EDWARD M. ROOB*

An early program for these meetings entitled my paper, "EmergingProblems in Debt Management." I would like to put my remarks in asomewhat broader context, namely, to consider the questidn, "Whatis debt management all about?" Clearly there are a number ofpossible answers; some would be of interest primarily to marketparticipants; others to academicians; still others to a more generalaudience. It seems to me that from the standpoint of the Treasurymany of our objectives in debt management revolve around acontinuing effort to ensure that the U.S. Government securityremains the best in the world. It is in this context that I believe wemust consider the various technical and special policy aspects of debtmanagement.

From a practical standpoint of course, making these securities thebest in the world means that buyers will pay a relatively high pricefor them with consequent savings to the taxpayer. This in turnrequires that a smoothly functioning secondary market must existwherein investors and traders can move freely into and out of them,from one to another maturity area and from issue to issue with aminimum of transaction cost. The combination of high quality andliquid secondary markets in turn allows the Treasury to achieve amaximum degree of flexibility in the amounts, timing and maturityof the issues it sells.

Potentially we can use this flexibility to help promote economicstabilization. Henry Wallich’s paper considered a number of aspectsof this question. It seems to me that in one important sense debt

*Special Assistant to the Secretary of the Treasury for Monetary Affairs.

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180 ISSUES IN FEDERAL DEBT MANAGEMENT

management is less important than it used to be: Treasury’s borrow-ing operations are no longer the dominant force in the total U.S.credit picture, although the growth in agency borrowing and Federalcredit programs are offsetting some of this relative decline as BruceMacLaury points out.

Nonetheless, I believe that Treasury borrowing operations anddebt management policies may continue to play a role in overalleconomic stabilization policy. Our choice of maturity and the timingof our borrowing operations can still have an influence on the flowof credit and relative interest rates in financial markets and thereforeon the economy.

On a day-to-day, year-to-year basis maintaining and improving thequality of U.S. Government securities is a continuing job requiringflexibility and adaption of new initiatives in our operations. I wouldlike to address myself to the following questions: What have we doneto accomplish our objectives? Have we been entirely successful?What are some of the problems we have faced and are likely to facein the future?

Achieving the Objectives

Of the significant changes in Federal financing activities in recentyears it is clear that some have been forced upon us by the changingcharacter and scope of Federal financing and the general U.S.financial environment, some have come from our own initiative.Realistically, not all of the changes in the environment in which wework have been entirely beneficial to the market, to orderly debtmanagement or to flexible Federal financing.

For the most part, however, we hope the changes we have madehave led or will lead to a better meshing of Federal financingoperations with the market demands of other borrowers and to acontinuing improvement in the functioning and efficiency of themarket for Federal and federally sponsored obligations.

The major changes that we have initiated in direct Federalfinancing over the last few years have been:

(1) the greater use of auctions;(2) an increased reliance on cash as opposed to exchange

financings;(3) an increased emphasis on long-term securities; and(4) a continuing effort toward greater regularization of

Treasury financing operations.

POLICY ASPECTS ROOB 181

The possibility of auctioning Treasury coupon-bearing obligationshad been discussed by economists in and outside of the Treasury fora number of years. There were a good many reasons why we did notmake great use of auctions until recently, not the least of which wasthe normal conservatism of all debt managers. In addition to this,however, few borr6wings in the note and bond area were for cash;price experience with the cash offerings was good; and there wasconcern about market reaction to a cash auction since -whateverthe facts - the Treasury’s limited experiment with syndicate bondauctions in the early 1960s had left a sour taste in the mouths ofmany market participants.

As the 1960s ended the situation was somewhat different. Therewas a greater need for cash financing due to large budget deficits,part of which we felt should be in the coupon area. While theproblem seems to me easily exaggerated, a considerable body ofopinion concerned with the difficulties for monetary authorities inmaintaining a so-called even keel during periods of Treasuryfinancing felt that auction techniques could ameliorate thesedifficulties. Moreover, security prices had become more volatile,increasing the attractiveness of auction sales as a means of achievingclose pricing of new issues, while at the same time eliminating theuncertainties inherent in guessing allotment percentages in fixed-price offerings.

We undertook our first tentative steps toward establishing noteand bond auctions as a routine option for our borrowing operationsin late 1970 with the sale of a 6a/~ percent, 18-month note auction.Since then, auctions, in both the traditional and uniform-price forms,have become the major method of pricing new Treasury notes andbonds.

In the process of developing and refining the auction technique,we have experimented in the sale of very long-term maturities, wherethe price fluctuation risk is greater, with so-called "’Dutch" auctions.We have also now had experience in auctioning long notes under avariety of market conditions. The "Dutch" auction in which allsubscribers receive the security at the same price, and thus far therehave been only two, were thought to have both advantages and dis-advantages. The major advantage cited for the Dutch auction is thatit would provide a basis for greater confidence in bidding and thusattract a greater volume of bidding and more interest by non-professional investors. On the other hand a supposed disadvantage ofthe technique is that it would short-circuit the professional under-writers by removing any dealer spread that they may gain.

182

Results of Auctions

ISSUES IN FEDERAL DEBT MANAGEMENT

The results of the two auctions which we have held, admittedly asmall sample, indicate an interesting response. First, there is onlyscant evidence that the Dutch auctions attracted a significantlydifferent type of bidder from what would be expected of any sale oflong-term maturities. Second, professional dealer interest in both ofthese auctions was substantial, accounting for 45 percent of awardsof the 6S/~s and over 60 percent of the 7s. Third, interest by otherinvestor groups who might be attracted to the securities by thesmaller price risk was in fact small. Total coverage in both auctionswas substantial indicating that the Dutch auction keeps the profes-sional and may attract other bidders. Distribution following theauction was effectively accomplished with minimal price changeimplying that, in fact, the dealer did perform his traditional under-writing role. The pattern of bidding may have been different fromsome of the hypothetical expectations, but the resulting yield estab-lished on the securities was in both cases pretty much in line withgeneral expectations at the time of bidding. Nonetheless, our experi-ence with Dutch auctions is still limited, and it may well be too earlyfor us to reach much in the way of a firm conclusion on the relativesuccess of the Dutch auction.

On the broader subject of long-term issues, the 41/~ percentinterest-ceiling restrictions and the rise in the level of market ratesforced the Treasury to discontinue any financing through long-termbonds after the mid-1960s. As a result, the market for long-termTreasury issues has in recent years become undesirably thin.Quotations are often only nominal, as many of yon know, andtrading is spotty. Not only was the Treasury’s borrowing flexibilityconstrained by this change, but stabilization operations in the longmarket by both the Treasury and the Federal Reserve were neces-sarily limited. In a general way this was not in keeping with ourdesire to have the best security in all maturity areas.

The $10 billion authority granted to the Treasury in the spring of1970 to sell long-term securities outside of the 41/~ percent ceilingprovided us with the opportunity to regain our flexibility in finan-cing and to begin the revitalization of this segment of the market. Todate, we have issued some $8.5 billion of these securities. Most werein the intermediate-to-long area where market response was morepredictable and the risk of undesirable rate pressures less, but $1.2billion were sold in the 20-25 year area. This is admittedly a small,slow beginning; and many of the issues have found their way intoGovernment account and Federal Reserve hands. But it is a beginning

POLICY ASPECTS ROOB 183

and caution and prudence are needed if we are to continue theprocess of reestablishing the market for these issues in an orderlyway without producing undesirable rate increases for other bor-rowers.

We hope the Congress will see fit to provide us with the authorityfor another tranche of long-term issues outside of the 41/~ percentceiling and thus give us the flexibility we need to further expand ourlong-term borrowing activities, to give investors a broader choice oflong-term Treasury obligations, and to restore at least some possi-bility of stabilization operations in long markets.

The third facet of direct Treasury borrowing in which ][ believe we~ave initiated significant changes in recent years is in the regular-ization of those activities. For many years the bill offerings and thequarterly refunding have been our only regularly scheduled borrow-ing activities. But in the last year alone there has been a considerableadvance toward a greater variety of issues being sold or dated on aregular schedule. For example, the nine-month and one-year billofferings, which used to come at varying points near the end of themonth, have been converted to a cycle of 52-week bills which will besold every four weeks on a regular basis when the original cycle iscompleted. Not only will this procedure establish a regular pattern ofsales, allowing for a more orderly distribution of the bills, but it willalso provide a more regularly timed instrument for investors’ cashmanagement.

Last fall we also introduced a degree of regularity in part of ournote financing with the offering of two-year notes on a maturityschedule which will eventually result in a quarterly cycle. Thesesecurities, we hope, will meet the needs of both the market and theTreasury for a cash-management instrument outside the bill area. Asyou know, we quickly ran into problems in establishing this cycle ofnotes when sales of special issues to foreigners this spring resulted ina sharp runup in our cash position, obviating the need to issue thetwo-year securities at the end of March and June.

A Problem of Regularization

While we will fill in these gaps in the cycle later, either on quar-terly or off-quarterly dates, the postponement of these issues pointsup an important problem in seeking greater regularization in ~ihetiming and maturity of Federal financing activities. This is the in-creasing difficulty of projecting the absolute size of our cash needs.We may be doing better in our projections and the relative size of the

184 ISSUES IN FEDERAL DEBT MANAGEMENT

errors may be smaller, but as the size of Government receipts andexpenditures have risen, the absolute size of projection discrepancieshas also tended to increase. It is this type of error that causes prob-lems when one is trying to determine market-borrowing require-ments. Of course in the last year, the changing tax picture and theunpredictable reactions of the tax-paying public to revisions in taxregulations - especially the now-famous overwithholding situation --have posed a special problem. In addition, we have had the problemof providing Treasury issues for foreign official investment of dollarsacquired in foreign exchange support activities.

To some extent, these particular aspects of our cash projectionproblems may lessen as time goes on. Nonetheless, the Federal sectoris likely to become more rather than less complex in coming yearsand our basic problem is not likely to go away.

All of this does not say that regularization in our borrowingactivities is doomed to take a back seat. It does suggest, however,that we cannot tie down our debt-management strategy too much.Greater regularization of the timing of our operations must beaccompanied by new flexibilities in other aspects of our financingwhich recognize that our needs themselves are not regular and, withthe growing complexity of government, those needs may be subjectto a greater number of unpredictable and sizable variations.

Direct Treasury borrowing operations are only one aspect ofFederal finance. More and more the growth in agency needs requiresus to look at the whole Federal financing pie if we are to maintainthe quality of our securities and insure the flexible, efficient opera-tion of our market. At the end of fiscal 1970, $35.7 billion of issuesby the Government-sponsored agencies were outstanding. In addi-tion, there were some $12.5 billion of securities of the agenciesincluded in the budget. While only small changes have occurred inthe volume of securities issued by the budgeted agencies, borrowingby the sponsored agencies has risen markedly. Bruce MacLaury wentinto these developments in detail, so I will not review them here.

However, I do want to make several points with respect to thesubject. First, the Treasury takes its responsibilities of coordinatingagency needs seriously. We consider it our responsibility to recognizethat in the area of Federal finance, all participants, including theTreasury, must be viewed as part of the whole. Secondly, we wouldbe delinquent in exercising our responsibilities to the market placeand the agencies were we not to recognize the need for coordinationof approach to the market by each agency so that all can shareequitably in their ability to be financed. In the function of debt

POLICY ASPECTS ROOB 185

management we do not, and are not entitled to, view our preroga-tives of financial advisor, coordinator, and "traffic cop" as allowingus to censor program responsibilities of the agencies; nor do we viewourselves as having the right to set priorities as between programsthrough the vehicle of accessibility to the marketplace. Therefore, itis incumbent upon us to treat each agency with full awareness oftheir needs and objectives. To this end we have added a new office tothe staff of the debt management team. The major function of thisposition will be to make an overall appraisal of agency needs andensure that each financing request can fit into the overall objective ofkeeping Federal securities as the premier credit instrument in theworld.

Changes in Agency I~¥nancing

To be sure a number of changes in the Federal agency financingpicture are likely when the Federal Financing Bank gets underway.In particular, it should provide us with a means of achieving bettercoordination of the borrowin~ activities of the agencies so that theirincreased needs for cash will be better absorbed by the market. Buteven with the Financing Bank eventually in operation the rise in thedollar volume of Federal agency borrowing over time and the insti-tutional changes that are going on must be recognized as adding anew dimension to Federal finance and debt-management policy. Andaside from the purely technical considerations which are likely tocause some problems, the size of agency financing and the wideningneeds for direct Treasury financing bring into question a number ofaspects of traditional Federal financing theory and debt manage-ment.

In the past, agency borrowing was largely considered a necessary,but nonetheless small, part of Federal finance. As such the needs andthe effects of that borrowing on the market could be thought of asmarginal. With the agency needs growing rapidly, the Treasury canno longer view its own financing needs in isolation. As I have said, wehave to look at the whole Federal finance pie. Among the moreimportant questions this has raised is whether the Treasury can lookat the traditional theory of Federal debt management and merelyexpand that philosophy to embrace the agencies. Should it avoid inits own financing activities the maturity areas needed most byagencies? This would clearly limit our borrowing flexibility. And itwould undoubtedly affect the efficiency and operation of ourmarket and the attractiveness of our securities as well. However, the

186 ISSUES IN FEDERAL DEBT MANAGEMENT

agencies, and therefore the Treasury in coordinating agency financingactivities, have a responsibility, implied in the Federal FinancingBank itself, to borrow on terms consistent with their program char-acteristics and asset structure. This factor somewhat limits our discre-tion in using the entire maturity spectrum to achieve market orstabilization goals. In light of these factors the Treasury increasinglyneeds to consider its own borrowing patterns in the context ofagency maturity characteristics. It is the overall structure of Federalobligations that is really important, not Treasury or agency debttaken singly.

From the Treasury’s cash management standpoint, of course, agreater concentration of borrowing in the short-term area could bedesirable. The market for short-term securities is highly resilient andcan take sizable additions or repayments of securities with a minimalinterest-rate impact. Because of the market’s resilience, announce-ment of new borrowitxg needs can be made on relatively short notice.Thus, swings in our cash needs, especially if unexpected, could bemet with relative ease. Very likely a concerted movement in thisdirection for our cash-management borrowing requirement wouldnecessitate some changes in our current bill offerings. I am sure thata number of alterations might be suggested; two that come to mindreadily are more frequent changes in the size of the weekly billauctions to match our particular cash needs and, perhaps as a supple-mentary measure, the increased use of bill strips.

There are a number of other developments that have arisen inconnection with changing institutions and market arrangementswhich bear careful watching if we are going to insure the continuedhigh quality of our securitie~ and the efficient functioning of ourmarket. From the technical point of view, the possibility exists thatwe will extend the book-entry system beyond its current limits. Inthe market we see the rise of bond funds, the development of tradingaccounts rather than portfolio investment accounts at a number ofbanks and securities houses, nationwide brokerage services in Govern-ment and agency securities, etc. This broadened interest is in someways beneficial - speculation has a valid function. However, I cannothelp but feet that some of these recent developments, are based on apresumption of consistent success in outguessing the market and it issafe to assume that not everyone is going to be uniformly successfulin that game. We do not need to oversell our market. Our basicinterest must be to satisfy the needs of the prudent investor on theone hand and the market-making professional on the other - thegroups upon which we must rely in the long run for an effectivemarket for our securities.

POLICY ASPECTS ROOB 187

Conclusions

Altogether, then, I believe that the last few years have witnessed arather remarkable set of changes in the profile of Federal financingactivities. We have not innovated for innovation’s sake, of course; butwe have not shrunk from new ideas where the needs of the Govern-ment and the functioning of the market for our securities could beimproved by their adoption.

The changes which have taken place have certainly not come with-out some problems. But, in turn, the problems which have arisen -both in the sense of the general problems of debt and cash manage-ment and in the sense of the needs of particular segments of themarket - have themselves led to introduction of new ideas andtechniques.

I hope that this process of evolution will continue, and in factthere seems little doubt that it can do otherwise. Direct Federalfinancing needs are becoming increasingly complex, and the pro-jection of those needs is more and more difficult. The growth of theagencies’ needs poses further problems. And the entire market andfinancial environment is always changing. Each and every one ofthese will lead to problems and opportunities for Treasury debt man-agers, and from those problems and opportunities I expect will comefurther shifts and innovations in our borrowing and debt-management policies.

In the final analysis our guiding consideration in dealing with anyof these questions must be the integrity of our securities and of ourmarketplace.

DISCUSSION

ELI SHAPIRO*

Managing the Federal debt in a way that keeps the cost low andthe holders happy, while at the same time managing the debt so as toaffect the level and structure of interest rates according to the chang-ing needs of stabilization policy, are two central and conflictingobjectives for Treasury debt managers. These conflicting goals causethe Treasury to have a schizophrenic view as to the kind of govern-ment securities market they would like to have as well as a schizo-phrenic position as to the manner in which they should act - giventhe market they seem to have. Ed Roob’s paper presents severalexamples of these tensions and conflicting images within the Trea-sury. I do not want to give the impression that the Treasury seems tobe alone in its confusion and inner conflict. As I hope to make clear,both the academicians and the market practitioners represented byus here also share in this two-faced view of the Treasury objectivesand the market’s reality.

When considering its objective of financing the Federal debt, theTreasury wants its securities to be seen by participants in the marketsas the "best" of securities sold in the "best" of markets. In this light,the government market should contain a broad range of maturityalternatives with a sufficient depth of demand at any maturity, orenough substitutability among maturities that the prices of securitiesof different maturities are unaffected by volume of new issues or ofsecondary trading. In fact, the Treasury feels constrained to placenew debt issues in those maturity areas not well represented byoutstanding issues in order to foster this perfection and substi-tutability. Moreover, the Treasury seems to consider the lack of anactive market in long governments, which is caused in large part bythe ceiling on interest rates on bonds, to be a significant limit on itsflexibility and a major weakness in the market as a whole.

*Chairman, Finance Committee, The Travelers Corporation.

DISCUSSION SHAPIRO 189

A consequence of such a broad and fluid market that seems ofgreat importance to the Treasury is that the better the market inthese terms, the lower is the cost to the Treasury of financing thedebt.

When debt management is the objective at issue, however, thepreferred market structure would seem to be quite different. Theprimary objective of debt management is to affect the level ofexpenditures or demand by affecting the level and/or structure ofinterest rates in the government market and thereby the level and/orstructure of all interest rates. This objective can be achieved throughchanges in the volume of government securities outstanding in differ-ent maturity classes only if the government-securities market issegmented and imperfect and only if other security markets aresimilarly segmented and imperfect. If the impact on rates of thevolume of new issues of governments does not affect prices to anysignificant extent, then the market is as the Treasury would like it tobe in order to attract investors and keep debt charges low, but it isineffective for achieving stabilizing interest rate objectives throughdebt-management activities.

This inconsistency in the objectives for the structure of the marketis mirrored in an inconsistency between the objectives of low costand effective stabilizing debt management. The Treasury seems to actas if the imperfections in the long government market pose aproblem for it. Should the Treasury try to extend the maturities forwhich there is significant volume of securities outstanding (assumingCongress permits this) the current imperfect structure of the marketis likely to cause significant increases in long government rates inresponse to such an increase in outstandings. This increased costseems to cause the Treasury to avoid these maturities. On the otherhand, the greater the imperfections, the bigger will be the impact onrates or "bang-per-buck" the Treasury would get from security salesor purchases made in these maturities for debt-management pur-poses.

For example, if the overall stabilization objective argues for higherlong-term interest rates to assist in reducing some demands, an im-perfect long government market implies that a sale of long govern-ments would lead to a significant rise in long government rates andincreased interest payments by the Treasury. However, as longcorporates and tax-exempts responded to these increases, as privateplacement yields rose, and as households switched from deposits togovernments, corporates, bond funds, etc., the Treasury could have asignificant impact on the overall level of rates and thereby oneconomic activity.

190 ISSUES IN FEDERAL DEBT MANAGEMENT

The conflict between attempts to manage the debt at reasonablecost and attempts to affect the structure of rates without consid-eration of cost to the Treasury (because the costs are bettermeasured by more inflation rather than interest cost to the Treasury)clearly drives the Treasury in opposite directions. Attempts to act inways which stabilize the market so as to make it as attractive aspossible to investors at times have to be undone by actions meant tosurprise the market, alter rates and use the market to attempt toachieve stabilization objectives.

This inconsistency within the Treasury is broadly reflected in thismeeting at Bald Peak. The academicians among us feel more andmore that the empirical evidence is consistent with the view that thegovernment security market is a highly-efficient market. In this view,the maturity distribution of the outstanding Treasury debt, andpossibly even the maturity distribution of new issues, has little, ifany, lasting impact on the level and structures of rates. According tothis view, as other forms of short debt grow to larger and largeramounts, the Treasury’s effects on short rates have been continuallyblunted. Duesenberry and Bosworth suggest that if there is any effectof maturity on interest rates it is the impact of all short or long debtand not just Treasury debt. Henry Kaufman has documented therelative decline of Treasury debt as a fraction of total debt out-standing. To this group, Federal debt management is a dead issue.

At the same time, some of the older academics and, I would guess,all of the market practitioners feel the the Treasury’s maturity andvolume choices are of enough Significance to give it great attention inour assessment of the outlook for rates. As to the issue, of the per-fection of the market, many of us here make our living from itsimperfections. In fact, it is my guess that those of us who earn aliving from the market’s imperfections live better than those whoearn a living trying to document its perfection.

If we outside the Treasury must live with all these inconsistencies,perhaps we should be cautious before being too hard on the Treasuryas it deals with them as well.