY08 FY09

Receipts were down

1,000

1,500

2,000

$ B

illio

n

$413 B YoY


0

500

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

Source: DTS

DTS numbers are approximate and

may not match MTS.

Tax Receipts Continue to Decline

40%

Rolling 12-Month Growth Rates

Corp TaxesWH Taxes

20%

30%WH TaxesnWH Taxes

0%

10%

-20%

-10% WH taxes down $108 B YoY, or 11 %

-40%

-30% nWH taxes down $143 B YoY, or 31%

Corp taxes down $128 B YoY, or 36%


-50%

Mar

-82

Mar

-83

Mar

-84

Mar

-85

Mar

-86

Mar

-87

Mar

-88

Mar

-89

Mar

-90

Mar

-91

Mar

-92

Mar

-93

Mar

-94

Mar

-95

Mar

-96

Mar

-97

Mar

-98

Mar

-99

Mar

-00

Mar

-01

Mar

-02

Mar

-03

Mar

-04

Mar

-05

Mar

-06

Mar

-07

Mar

-08

Mar

-09

Treasury Marketable Financing in FY2008 and FY2009

Treasury Marketable FinancingFY 2009 FY 2008

($ Billions) October 1, 2008 - September 30, 2009 October 1, 2007 - September 30, 2008

Issued MaturedNet SOMA Activity *

Net Cash Raised Issued Matured

Net SOMAActivity *

Net CashRaised

Bills (includes SFPs) $6,920.5 $6,417.8 $0.0 $502.7 $4,632.9 $4,101.2 ($152.0) $531.7

Nominal coupons $1,886.6 $640.7 $0.0 $1,245.9 $814.6 $626.2 ($5.5) $188.5

TIPS $58.5 $20.8 $0.0 $37.7 $61.9 $21.8 $3.5 $40.1

Total $8,865.6 $7,079.3 $0.0 $1,786.3 $5,509.5 $4,749.2 ($153.9) $760.4

* Note: Negative SOMA activity represents redemptions Note: Negative SOMA activity represents redemptions. Positive SOMA activity represents additional issuance of securities, made possible by redemptions in maturing securitieswith the same settlement date; these are offsetting transactions and are net cash neutral.


Cumulative Net Financing Flows since FY2007

$3,000

SFP Amounts CMBs RegBills TIPS Notes Bonds Net Mktable Borrowing$ Billions

$2,500

$1,500

$2,000

$500

$1,000

$0

$500

Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09


-$500FY 2007 FY 2008 FY 2009

Cumulative Net Coupon Issuance since FY 2007

1,400

1,600

350

400

2-year (LHS) 3-year (LHS)


1 000

1,200

200

250

300

Bill

ions

)

Bill

ions

)


Total (RHS)

800

1,000

100

150

e N

et Is

suan

ce ($

e N

et Is

suan

ce ($

400

600

0

50

Cum

ulat

ive

Cum

ulat

ive

0

200

-150

-100

-50


Oct

-07

Nov

-07

Dec

-07

Jan-

08

Feb-

08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-0

8

Aug

-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

Apr

-09

May

-09

Jun-

09

Jul-0

9

Aug

-09

Sep

-09

Treasury Cash Balances

125

150

175$ Billions

Treasury Daily Operating Cash BalanceExcluding SFPs

FY 2007 FY 2008

FY 2009 FY 2010

Note: Data through October 23, 2009

Sep. 15Dec. 15 Apr. 15 Jun. 15

50

75

100

125

0

25

Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep

800

$ Billions Daily Treasury Operating Cash Balances Note: Data through October 23, 2009

500

600

700

800Cash Balance w/o SFPs Cash Balance w/SFP

g ,

200

300

400


0

100

Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09

Portfolio Distribution

67%

69%

71%Nominal Coupons as a Share of Total Portfolio

33%

35%

37%

Bills as a Share of Total Portfolio

All Bills Regular Bills

59%

61%

63%

65%

23%

25%

27%

29%

31%g

55%

57%

59%

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-0917%

19%

21%

Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09

60%

70%

80%Total Portfolio

11%

12%

13%TIPS as a Share of Total Portfolio

20%

30%

40%

50%TIPS Nominal Coupons

Standard Bills CMBs/SFPs

7%

8%

9%

10%


0%

10%


5%

6%


Monthly Change in Debt Outstanding versus Average Maturity

58

60

500

600Average Maturity (Months)$ Billions

GSE Preferred Stock Purchase Program begins Oct 2008

Issuance of SFP bills begins Sept 2008 SFP bills peak at $560 B Nov 2008

54

56

400

Capital Purchase Program $115 B dispersed Oct 2008$36 B disbursed Nov 2008

50

52

200

300Bulk of $168 B Stimulustax rebates disbursed

May - Aug 2008•Average Maturity Oct 2008: 48.5 monthsBills o/s: $1.9 T and Coupons o/s: $3.8 T

•Average Maturity Sept 2009: 52.7 monthsBills o/s: $1.9 T and Coupons o/s: $5.0 T

44

46

48

0

100

40

42

44

-200

-100

7 7 7 7 7 7 7 7 7 7 7 7 8 8 8 8 8 8 8 8 8 8 8 8 9 9 9 9 9 9 9 9 9

Bills Coupons Average MaturityTax year 2008refunds peakFeb 2009

$40 BAIGInvestmentNov 2008


Jan-

07

Feb-

07

Mar

-07

Apr

-07

May

-07

Jun-

07

Jul-0

7

Aug

-07

Sep

-07

Oct

-07

Nov

-07

Dec

-07

Jan-

08

Feb-

08

Mar

-08

Apr

-08

May

-08

Jun-

08

Jul-0

8

Aug

-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan-

09

Feb-

09

Mar

-09

Apr

-09

May

-09

Jun-

09

Jul-0

9

Aug

-09

Sep

-09

Debt Maturity Measures

9090

MonthsMonths

Average Maturity of Issuance 1/

70

80

70

80

60

70

60

70

40

50

40

50Average Maturity of Marketable Debt Outstanding

30

40

30

40

1/ Rolling 4-quarter average


20201980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Rolling 4-quarter average

Maturing Coupons

80

90$ Billions November 15, 2009-August 15, 2039

2 YR NOTE 3 YR NOTE 5 YR NOTE 10 YR NOTE 30 YR BOND7 YR NOTE 5 YR IIS NOTE 10 YR IIS NOTE 20 YR IIS BOND 30 YR IIS BOND

*Based on coupon securities outstanding as of October 15, 2009

In the next 5 years 73 days will have maturities greater

60

70

In the next 5 years, 73 days will have maturities greater than $20 billion and 46 days greater than $30 billion.

40

50

20

30

0

10


15-N

OV

-200

9

15-F

EB

-201

0

15-M

AY

-201

0

15-A

UG

-201

0

15-N

OV

-201

0

15-F

EB

-201

1

30-J

UN

-201

1

15-N

OV

-201

1

15-F

EB

-201

2

15-M

AY

-201

2

15-A

UG

-201

2

15-N

OV

-201

2

31-M

AR

-201

3

15-J

UL-

2013

15-N

OV

-201

3

28-F

EB

-201

4

30-J

UN

-201

4

15-N

OV

-201

4

15-N

OV

-201

5

15-M

AY

-201

6

31-A

UG

-201

6

15-J

UL-

2017

15-J

UL-

2018

15-J

UL-

2019

15-M

AY

-202

1

15-A

UG

-202

3

15-F

EB

-202

6

15-N

OV

-202

7

15-F

EB

-202

9

15-F

EB

-203

6

15-M

AY

-203

9

Primary Dealer and Government Deficit Estimates

FY 2010 Deficit Estimates $ BillionsPrimary Dealers* CBO OMB

Current: 1 393 1 381 1 502Current: 1,393 1,381 1,502Range based on average absolute forecast error** 1,203-1,583 1,081-1,681 1,219-1,785Estimates as of: Oct 09 Aug 09 Aug 09

FY 2010 Marketable Borrowing Range*** 1,200-1,750FY 2011 Marketable Borrowing Range*** 725-1,400g g

* Primary Dealers reflect average estimate. Based on Primary Dealer feedback on October 29, 2009.** Ranges based on errors from 2005-2009.*** Based on Primary Dealer feedback on October 29, 2009.


OMB Long-term Deficit and Borrowing Projections

3.0%

3.5%

4.0%

600

700

800Interest Expense as % of GDP OMB

8/09 MSR

Interest Expense as % of GDP (RHS)100%

120%

140%

20

25

30Debt as % of GDP

Held by PublicHeld by Govt

Gross Debt % of GDP (RHS)

OMB 8/09 MSR(LHS)

(LHS)

1.0%

1.5%

2.0%

2.5%

200

300

400

500

$Bill

ions

GDP (RHS)

10-y Rolling-Avg (RHS)

40%

60%

80%

10

15

20

Held by Public% (RHS)

$Tril

lions

Annual Surplus/Deficits OMB

0.0%

0.5%

0

100

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

Interest Expense (LHS)

0%

20%

0

5

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012

2016

(RHS)

Held by Govt Accts% (RHS)

-2%

0%

2%

4%

400

-200

0

200

400

p OMB 8/09 MSRSurplus/Deficits

(LHS)

1,500

2,000

10%

12%

14%

Net Marketable Borrowing as % of GDP

OMB 8/09 MSR

-8%

-6%

-4%

2%

1 200

-1,000

-800

-600

-400$

Bill

ions

Surplus/Deficits as a % of GDP (RHS)

500

1,000

2%

4%

6%

8%

$Bill

ions

Net Marketable Borrowing as % of GDP (LHS)


-12%

-10%

-1,600

-1,400

-1,200

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016

2019

-500

0

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

-4%

-2%

0%

Net Marketable Borrowing (RHS)

Rescheduled 4-Week Bill Auctions Due to Calendar Constraints

2:00 PM

Rescheduling of 4-Week Bill Auctions Due to ConflictsFY2008 - FY2009

1:30 PM

2:00 PM

1:00 PM

lose

Tim

e

12:00 PM

12:30 PM

Bill

Auc

tion

C

In FY2009, the frequency with which 4-week auctions were rescheduled to 11:30 AM increased significantly.

11:30 AM

7 auctions in FY2008 23 auctions in FY2009

g y


11:00 AMOct-07 Jan-08 Apr-08 Jul-08 Nov-08 Feb-09 May-09 Aug-09

4-Week Bill Coverage Ratios and Offering Amounts

5 50

6.00

1:00 p.m. Close 11:30 a.m. Close

4.50

5.00

5.50

3.50

4.00

erage ratio

2.50

3.00Cove

1 00

1.50

2.00


1.00

0 5 10 15 20 25 30 35 40 45

Amount Offered (in Billions)

Potential Cost Saving of Moving to 30-Year TIPS

3 5

4.0

3.0

3.5

d

2.0

2.5

Yiel

d

1.0

1.5

006

007

007

007

007

008

008

008

008

009

009

009

009

Source: Barclays Live

10/1

0/20

1/10

/20

4/10

/20

7/10

/20

10/1

0/20

1/10

/20

4/10

/20

7/10

/20

10/1

0/20

1/10

/20

4/10

/20

7/10

/20

10/1

0/20

10yFwd10y zcis 20yFwd10y zcis


Source: Barclays LiveGraph shows 10-year and 20-year forward zero-coupon inflation levels for 10 years derived from Zero Coupon Inflation Swap data.Long-term inflation expectations are assumed to be stable; therefore, an upward sloping curve demonstrates an increasing inflation risk premium.

What adjustments to debt issuance if any should Treasury make inWhat adjustments to debt issuance, if any, should Treasury make in consideration of its financing needs in the short, medium, and long term?


TBAC Presentation to Treasury

November 3, 2009

TBAC Presentation to Treasury:Exit StrategiesExit Strategies

November 3, 2009

2

Outline

•Importance of the Exit Strategy

•Form and likely Sequence•Removal of Excess Reserves•Ending the MBS purchase program•Raising the Funds rate target

•Implications for the Treasury and related markets

•Potential policy errors

•Conclusions/Recommendations

Importance of the Exit Strategy

•Near zero interest rates have had a significant impact on investor demand for many asset classes

•Many investors can not stay in cash or earn zero for long•Pension funds•Insurance companies•Endowments•Retired individuals living on income

•Zero yields on money market funds have pushed investors into longer-dated riskier asset classes

•The return of low cost financing as repo markets have reopened (aided by TALF and other Fed programs) has pushed leveraged investors into longer-dated riskier assets classes

•The increased demand has benefited Treasuries somewhat, but has benefited risk assets such as corporate bonds and securitized assets even more

•When the markets anticipate the move away from zero, the impact on longer dated risk assets may be significant due to reduced investor demand


•Investors have been moving out of cash and into longer-dated risk assets as the markets have stabilized and cash earns zero

•This can be seen in mutual funds flows

-300

-200

-100

0

100

200

300

400

Q108 Q208 Q308 Q408 Q109 Q209 Q309

-80

-60

-40

-20

0

20

40

60

80

100

120

140

Q108 Q208 Q308 Q408 Q109 Q209 Q309

-60

-50

-40

-30

-20

-10

0

10

20

30

Q108 Q208 Q308 Q408 Q109 Q209 Q309

US Equity Mutual FundsMoney Market Funds US Fixed Income Mutual Funds$ billions


The sponsorship for longer dated risk assets has led to lower yields

0

1

2

3

4

5

6

7

Jun/2008 Sep/2008 Dec/2008 Mar/2009 Jun/2009 Sep/2009

10yr treasury

Current coupon mortgage

0

5

10

15

20

25

Jun/2008 Sep/2008 Dec/2008 Mar/2009 Jun/2009 Sep/2009

IG Corporates (Barc lays Index)

HY Corporates (Barc lays Index)

10-yr Super Senior CMBS

% yield

Form and Likely Sequence of the Fed’s Exit Strategy

• The Fed has a very difficult task to get the form and timing correct• Importance of the first move• Uncertainty and fragility of the economic recovery• Dependence of housing and other sectors on low rates

• As a result, predicting the form and timing of the exit strategy is also difficult

• The most likely sequence appears to be 1. Draining excess reserves 2. Ending MBS purchases3. Raising the Funds rate target

Form and Likely Sequence: This Tightening Cycle is Different

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

0

200

400

600

800

1000

1200

Funds rate target

Reserve balances with theFederal Reserve Banks

$ billions

Form and Likely Sequence: Excess reserves to neutralize

Form and Likely Sequence: Alternatives for Neutralizing Reserves

•Raise the funds rate and thereby the rate paid on excess reserves•Increases opportunity cost of using reserves•Potential complication(s): requires Fed to raise the funds rate

•Reverse repurchase agreements•Banks and perhaps money markets potential counterparties•Changes composition of Fed’s liabilities•Potential complication(s): reverse repos for TSYs cleaner than for MBS, scope for draining reserves unclear

•Term deposits •Banks move overnight reserves into term facility •Potential complication(s): Mechanism for setting rate and bank utilization unclear, implications for LIBOR market

•Sell assets•Shrinks asset and liability sides of the balance sheet•Potential complication(s): Private appetite for additional MBS and Treasury securities unclear

Form and Likely Sequence: Reverse Repos

•Direct with Dealers•Initial capacity $150 - $200 billion•Tier one capital relief could boost capacity in some instances•Unlimited term

•Direct with Money Market funds•Initial capacity near $1000 billion•Term less than 7 days•Requires cumbersome setup

•TALF Model•Banks are agents; allow access to MM with cumbersome setup•No incentive for Banks

Market implications•Compete with other short-term investments•Upward pressure on bill rates

Form and Likely Sequence: balance sheets, reserves and treasury demand

Treasuries and agencies 163.2Other 65.7Total 228.9

Change in securities from Dec 17th

Cumulative change in composition of bank assets

•Loans and leases declined from $7.3 trillion to $6.7 trillion over the past year

•Declines are being partially offset by securities purchases, particularly Treasuries

•Reserves being moved to securities?

-600

-500

-400

-300

-200

-100

0

100

200

300

Dec/2008 Feb/2009 Apr/2009 Jun/2009 Aug/2009

Securities in bank credit

Loans and leases in bank credit

Cash assets

$ billions

Form and Likely Sequence: Ending MBS Purchases

The Fed’s purchases of MBS have had a significant impact on valuations

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3.5 4 4.5 5 5.5 6 6.5 7 7.5

FNMA 30y fixed

FGLMC 30y fixed

MBS Spreads Fed Holdings as % of Total Outstanding by Coupon

-50

0

50

100

150

200

250

2003 2004 2005 2006 2007 2008 2009

Libor OAS

Zero vol spread

bps

Form and Likely Sequence: Ending MBS Purchases

Housing market still fragile and needs low mortgages rates

-25

-20

-15

-10

-5

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009

Case Shiller HPI,y/y

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

2004 2005 2006 2007 2008 2009

Subprime

Alt-A

Option ARM

Prime jumbo

All

0

200

400

600

800

1,000

1,200

1,400

2005 2006 2007 2008 2009

Jumbo Alt-ASubprime Other Home EquityNon Agy Agy

$ billion

House Prices 60 days+ Mortgage Delinquencies Gross MBS Issuancepercent

Form and Likely Sequence: Raising the Fed Funds Rate

•Markets pricing in the first move in the first half of 2010 and expecting gradual tightening similar to the past

•Another possibility is a discreet initial move (to 1% for example) to remove emergency level followed by a pause and then gradual tightening

0.0

1.0

2.0

3.0

4.0

5.0

6.0

2005 2006 2007 2008 2009 2010 2011 2012

Funds rate target

Eurodollar curve

percent

Market Implications: Net Fixed Income Supply

-1000

-500

0

500

1000

1500

2000

2500

3000

3500

2003 2004 2005 2006 2007 2008 2009 2010

Corporate and foreignbondsMunicipals

Agency/GSE-backed debt

Treasury securities

Open market paper

Total after Fed purchases

Total

E E

$ billions

Market Implications: Net Fixed Income Purchases

$ billions

Market Implications: Concern about higher real rates rather than inflation?

5yr5yr Forward TIPS Inflation Expectations Volatility Skew(1y10yr 100 high vs. 100 low strike)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2005 2006 2007 2008 2009

-10

-5

0

5

10

15

20

25

30

35

2005 2006 2007 2008 2009

bpspercent

Market Implications: Issuance and debt outstanding

0%

10%

20%

30%

40%

50%

60%

70%

80%

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Bills

Bonds

TIPS

2yr - 10yr

0%

10%

20%

30%

40%

50%

60%

70%

1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

Bills

Bonds

TIPS

2 - 10yr

Marketable Debt OutstandingQuarterly Issuance

Market Implications: Average Maturity of the Debt

0

10

20

30

40

50

60

70

80

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

0

2

4

6

8

10

12

14

16

Average maturity of debtprojectedCore CPI, y/y (right)10yr Treasury (right)

months percent

Market Implications: More TIPS Issuance

Advantages•Diversify and broaden the buyer base of Treasury debt in time of extreme borrowing need•Potentially further lower the funding cost of nominals if TIPS remove some inflation risk premium•Further extends average maturity of issuance and debt•Limited risk because tax receipts effectively hedge Treasury inflation exposure

Disadvantages•Given low breakevens, there is potential for higher explicit cost relative to nominal•If there is substantial further disinflation or deflation, buyer base for TIPS may dwindle just as issuance increases

TIPS as Percentage of Nominals Outstanding

0%

2%

4%

6%

8%

10%

12%

14%

1997 1999 2001 2003 2005 2007 2009

Potential Policy Errors

Fiscal considerations•Lack of budgetary restraint

•Big issue for non-US investors•Need spending cuts or tax revenue increases as economy stabilizes•Need to refrain from a second fiscal stimulus

Monetary considerations•Liquidity programs

•Many of the programs addressing the money markets and financing can be removed now•TALF is still needed to restart the shadow banking system, particularly for more difficult assets

•MBS program•Housing market still needs low rate•Stopping purchases vs. selling MBS

•Traditional policy•Raising rates too soon is the bigger risk

Conclusions

•The Fed’s exit strategy is a significant challenge and the form and timing will have a significant impact on the broad financial markets

•The likely first step will be the use of reverse repos to remove excess reserves from the banking system

•The eventual increase in the Fed funds rate target will have the biggest impact and will likely come at a time when supply of fixed income securities is increasing and the Fed has stopped purchasing longer-dated securities

•The Treasury should continue to have a very transparent plan to increase issuance given the growing deficit and

•Extend average maturity•Issue more inflation-linked debt

Treasury Borrowing Advisory Committee:

Optimal Issuance Strategy

Quarterly Meeting

November 3 2009November 3, 2009

Questions

Given the recent trends in the economy and the government’s fiscal position, please discuss Treasury’s plan to lengthen the average maturity of the portfolio in the medium term. Is there an optimal average maturity range given structural financing needs in the medium and long term? Does it make sense tomaturity range, given structural financing needs in the medium and long term? Does it make sense to apply asset-liability management to Treasury’s marketable debt portfolio? Can you discuss approaches to financing and risk management by other sovereign nations and how they might be applicable to the US Treasury debt management?

22

Agenda

♦ Background

♦ Optimization Model/Debt management strategies

♦ Conclusions:

1 Inflation higher interest rate and roll over risk should be the primary concerns in1. Inflation, higher interest rate and roll over risk should be the primary concerns in Treasury’s debt management strategies.

2. In most scenarios, it is prudent to lengthen maturities significantly from current average maturity of 50 months Our base case is to extend to 74 months stretch case toaverage maturity of 50 months. Our base case is to extend to 74 months, stretch case to extend to 96 months.

3. The objective of lowest borrowing cost could lead to higher yields that conflict with monetary policy objectivemonetary policy objective.

4. Clever debt management strategy could potentially reduce debt service cost meaningfully, but still can’t completely substitute for prudent fiscal policy.

33

Comparison of debt management strategies across the G7

Debt management strategies across the G7g gAv g Maturity % Foreign Total Public Ratio of Ratio of debt Interest Pay ments Debt Management

Country (y ears) Ow nership Debt (USD $bn) Debt to rev enue to GDP as share of rev enue Methodology SummaryUSA 4.25 49% 7551** 359% 53% 18% Cashflow matching. No ALM framew ork currently usedUK 14.2 30% 1,347.1 118% 56% 3.30% Cashflow matching. No ALM framew ork currently used

Optimizes mix of funding instruments to minimize long term cost and

Germany 6.10 30%* 1522 151% 65.90% 6.10%risk for the issuer. Deriv ativ e instruments such as sw aps are also used

France 6.70 30%* 1689.7 137% 67.40% 5.70%Cashflow management. Management of av erage maturity and effort made to ensure liquidity in issuesStrategic scenario analy sis and risks. Use of v arious cash and

Italy 6.87 30%* 2382.5 230% 105.80% 11.10% deriv ativ es products to minimize cost of debt and reduce riskJapan 7.00 6% 9875.1 2331% 190% 26.20% Cashflow matching. No ALM framew ork currently usedAustralia 5.60 53% 92.87 19% 4.60% 2.60% Cost and risk optimization. Use of sw aps until Nov 2007

Driv en by set of principles to minimize risk and costs of debt and help the DMO issue debt cost-effecitv ely . Focus is on fiscal control,

New Zealand 5.60 72% 35.8 49% 15.60% 6.00%

gov ernment balance sheet risk management, and containment of moral hazard, and limiting contingent liability risk to the Gov ernment. Contingent liabilities are disclosed, analy zed and contained on a sub-national lev el w ith limited central gov ernment interv ention.

Source: JP Morgan

* Estimated ow nership for Eurozone debt by non Eurozone members** Debt held by public

4

Sou ce: J o gan

Average maturity of outstanding treasuries is approximately 50 months, which is near 25-year lows!

Average Maturity of Outstanding Treasuries, Months

70

75Treasury added a 20-year maturity point and increased sizes across the curve

30-year bonds were eliminated, issuance was reduced, and buybacks occurred, reducing the average maturity

65

sizes across the curve

55

60

50

Substantial unexpected funding needs prompted high amounts of bill issuance, further reducing average maturity

45Dec-80 Sep-86 May-92 Feb-98 Oct-03 Jun-09

Source: JP Morgan

55

Sou ce: J o gan

Total federal government debt to GDP ratio was only higher during WW II

Source: Bianco Research

66

Source: Bianco Research

Debt to GDP about to go up significantly

Source: White House Office of Management and Budget Congressional Budget Office

77

Source: White House Office of Management and Budget, Congressional Budget Office

Mandatory spending has increased 5x faster than discretionary spending

Source: The Heritage Foundation 2009 Federal Revenue and Spending Book of Charts; and White House office ofM d B d

8

Management and Budget

Entitlement spending is confronting a demographic time bomb

Source: The heritage Foundation 2009 Federal Revenue and Spending Book of Charts; and Congressional BudgetOffi

9

Office

Plausible budget deficit outlook

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

CBO August Baseline -1587 -1381 -921 -590 -538 -558 -558 -620 -625 -622 -722

Plausible Revenue ChangesEGTRRA & JGTRAA 0 -4 -121 -217 -247 -260 -271 -281 -290 -298 -307AMT 0 -7 -69 -31 -34 -37 -41 -46 -53 -60 -70Interaction 0 0 -13 -44 -49 -53 -58 -64 -70 -77 -85Making Work Pay etc 0 48 141 199 203 201 199 198 199 202 205Making Work Pay, etc. 0 -48 -141 -199 -203 -201 -199 -198 -199 -202 -205High Income 0 76 106 131 140 147 155 165 175 186 186Debt Service 0 0 -4 -17 -42 -75 -109 -146 -189 -236 -286Subtotal Rev 0 17 -242 -377 -435 -479 -523 -570 -626 -687 -767

Plausible Spending ChangesPlausible Spending ChangesInflate Discretionary by GDP 0 -8 -33 -74 -120 -159 -194 -228 -261 -294 -328Iraq War Phaseout 0 1 7 29 59 83 97 104 106 111 115Debt Service 0 0 -1 -1 -3 -8 -13 -19 -28 -39 -52Subtotal Disc. Spending 0 -7 -27 -46 -64 -84 -110 -143 -183 -222 -265

Total Change 0 10 -269 -423 -499 -563 -633 -713 -809 -909 -1032

Resulting Surplus / Deficit -1587 -1371 -1190 -1013 -1037 -1121 -1191 -1333 -1434 -1531 -1754

GDP 14140 14439 14993 15754 16598 17319 18019 18760 19524 20308 21114D fi it % f GDP 11 2% 9 5% 7 9% 6 4% 6 2% 6 5% 6 6% 7 1% 7 3% 7 5% 8 3%Deficits as % of GDP -11.2% -9.5% -7.9% -6.4% -6.2% -6.5% -6.6% -7.1% -7.3% -7.5% -8.3%Debt Held by Public 7612 8984 10174 11186 12224 13345 14536 15869 17304 18836 20590Debt / GDP 54% 62% 68% 71% 74% 77% 81% 85% 89% 93% 98%Interest 177 199 250 319 420 556 657 746 841 934 1038Interest Rate 2.3% 2.2% 2.5% 2.9% 3.4% 4.2% 4.5% 4.7% 4.9% 5.0% 5.0%

10Source: Concord Coalition, CBO, JCT, The Lindsey Group

The federal budget has benefited from the decline in rates, BUT approximately 40% of marketable Treasury securities now mature in less than 1 year

18%

Interest payments on federal debt

10%

12%

14%

16%

18%

4%

6%

8%

10%

0%

2%

1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Net interest as % of federal budget Average interest paid

Source: Economic Report of the President 2009

Net interest as % of federal budget Average interest paid

11

Source: Economic Report of the President 2009

Interest payments to rise substantially

Source: Heritage Special Report July 27, 2009; Office of Management and Budget, Budget of the United States Government, FY 2010, Historical Table, Table 3.2, (July 15, 2009); Congressional Budget Office, A Preliminary Analysis of the President’s Budget and an Update of CBO’s Budget and Economic Outllook, March 2009, (July 15, 2009). Figures adjusted for inflation into 2009 dollars.

12

Large fiscal expansions coupled with debt monetization lead to inflation

Source: Deutsche Bank Global Markets Research

13

Sou ce: eutsche ank Global a kets esea ch

O fOptimal Maturity of Issuance

14

Definition of the problem

A f 15 i d dit i j t f di d th t

Overview- Across a range of 15 economic and credit scenarios, we project funding needs over the next 10 years

- Our goal is to find the optimal average maturity of debt issuance given different risk scenarios over the next 3 yearsscenarios over the next 3 years

Setup of problem:

- Decision variable: % gross issuance of 2009-2011 to be issued in 3-months and 10-years

- Objective: Minimize the total cost of debt service from 2010-2020 (try to consider a confidence crisis on sovereign credit by 2020)

- Constraints:

-Maintain enough net issuance in bills and 10-years to meet investor needs

-Additional Consideration

-Keep yields within a range to achieve monetary policy goals

1515

Overview of the model

Contingent Real Growth InflationContingent Liabilities

Annual Issuance Maturity of Shape of YieldCredit Spreads Duration SupplyAnnual Issuance (Deficit)

yIssuance

Shape of Yield Curve

p pp y

Cost of DebtCost of Debt

1616

Macro and credit scenarios

The model considers 15 scenarios:– 5 macro scenarios: combinations of growth and inflation5 macro scenarios: combinations of growth and inflation– 3 credit scenarios: optimistic, base case and disaster

Four focus scenariosCredit Losses

Scenario Description InflationReal

GrowthFannie / Freddie FDIC

Extraordinary Assistance Total

1 Base Case 2% 2% $300 $200 $75 $5752 Low Growth, low inflation (Japan) 0% 0% $300 $200 $75 $5753 Moderate growth, high inflation 2% 5% $300 $200 $75 $5754 High credit loss 2% 2% $600 $600 $200 $1,400

17

Yield curve dynamics

♦The 10-year rate is the sum of:- Real growth rate-InflationInflation-Credit spread: based on amount of credit losses-Inflation risk premium: 50 bps + 20% of current inflation-An adjustment for duration supply: assume $1trn in net issuance leads to 1% increase in yields. *

♦The 3-month point is largely determined by the Fed:- Taylor rule: d(3-month Yield) = 1.5 * d(Inflation) + 0.5 * d(Real Growth)- The 3-month credit spread is smaller than the 10-year spread and varies by credit scenario- The impact of duration supply is small: $1trn in net issuance increases yields by 7 bps- The impact of duration supply is small: $1trn in net issuance increases yields by 7 bps

Rates in 2020 across focus scenarios

S i G th I fl ti Credit Inflation Impact of D 10 Yi ld 3 Yi ld D bt / GDPScenario Growth Inflation C ed t

Spreadat o

Risk Prem Durn Supply

10-yr Yield 3m Yield Debt / GDP

Base 2.0% 2.0% 0.25% 0.9% 2.3% 7.5% 2.9% 123%Japan 0.0% 0.0% 0.25% 0.5% 2.1% 2.8% 0.0% 149%High Inflation 2 0% 5 0% 0 25% 1 5% 2 9% 11 7% 7 4% 117%

* A recent study by JP Morgan concluded that net issuance of 10yrs in the amount of 1% of GDP causes yield to rise by 30bps. This would imply that yields would rise by 2% given $1 trn in issuance. We found this lead to yield curves that were implausibly t b 2020 h l d th ff t W d f l th t th ff t d i d l i th ti id

High Inflation 2.0% 5.0% 0.25% 1.5% 2.9% 11.7% 7.4% 117%High Credit 2.0% 2.0% 1.75% 0.9% 2.9% 9.6% 4.3% 140%

1818

steep by 2020 so we halved the effect. We do feel that the effect we used in our model is on the conservative side.

Budget outlook across scenarios

Federal budget in focus scenariosFederal budget in focus scenarios

2011 Yield Curve 2020 Yield Curve

% Bill in G

Avg M t it f A M t it

Deficit / GDP D bt / GDP

Debt Service / GDP i

ScenarioGross

SupplyMaturity of

IssuanceAvg Maturity of Debt 2011 3m 10y 3m 10y

GDP (2015-2020)

Debt / GDP in 2020

/ GDP in 2020

Base 56% 55 74 2.2% 5.8% 2.9% 7.5% 9% 123% 7%Japan 81% 26 51 0.2% 2.8% 0.0% 2.8% 7% 149% 3%High Inflation 3% 116 96 4.4% 7.8% 7.4% 11.7% 11% 117% 9%High Credit 42% 70 83 2.6% 7.0% 4.3% 9.6% 9% 140% 9%

1919

Optimization across scenarios

♦In the low growth / low inflation scenario, we want to keep issuance as short as possible

♦In the high inflation scenario, we should issue long now to lock in low rates

Average Debt Service / GDP: 2015-2020

8.00%

9.00%

10.00%

116 (96)

4.00%

5.00%

6.00%

7.00%

55 (74)

70(83)

2.00%

3.00%

12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 108

Maturity of Debt Issuance

26 (51)

y

Base Case Japan High Inflation High Credit Loss

Line shows optimal maturity of issuance to minimize total debt service cost for 2009-2020Number in parentheses is average maturity of total debt at the end of 2011

2020

Number in parentheses is average maturity of total debt at the end of 2011

Optimal issuance across macro and credit scenarios

Real I fl ti % of M t it 3 10 Deficit / Debt / Debt Service Recent Issuance Yield Curve

Current macro environment

Growth Inflation Bills Maturity 3m 10y /GDP

/GDP / GDP

-1% 1% 70% 26 0.08% 3.59% 14% 50% 1.3%

Optimal issuance for a given macro environmentBase Case Tax Rate 30% Higher Taxes

Real Growth Inflation

% Bills in Gross

Supply

Debt Maturity 3m 10y

% Bills in Gross

Supply


0% 0% 80.6% 26 0.2% 2.8% 7.4% 149% 3.5% 83.6% 22 0.2% 2.7% 4.9% 112% 2.5%

Base Case Tax Rate 30% Higher Taxes

Debt Service / GDP in

2020

Optimal Issuance Yield Curve in 2020Deficit /

GDP (2015-20)


GDP (2015-20)

Debt / GDP in

2020

Debt / GDP in

2020


2020

Optimal issuance for a given macro/credit environment

2% 2% 55.6% 55 2.2% 5.8% 8.9% 123% 6.6% 60.4% 49 2.2% 5.7% 5.5% 87% 4.6%2% 5% 3.4% 116 4.4% 7.8% 11.1% 117% 9.3% 10.5% 108 4.4% 7.8% 7.4% 81% 6.1%4% 0% 62.7% 47 1.2% 5.5% 7.0% 107% 5.4% 66.9% 42 1.2% 5.3% 2.8% 71% 3.6%4% 5% 0.0% 120 4.9% 8.8% 10.6% 96% 8.8% 0.0% 120 4.9% 8.8% 5.4% 60% 5.4%

p g

Real Growth Inflation Credit

Losses (bn)

% Bills in Gross

Supply


% Bills in Gross

Supply

Debt Maturity

(mos)3m 10y

Deficit / GDP

(2015-20)

Debt / GDP in

2020

Base Case Tax Rate 30% Higher Taxes


2020


GDP (2015-20)

Debt / GDP in

2020


2020

Optimal Issuance Yield Curve in 2020

0% 0% $6 82.7% 23 0.1% 2.5% 7.4% 142% 2.9% 85.7% 20 0.1% 2.4% 4.8% 105% 2.1%0% 0% $575 80.6% 26 0.2% 2.8% 7.4% 149% 3.5% 83.6% 22 0.2% 2.7% 4.9% 112% 2.5%0% 0% $1,400 73.1% 34 0.6% 4.0% 7.9% 168% 5.9% 76.3% 31 0.6% 3.9% 5.6% 128% 4.3%2% 5% $6 6.5% 112 4.4% 7.5% 11.1% 111% 8.6% 13.2% 105 4.4% 7.5% 7.2% 75% 5.5%2% 5% $575 3.4% 116 4.4% 7.8% 11.1% 117% 9.3% 10.5% 108 4.4% 7.8% 7.4% 81% 6.1%2% 5% $1,400 0.0% 120 4.8% 8.8% 11.7% 132% 12.0% 0.0% 120 4.8% 8.8% 8.2% 93% 8.1%

2121

Impact of duration supply

♦ Our choice of maturity is highly dependent on the impact of duration supply on yields

♦All else equal if issuing more long debt has a larger impact on rates, the optimal maturity q g g g p , p ywill be shorter

Average Debt Service Across all Scenarios / GDP: 2015-2020

7.50%

8.00%

8.50%

9.00%

56 months

5.50%

6.00%

6.50%

7.00%

9

56 months

5.00%12 18 24 30 36 42 48 54 60 66 72 78 84 90 96 102 108

Maturity of Debt Issuance

$1 trn in issuance -> 1% in yield $1 trn in issuance -> 2% in yield

79 months

2222

y y

Implications of monetary policy constraints for debt issuance

♦ The lowest-cost issuance strategy may lead to yields that conflict with monetary policy goals

♦ If we restrict ourselves to strategies that limit near-term bond yields, the maturity of issuance will be shorter

Issuance strategies across targeted yields

A M i Maximum Allowed 10-

Year Yield

Average Maturity of Issuance 2009-

2011 Debt Maturity 2011Debt Service / GDP

2015-2020 *None 79 87 5.7%5 5% 74 84 5 7%5.5% 74 84 5.7%5.0% 56 75 5.8%4.5% 41 65 5.9%4.0% 28 53 6.2%

* Maximum across all scenarios** Average across scenarios

3.5% 16 41 6.7%3.0% 15 39 6.8%

2323

** Average across scenarios

The choice of maturity matters, but without budgetary restraint the cost of debt could spiral

♦ In a high credit loss, high inflation scenario issuing long-dated debt from 2009-2011 can reduce debt service cost in 2020 by 13% of government revenues

♦ But even with the optimal maturity debt service costs will be unbearable

♦The dashed lines assume spending is cut by 30% by 2012

Debt Service as % of Federal Revenues: High Inflation, High Credit Scenario

90%

40%50%

60%70%

80%

0%10%

20%30%

40%

0%2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

25 Months 54 Months 120 MonthsMaturity of debt issued 2009-2011:

2424

Recap

Four Conclusions:

1. Inflation, higher interest rate and roll over risk should be the primary concerns in Treasury’s debt management strategies.

2. In most scenarios, it is prudent to lengthen maturities significantly from current average maturity of 50 months. Our base case is to extend to 74 months, stretch case to extend to 96 months.

3. The objective of lowest borrowing cost could lead to higher yields that conflict with monetary policy objective.

4. Clever debt management strategy could potentially reduce debt service cost meaningfully, but still can’t completely substitute for prudent fiscal policy.

2525

Future Research

♦ We did not fully consider entitlement and state and local government as potential contingent liabilities Hence risk to the model is to the upsidecontingent liabilities. Hence risk to the model is to the upside.

♦ We can enhance the model on duration supply going forward. Current literature focused on historical regression. Possible new variables to consider: oil, dollar debasement, change of foreign demand and US saving ratechange of foreign demand, and US saving rate.

♦ We can attempt to model the rollover risk in a different context. We can tie the front end credit spread to the amount of short term debt maturing within a certain time frame.

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Presentation to the Treasury Borrowing Advisory Committee · 03-11-2009 · FY 2009 FY 2010 Note:...

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