Debt Management
Treasury Has Refined Its Use of Cash Management Bills but Should Explore Options That May Reduce Cost Further Gao ID: GAO-06-269 March 30, 2006One result of persistent fiscal imbalance is growing debt and net interest costs. Net interest is currently the fastest-growing "program" in the budget and, if unchecked, threatens to crowd out spending for other national priorities. This report was done under the Comptroller General's authority. GAO examined the Department of the Treasury's (Treasury) growing use of unscheduled short-term cash management bills (CM bills). Specifically GAO (1) describes when Treasury uses CM bills and why, (2) describes the advantages and disadvantages of CM bills, (3) describes steps taken by Treasury to reduce the overall borrowing costs associated with CM bills, and (4) identifies possible options Treasury could consider to reduce the use and cost of CM bills further.
Treasury makes large, regularly occurring payments, such as Social Security and federal retirement payments, in the beginning of each month but receives large cash inflows in the middle of each month from income tax payments and note issuances. Because regular bills alone are not sufficient to fill these intramonth cash financing gaps, since 2002 Treasury has increasingly issued CM bills to bridge this gap. CM bills allow Treasury to obtain cash outside of its regular borrowing schedule in varying amounts and maturities, but Treasury pays a premium for doing so. GAO's analysis found that Treasury paid a higher yield on CM bills than that paid on outstanding bills of similar maturity in the secondary market. Treasury has taken steps to reduce the use and cost of CM bills. Treasury added a 4-week bill to its regular auction schedule in 2001, which led to reduced CM bill issuance, shorter terms to maturity, and lower borrowing costs in 2002. Treasury has also fine-tuned CM bill issuance by borrowing closer to the time when it needs cash. However, borrowing costs associated with CM bills have increased since 2003. While Treasury has made progress towards reducing the cost of CM bills, it may be possible to do more. GAO's analysis indicates that the yield differential has increased as short-term rates have risen. If these rates rise further, as market participants expect, so will the yield differential. While Treasury does not vary its debt management strategy in response to changing interest rates, it should be mindful of their effect on the relative cost of unscheduled CM bills and explore options to reduce the frequent use of CM bills and ultimately overall borrowing costs. GAO identified options worth exploring such as any additional opportunities for closer alignment of large cash flows; possible options for increasing earnings on excess cash balances; and introduction of a shorter-term regular instrument.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
Director: Team: Phone:GAO-06-269, Debt Management: Treasury Has Refined Its Use of Cash Management Bills but Should Explore Options That May Reduce Cost Further
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Management Bills but Should Explore Options That May Reduce Cost
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Report to the Secretary of the Treasury:
March 2006:
Debt Management:
Treasury Has Refined Its Use of Cash Management Bills but Should
Explore Options That May Reduce Cost Further:
GAO-06-269:
GAO Highlights:
Highlights of GAO-06-269, a report to the Secretary of the Treasury:
Why GAO Did This Study:
One result of persistent fiscal imbalance is growing debt and net
interest costs. Net interest is currently the fastest-growing ’program“
in the budget and if unchecked, threatens to crowd out spending for
other national priorities. This report was done under the Comptroller
General‘s authority and examines the Department of the Treasury‘s
(Treasury) growing use of unscheduled cash management bills (CM bills).
GAO describes (1) when Treasury uses CM bills and why, (2) the
advantages and disadvantages of CM bills, and (3) steps taken by
Treasury to reduce the overall borrowing costs associated with CM
bills. GAO identifies possible options Treasury could consider to
reduce the use and cost of CM bills further.
What GAO Found:
Treasury makes large, regularly occurring payments, such as Social
Security and federal retirement payments, in the beginning of the month
and often receives large cash inflows in the middle of the month from
income tax payments and note issuances. Because regular bills alone are
not sufficient to fill these intramonth cash financing gaps, since 2002
Treasury has increasingly issued CM bills to bridge this gap. CM bills
allow Treasury to obtain cash outside of its regular borrowing schedule
in varying amounts and maturities, but Treasury pays a premium for
doing so. GAO‘s analysis found that Treasury paid a higher yield on CM
bills than that paid on outstanding bills of similar maturity in the
secondary market.
Treasury has taken steps to reduce the use and cost of CM bills.
Treasury added a 4-week bill to its regular auction schedule in 2001,
which led to reduced CM bill issuance, shorter terms to maturity, and
lower borrowing costs in 2002. Treasury has also fine-tuned CM bill
issuance by borrowing closer to the time when it needs cash. However,
borrowing costs associated with CM bills have increased since 2003.
Borrowing Costs Associated with CM Bills (Fiscal Years 1996–2005):
[See PDF for image]
[End of figure]
While Treasury has made progress towards reducing the cost of CM bills,
it may be possible to do more. GAO‘s analysis indicates that the yield
differential has increased as short-term rates have risen. If these
rates rise further, as market participants expect, so will the yield
differential. While Treasury does not vary its debt management strategy
in response to changing interest rates, it should be mindful of their
effect on the relative cost of unscheduled CM bills and explore options
to reduce the frequent use of CM bills and ultimately overall borrowing
costs. GAO identified options worth exploring such as any additional
opportunities for closer alignment of large cash flows; possible
options for increasing earnings on excess cash balances; and
introduction of a shorter-term regular instrument.
What GAO Recommends:
GAO recommends that Treasury explore options such as those identified
in this report and any others it identifies to help it achieve its
lowest-cost borrowing objective. If Treasury determines that any of
these changes would be beneficial, GAO encourages Treasury to begin
discussions with relevant federal agencies and the Congress about
obtaining the necessary authorities.
Treasury generally agreed with our findings, conclusions, and
recommendations and is committed to exploring ways to reduce financing
costs through changes in the use of CM bills.
www.gao.gov/cgi-bin/getrpt?GAO-06-269.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Susan J. Irving at (202)
512-9142, irvings@gao.gov or Thomas J. McCool at (202) 512-2700,
mccoolt@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Objectives, Scope, and Methodology:
Treasury Uses CM Bills to Help Fill Cash Financing Gaps:
CM Bills Generally Had Higher Yields than Outstanding Bills of Similar
Maturity but Lower Borrowing Costs than Currently Available
Alternatives:
Treasury Has Refined Its Use of CM Bills but Costs Have Begun to
Increase:
Options Exist That May Reduce the Use and Cost of CM Bills:
Conclusion:
Recommendation for Executive Action:
Agency Comments:
Appendixes:
Appendix I: Detailed Methodology and Findings of Statistical Analysis
of Cash Management Bill Yield Differential:
Previous Research Based on Earlier Data Suggests Some CM Bill Features
May Reduce Costs:
Comparing CM Bill Yields with Secondary Market Yields on Similar-
maturing Treasury Bills:
The Introduction of the 4-week Treasury Bill Reduced CM Bill Maturities
and Their Relative Importance in Short-term Financing:
Our Study Focused on CM Bills Issued during Fiscal Years 2002-2005:
Yield Differential Is Positively Correlated with Level of Treasury Bill
Yields:
Yield Differential Is Positively Correlated with Auction Amounts:
Maturity on or around Large Tax Payment Dates Reduces Yield
Differential:
CM Bills Issued in Multiple Tranches May Require Higher Yield
Differentials:
Yield Differential Is Not Affected by Timing of Issuance:
Several Findings from Earlier Studies Are No Longer Supported:
Selected CM Bill Features Reduce Yields but Opportunities for
Additional Exploitation of These Features May Be Limited:
Appendix II: Analysis of CM Bill Auctions:
Trading Activity Was Lower Prior to CM Bill Auctions than 4-week Bill
Auctions:
Yield Treasury Paid on CM Bills Generally Reflected Market Information
at the Time of the Auction:
CM Bill Auctions Are More Concentrated and Have Fewer Awarded Bidders
than 4-week Bill Auctions:
More Common Performance Measures Indicate High Demand for CM Bills but
Greater Uncertainty in CM Bill Auctions Compared with 4-week Bill
Auctions:
Appendix III: Selected Bibliography:
Appendix IV: Comments from the Department of the Treasury:
Appendix V: GAO Contacts and Staff Acknowledgments:
Tables:
Table 1: CM Bills Issued on the 1st-3rd Days of the Month That Mature
on the 15th Day of the Month:
Table 2: DISPs over the Last Decade (Fiscal Years 1996-2005):
Table 3: Illustrative Comparison of 4-week and CM Bill Borrowing Costs:
Table 4: Illustrative Effect of Issuing CM Bills in Multiple Tranches
on Borrowing Costs:
Table 5: Key Features of CM Bills before and after the 4-week Treasury
Bill's Introduction:
Table 6: Regressions Explaining the Yield Differential (Fiscal Years
2002-2005):
Table 7: Pre-and Postauction Trading Activity in CM Bills and 4-week
Bills (Fiscal Years 2002-2005):
Table 8: Average Spread between Auction and When-issued Yields at Time
of Auction (Fiscal Years 2002-2005):
Table 9: Bid-to-cover Ratios for CM and 4-week Bills (Fiscal Years 2002-
2005):
Table 10: Auction Tails for CM and 4-week Bill Auctions (Fiscal Years
2002-2005):
Figures:
Figure 1: Treasury's April 2005 Regular Borrowing Schedule:
Figure 2: Smoothing the Payment of Social Security Benefits:
Figure 3: Cash Balance and CM Bill Issuance during Fiscal Year 2005:
Figure 4: Cash Receipts and Maturity Dates of CM Bills Issued during
Fiscal Year 2005:
Figure 5: Annualized Federal Funds Rate and CM Bill Yields (Fiscal
Years 1996-2005):
Figure 6: Yield Differential (Fiscal Years 1996-2005):
Figure 7: Repurchase Agreements:
Figure 8: Yield Differential and the Average Level of Short-term
Treasury Yields (Fiscal Years 2001-2005):
Figure 9: Steps Taken in Recent Years to Increase the Rate Paid on
Treasury's Cash Balances:
Figure 10: Amount of CM Bill Issuance (Fiscal Years 1996-2005):
Figure 11: Average Size of CM Bills Issued (Fiscal Years 1996-2005):
Figure 12: Weighted Average Term to Maturity of CM Bills (Fiscal Years
1996-2005):
Figure 13: Annualized Amount Outstanding (Fiscal Years 1996-2005):
Figure 14: Total Borrowing Costs Associated with CM Bills (Fiscal Years
1996-2005):
Abbreviations:
BPD: Bureau of the Public Debt:
CBO: Congressional Budget Office:
CM bill: Cash management bill:
DISP: Debt issuance suspension period:
DMO: Debt Management Office:
Fannie Mae: Federal National Mortgage Association:
FMS: Financial Management Service:
Freddie Mac: Federal Home Loan Mortgage Corporation:
SSA: Social Security Administration:
TAD: Treasury Auction Database:
TIO: Term Investment Option:
TIPS: Treasury Inflation-Protected Securities:
Treasury: Department of the Treasury:
TT&L: Treasury Tax and Loan:
WSJ: Wall Street Journal:
Letter March 30, 2006:
The Honorable John W. Snow:
Secretary of the Treasury:
Dear Mr. Secretary:
One result of persistent fiscal imbalance is growing debt and net
interest costs. Net interest on the federal debt is currently the
fastest-growing "program" in the budget. The Congressional Budget
Office (CBO) projects that interest cost will increase by more than 50
percent over the next 5 years. If unchecked, interest spending
threatens to crowd out spending for other national priorities such as
educating our children, safeguarding the environment, and ensuring
national security.[Footnote 1]
The Department of the Treasury's (Treasury) primary debt management
goal is to finance the government's borrowing needs at the lowest cost
over time. To meet this objective, Treasury issues debt through
auctions in a "regular and predictable" pattern across a wide range of
securities including nominal bills, notes, and bonds, and Treasury
Inflation-Protected Securities (TIPS).[Footnote 2] According to
Treasury, because investors and dealers rely upon the routine
availability of Treasury securities they tend to pay a slight premium,
which lowers Treasury's borrowing costs.
Since 1975, Treasury has supplemented its regular and predictable
auctions with unscheduled cash management bill (CM bill) auctions to
finance short-term cash needs while providing short notice to market
participants. However, Treasury officials and researchers indicated
that Treasury pays a premium on CM bills in part because of their
irregularity and short-term nature. We examined Treasury's use of CM
bills to provide insights into options Treasury might consider to
reduce CM bill use, the premium paid on CM bills, and ultimately
government borrowing costs.
This report is part of GAO's ongoing work on Treasury's cash and debt
management practices and was done under the Comptroller General's
authority. We examined general patterns of CM bill issuance over the
last 10 fiscal years--fiscal years 1996-2005, but focused on the last 4
fiscal years after Treasury introduced a new regular 4-week bill in
2001 to reduce the use of CM bills. The objectives of this report are
to (1) describe when Treasury uses CM bills and why, (2) describe the
advantages and disadvantages of CM bills, (3) describe steps taken by
Treasury to reduce the overall borrowing costs associated with CM
bills, and (4) identify possible options Treasury could consider to
reduce the use and cost of CM bills further.
Results in Brief:
Since 2002, Treasury has increasingly issued CM bills to fill
intramonth cash financing gaps that regular bills alone cannot fill.
Treasury issues CM bills in the beginning of the month to raise cash
for Social Security, federal retirement, and other scheduled payments.
Treasury typically sets the maturity of CM bills to the 15th of the
month when notes are issued and tax payments are received. Treasury has
also relied on CM bills when it is nearing the debt ceiling to help it
pay the government's bills while keeping debt under the statutory
limit.[Footnote 3]
CM bills provide Treasury flexibility to obtain cash outside its
regular borrowing schedule, but Treasury pays a premium for doing so.
During our study period (fiscal years 1996 through 2005) Treasury paid
a higher yield on most CM bills than outstanding bills of similar
maturity paid in the secondary market.[Footnote 4] The higher yield,
hereafter called the "yield differential," is measured as the
difference between the CM bill yield Treasury obtained at auction and
the average secondary market yield on outstanding Treasury bills that
are most similar (in terms of maturity) to the CM bill on the day of
auction.[Footnote 5] Our statistical analysis of certain features of CM
bills, such as size issued and dates of issuance and maturity, from
fiscal year 2002-2005 (after the introduction of the 4-week bill) shows
that, all other things equal, issuing relatively larger CM bills
resulted in a higher yield differential. We also found that CM bills
that were part of a "multiple tranche"--successively issued CM bills
maturing on the same day[Footnote 6]--tended to have higher yield
differentials but this is only significant at the 10 percent level and
it is sensitive to the inclusion of other explanatory variables. CM
bills maturing around large tax payment dates tended to have lower
yield differentials. We also found that a key driver of the yield
differential is the general level of short-term yields in the economy,
a factor that is outside Treasury's control. A continuation in the rise
of short-term yields is therefore likely to result in higher yield
differentials. Although auction performance theoretically has an effect
on the yields Treasury obtained at auction, we did not find any
statistically significant relationships between the auction performance
measures we examined and the yield differential.
Treasury can accumulate and maintain higher cash balances or issue 4-
week bills instead of using CM bills to meet short-term cash
shortfalls. However, despite their higher yield, CM bills are generally
less costly than either of these alternatives. Treasury faces a
negative funding spread--the interest earned on cash balances is
generally insufficient to cover the cost of increased borrowing
necessary to maintain these balances. The negative funding spread is
due in part to the formula it established in 1978 for the interest it
earns on cash balances.[Footnote 7]As a result, it is generally more
cost-efficient to repay debt and then issue a CM bill than run higher
cash balances. CM bills are also less costly than a regular 4-week bill
for shorter-term needs (i.e., less than 28 days). This is true because
although 4-week bills tend to have a lower yield, they are outstanding
for a longer period of time. As a result, the borrowing cost of a 4-
week bill is generally greater than a CM bill of shorter maturity (less
than 28 days).
Treasury has taken steps to lower the use and overall cost of CM bills.
In 2001, Treasury introduced the 4-week bill to help reduce the use of
CM bills. This led to a reduction in the amount of CM bills issued and
their term to maturity. Also, instead of issuing one large CM bill,
Treasury has increasingly issued CM bills in multiple tranches.
Although CM bills issued as part of a multiple tranche may have higher
yield differentials than CM bills not part of a multiple tranche, they
allow Treasury to borrow cash closer to the day it is needed, which
reduces the average issue size, term to maturity, and annualized amount
outstanding. Therefore, the savings that multiple tranche CM bills
provide more than offset the higher yields such issues might entail.
Declining interest rates, which reached historical lows in recent
years, also helped reduce borrowing costs from 2001 to 2002. However,
the cost of CM bill issuance has increased since 2003.
CM bills will continue to be a necessary debt management tool to meet
unexpected cash needs when Treasury has low cash balances and when
Treasury is nearing the debt ceiling. Our analysis indicates that the
yield differential has increased as short-term rates have risen. If
these rates rise further, as market participants expect, so will the
yield differential. While Treasury does not vary its debt management
strategy in response to changing interest rates, it should be mindful
that increasing rates are likely to raise the relative cost of
unscheduled CM bills. As a result, Treasury should consider options
that may reduce the frequent use of CM bills and ultimately overall
borrowing costs.
We identified a range of options Treasury can consider that may reduce
the use of CM bills, the premium paid on CM bills, and overall
borrowing costs. One of the more promising options is exploring
additional opportunities for closer alignment of large cash flows to
help eliminate the frequent cash financing gap in the first two weeks
of the month. Treasury can also reexamine options for increasing
earnings on its excess cash balances, which would narrow the negative
funding spread and may ultimately reduce the need to rely on CM bills.
Other options include introducing a shorter-term instrument; increasing
transparency on the potential size of CM bills; relaxing rules for CM
bill auctions; and exploring other nations' debt management practices.
We recommend that Treasury explore options such as those discussed in
this report and any others it identifies that may help it achieve its
lowest-cost borrowing objective. We recognize that there are a number
of trade-offs to consider with each of these options. In its
exploration Treasury should consider the costs and benefits, including
how options may be combined to produce more beneficial outcomes, and
determine whether the benefits--in the form of lower borrowing costs--
to the federal government (and so to taxpayers) outweigh any costs
imposed on individuals, business, or other nonfederal entities.
Implementing some of these options would require changes to statutes or
regulations. If Treasury determines that any of these changes would be
beneficial, we encourage Treasury to begin discussions with relevant
federal agencies and the Congress about obtaining the necessary
authorities.
In oral and written comments on a draft of this report, Treasury
generally agreed with our findings, conclusions, and recommendations.
Treasury said that it is committed to continuing to explore ways to
further reduce financing costs through changes in the use of CM bills
and that many of the options we identified are embodied in its current
debt management policy. Treasury emphasized that statutory authority is
needed for some options, particularly changing the timing of receipts
and expenditures and improving earnings on excess cash balances.
Treasury also suggested some technical changes throughout the report
that we have incorporated as appropriate. Treasury's comments appear in
appendix IV. In addition, the Federal Reserve Board provided technical
comments that we incorporated as appropriate.
Background:
Congress has delegated to Treasury the power to borrow the money needed
to operate the federal government and manage the government's
outstanding debt subject to a statutory limit.[Footnote 8] Treasury's
primary debt management goal is to finance the government's borrowing
needs at the lowest cost over time. To meet this objective, Treasury
issues debt through auctions in a "regular and predictable" pattern
across a wide range of securities. Treasury does not "time the market"-
-or take advantage of lower interest rates--when it issues securities.
According to Treasury, because investors and dealers rely upon the
routine availability of Treasury securities they tend to pay a slight
premium, which lowers Treasury's borrowing costs. In addition, Treasury
also states that to support liquidity, it must issue "enough but not
too much" at each auction.[Footnote 9] If Treasury issued too little,
it could not sustain a deep and liquid secondary market for its
securities. If it issued too much, Treasury creates concern among
primary market participants that they may find it difficult to
distribute their holdings in the secondary market.
Treasury publishes a schedule with tentative announcement, auction, and
settlement (issue) dates up to 6 months in advance of regular security
auctions. Depending on the type of security, Treasury typically
auctions and then issues a security within a week or less. Treasury
generally issues short-term regular bills with 4-, 13-, and 26-week
maturities every Thursday and issues 2-and 5-year notes at the end of
each month.[Footnote 10] Three-and 10-year notes are issued in the
middle of each quarter and Treasury reopens 10-year notes 1 month after
their initial issuance.[Footnote 11] In addition, Treasury issues TIPS
in 5-, 10-, and 20-year maturities in certain months according to the
TIPS' maturity. Finally, Treasury issues 30-year bonds in the middle of
February[Footnote 12] and reopens the bonds in the middle of August.
Figure 1 depicts Treasury's April 2005 borrowing schedule.[Footnote 13]
Figure 1: Treasury's April 2005 Regular Borrowing Schedule:
[See PDF for image]
Note: The April 2-year note was issued on May 2 since the end of April
fell on a weekend. The 3-year note was not issued since April did not
fall in the middle of the quarter (i.e., quarterly refunding months--
February, May, August, and November).
[End of figure]
Treasury supplements its regular and predictable schedule with flexible
securities called CM bills. Unlike other securities, Treasury does not
publish information on CM bills on its auction schedule. Instead,
Treasury generally announces CM bill auctions anywhere from 1 to 4 days
ahead of the auction. The term to maturity--or length of time the bill
is outstanding--varies according to Treasury's cash needs. CM bills
allow Treasury to finance very short-term cash needs--for as little as
1 day--while providing short notice to market participants.
The United States Treasury is not alone in using CM bill-type
instruments to finance short-term needs and smooth cash flows. For
example, in the United Kingdom, the Debt Management Office (DMO) issues
CM bills to meet temporary cash flow needs that the DMO cannot
conveniently meet through its structured bill auctions and to help
smooth cash flows. The Bank of Canada, which auctions securities for
Canada's debt management, issues CM bills to help it minimize the level
and cost of carrying cash balances. Australia uses short-term
securities with 5-, 13-, and 26-week maturities to bridge within-year
cash flow mismatches, but may vary the maturities and issue shorter-
term securities of 3 to 6 weeks.
Objectives, Scope, and Methodology:
To understand when Treasury uses CM bills, we analyzed CM bills issued
over the last 10 fiscal years--fiscal years 1996-2005. This time period
provides a sufficiently large sample of CM bills--121--and allowed us
to analyze and show trends in CM bill use before, during, and after the
following events: 4 years of surpluses, five debt issuance suspension
periods (DISP) declared by the Secretary of the Treasury,[Footnote 14]
and the introduction of two new debt instruments--TIPS in 1997 and the
4-week bill in 2001. CM bill data were obtained from the Bureau of the
Public Debt (BPD). BPD's online database has 22 different features for
each Treasury security, including the amount, announcement, auction and
issue dates, the maturity date, and the yield. We examined these
features as well as others examined in earlier studies of CM bills to
identify patterns of CM bill auctions, issuance, and maturity.
To understand why CM bills are issued or mature at these times, we
examined Treasury's cash flows from fiscal years 1996-2005 using
publicly available data from the Financial Management Service's (FMS)
Daily Treasury Statements. We also met with Treasury officials from the
Office of Debt Management and the Office of Fiscal Projections. We
reviewed Treasury documents, including quarterly refunding statements
and policy statements, and Treasury Borrowing Advisory Committee
reports and minutes from quarterly refunding meetings.[Footnote 15]
We obtained views on the perceived advantages and disadvantages of CM
bills for Treasury, Federal Reserve operations, and investors in
meetings with Treasury officials, Federal Reserve officials, market
participants, including primary dealers and money market fund managers,
and market analysts. We also reviewed financial and economic
literature. We did not identify any key advantages or disadvantages of
CM bills for Federal Reserve operations and as a result these
operations are not a focus in this report.
To describe the key disadvantage of CM bills for Treasury--higher
yields--we estimated the differential between CM bill yields and the
yields on outstanding Treasury bills of similar maturity at the time of
auction using data from BPD and the Wall Street Journal (WSJ).[Footnote
16] To determine whether certain features might reduce the yield paid
on CM bills, we regressed the yield differential on key features. We
determined which features to examine on the basis of previous studies
of CM bills and Treasury auctions, our interviews with Treasury and
market participants, and our own analysis. While we analyzed the yield
differential for all CM bills issued during fiscal years 1996-2005, we
focused on the 55 CM bills issued during fiscal years 2002-2005 because
the introduction of the 4-week bill in 2001 substantially reduced CM
bill maturities and caused a structural change in the CM bill market.
For more information on our statistical analysis, see appendix I.
Because CM bill rates are determined in auctions, we examined auction
performance to determine whether there is any relationship between
selected performance measures and the yield differential. We also
examined whether CM bill auctions perform as well as regular 4-week
bill auctions because the 4-week bill is more similar to a CM bill--in
terms of issuance amount variance and its term to maturity--than other
Treasury securities. We evaluated each of the 284 CM and 4-week bill
auctions in fiscal years 2001-2005 (years since the introduction of the
4-week bill) using proprietary data from the Treasury Auction Database
(TAD) and GovPX--an interdealer broker database with information on
primary dealer transactions for all U.S. Treasury securities. We
analyzed auction performance measures mentioned in Treasury interviews,
Treasury studies of auctions,[Footnote 17] Borrowing Advisory Committee
minutes, and economic and financial literature/textbooks describing or
evaluating Treasury auction performance. See appendix II for more
information on our analysis of CM bill auctions.
We identified possible options to reduce the use and cost of CM bills
on the basis of our analysis of CM bill use, the yield differential,
and CM bill auction performance. We discussed these options with
Treasury, market participants, and others and we include their comments
as appropriate.
In order to assess the reliability of data used in this study,
including proprietary data from TAD and GovPX, and the publicly
available data from FMS, BPD, and WSJ, we examined the data to look for
outliers and anomalies and addressed such issues as appropriate. In
general, we chose databases that were used by Treasury and researchers
to examine Treasury markets and auction performance. Where possible and
appropriate, we corroborated the results of our data analysis with
other sources. On the basis of our assessment we believe the data are
reliable for the purposes of this review.
We conducted our review in Washington, D.C., from February 2005 through
March 2006 in accordance with generally accepted government auditing
standards.
Treasury Uses CM Bills to Help Fill Cash Financing Gaps:
Treasury frequently faces a cash financing gap of about 2-weeks
duration because of timing differences of large cash inflows and
outflows. Treasury makes large regular payments (e.g., Social Security
and federal retirement) in the beginning of the month and it often
receives large cash inflows in the middle of the month from income tax
payments and note issuances. Because regular bills alone are not
sufficient to fill this cash financing gap, Treasury has increasingly
used CM bills since 2002. Treasury has also relied on CM bills when
nearing the debt ceiling to help pay its bills while keeping debt under
the statutory limit.
Large Cash Outflows Occur at the Beginning of the Month:
Treasury's largest cash outflows generally occur in the beginning of
the month. For example, in fiscal year 2005, almost one-quarter of the
government's annual fiscal cash outlays (withdrawals excluding debt
redemption) were paid in the first 3 days of each month.[Footnote 18]
On or around the 1st of every month Treasury paid about $14 billion to
active duty military personnel, military and civilian retirees, and
others. In the beginning of some months, Treasury also paid up to $6
billion for Medicare. On or around the 3rd of every month it paid about
$21 billion in Social Security benefits. In total, Treasury made $718
billion cash payments in the first 3 days of months in fiscal year
2005.
These large payments in the beginning of the month are not anticipated
to decline soon. A Treasury official explained that Social Security
benefits paid on the 3rd of the month are anticipated to remain
relatively steady for a number of years and then decline because of
steps taken by the Social Security Administration (SSA) in 1997 that
have helped smooth cash payments out of Treasury. (Fig. 2 describes
these steps in more detail.) However, because beneficiaries receiving
benefits before 1997 continue to receive their benefits at the
beginning of the month, we estimate the large payments could last
another 10 years. Other federal benefit programs continue to pay all or
most of their benefits at the beginning of the month. If these payments
were, like Social Security, spread throughout the month, it would help
smooth cash flows and might reduce Treasury's need to use unscheduled
large CM bills at the beginning of the month.
Figure 2: Smoothing the Payment of Social Security Benefits:
[See PDF for image]
[End of figure]
Large Receipts Often Occur in the Middle of the Month:
In contrast to outlays, Treasury's largest cash inflows generally occur
in the middle of the month. Although the majority of federal tax
receipts are already fairly smoothed throughout the year, most
corporate and nonwithheld individual tax payments are made in the
middle of certain months throughout the year.[Footnote 19] Treasury
receives large corporate tax payments on (or around) the 15th of March,
April, June, September, and December. During fiscal year 2005, Treasury
received just over $213 billion of cash on these days. Treasury also
had large receipts in the middle of January, April, June, and September
from nonwithheld individual estimated tax payments, and after April 15
from the settlement of prior year individual income tax liability.
In addition to tax receipts, net cash raised from note issuances (i.e.,
issuance less redemption) on or around the 15th of the month more than
tripled from $78 billion in fiscal year 2002 to $297 billion in fiscal
year 2005. However, some large midmonth cash inflows from note issuance
will not endure because Treasury shifted 5-year note auctions from the
middle to the end of each month beginning in February 2006. As a
result, cash inflows from new 5-year debt issuance shifted from the
middle to the end of the month.
Regular Bill Issuances Alone Are Not Sufficient to Fill Cash Financing
Gap:
To achieve the lowest borrowing costs over time, Treasury seeks to
provide the market with a high degree of stability in the amount issued
of each security, with the requisite stability increasing with issuance
maturity. Treasury officials said they try to limit swings in regular
bill offerings. This means regular bill issuances cannot suddenly
increase by the amount needed to make large payments in the beginning
of the month nor suddenly decrease in the middle of the month to absorb
large inflows. In practice, Treasury only varied the amount of 13-and
26-week bills by $2 billion (less than 10 percent of the average amount
issued) from week to week in fiscal year 2005. Since Treasury
introduced the 4-week bill in 2001 to help reduce cash balance swings,
its issuance size varies more than that of other regular Treasury
bills. In fiscal year 2005, the size of the 4-week bill varied by as
much as $13 billion (more than three-quarters of the average amount
issued). Even so, to meet cash needs--which in fiscal year 2005
averaged almost $60 billion at the beginning of the month--Treasury has
come to rely on CM bills.
Treasury Has Increasingly Used CM Bills to Fill Frequent Cash Financing
Gaps:
The combination of low cash balances in the beginning of the month with
large cash inflows in the middle of the month has led to a general
pattern of CM bill issuance. Our analysis shows that from 2002 to 2005,
on average about half of CM bills were issued in the first 3 days of
the month. According to Treasury officials, Treasury decides to issue
CM bills when it has low cash balances, which often track the timing of
large payments. In fiscal year 2005, for example, Treasury issued 11 of
its 21 CM bills in the first 3 days of the month when it had below
average cash balances (the average cash balance for fiscal year 2005
was $25.5 billion) (see fig. 3). The amounts issued varied from $4
billion to $42 billion.
Figure 3: Cash Balance and CM Bill Issuance during Fiscal Year 2005:
[See PDF for image]
[End of figure]
The maturity dates of CM bills have varied over the 10-year period we
examined, but since 2002 CM bills have increasingly matured on the 15th
of the month when Treasury receives large cash inflows. In fiscal year
2005, Treasury set 68 percent of its $268 billion CM bill borrowings to
mature in the middle of March, April, June, September, and December
when Treasury receives large corporate and individual income taxes. In
these 5 months Treasury received 72 percent ($213.3 billion) of fiscal
year 2005 corporate income tax deposits.[Footnote 20] With only one
exception, all CM bills issued in fiscal year 2005, regardless of when
Treasury issued them, matured on or around the 15th of the month (see
fig. 4).[Footnote 21]
Figure 4: Cash Receipts and Maturity Dates of CM Bills Issued during
Fiscal Year 2005:
[See PDF for image]
[A] Cash receipts exclude net issuance of debt.
[End of figure]
Since 2002, Treasury has increasingly filled the approximately 2-week
financing gap by issuing CM bills at the beginning of the month and
setting the maturity date of these CM bills for the middle of
month.[Footnote 22] Table 1 shows that since 2002, 23 CM bills--or more
than 40 percent of the number of CM bills issued--have been issued on
the 1st-3rd days of the month and matured on the 15th day of the month.
These CM bills accounted for more than half of the total dollar amount
of CM bills issued in the last 4 fiscal years.
Table 1: CM Bills Issued on the 1st-3rd Days of the Month That Mature
on the 15th Day of the Month:
1996;
Number: 0;
Percent of total number issued: 0%;
Amount (billions of dollars): $0;
Percent of total amount issued: 0%.
1997;
Number: 1;
Percent of total number issued: 11;
Amount (billions of dollars): $26;
Percent of total amount issued: 16.
1998;
Number: 1;
Percent of total number issued: 14;
Amount (billions of dollars): $15;
Percent of total amount issued: 9.
1999;
Number: 5;
Percent of total number issued: 45;
Amount (billions of dollars): $99;
Percent of total amount issued: 42.
2000;
Number: 1;
Percent of total number issued: 10;
Amount (billions of dollars): $25;
Percent of total amount issued: 11.
2001;
Number: 5;
Percent of total number issued: 42;
Amount (billions of dollars): $162;
Percent of total amount issued: 47.
2002;
Number: 0;
Percent of total number issued: 0;
Amount (billions of dollars): $0;
Percent of total amount issued: 0.
2003;
Number: 3;
Percent of total number issued: 25;
Amount (billions of dollars): $69;
Percent of total amount issued: 39.
2004;
Number: 9;
Percent of total number issued: 60;
Amount (billions of dollars): $202;
Percent of total amount issued: 82.
2005;
Number: 11;
Percent of total number issued: 52;
Amount (billions of dollars): $175;
Percent of total amount issued: 65.
Total (1996-2001);
Number: 13;
Percent of total number issued: 20%;
Amount (billions of dollars): $327;
Percent of total amount issued: 23%.
Total (2002-2005);
Number: 23;
Percent of total number issued: 42%;
Amount (billions of dollars): $446;
Percent of total amount issued: 55%.
Source: GAO analysis of BPD data.
[End of table]
Treasury Also Uses CM Bills to Help Smooth Cash Flows during the April
Tax Season:
Over the last 10 years Treasury has relied on multiple CM bills to help
manage cash flows in April. The large cash balance swings in April
could not be accommodated by changes in the regular bill issuance
schedule according to Treasury officials and our analysis. To help
smooth large April cash flows, Treasury consistently issued three or
more CM bills every year between fiscal years 1996 and 2005 that
matured in the later half of April (on the 15th or later), when
Treasury typically received large tax receipts. For example, in fiscal
year 2005 Treasury issued three CM bills--two matured on April 15 and
one matured on April 18--totaling $47 billion and received about $41
billion in corporate and nonwithheld income and employment tax payments
on those dates.
Treasury Does Not Control the Timing of All Cash Flows:
Better aligning or smoothing cash inflows and outflows could reduce or
eliminate the frequent financing gap thereby reducing the need for some
CM bills but Treasury does not have authority to control the timing of
all cash flows. Treasury is a passive agent; it collects and disburses
federal funds at agencies' request.[Footnote 23] It does not determine
when major benefit payments are made. For example, the payment dates of
civil service and railroad retirement are set by law. Due dates for tax
payments are also set by federal statute.[Footnote 24]
Treasury does have some control over debt-related cash flows and has
considered how changes in its schedule affect cash flows. For example,
when making changes to its schedule in 2001, Treasury maintained
monthly issuance of 2-year notes, which are issued at the end of the
month and could help pay regular benefit payments in the beginning of
the following month. More recently, Treasury moved 5-year note issuance
from the middle to the end of the month. This change more closely
aligns 5-year note issuance with the beginning of the next month's
payments and may reduce CM bill issuance in the early part of months.
However, regular securities can only help fill cash financing gaps
temporarily. No regular security that matures on the same day another
is issued can be used to fill cash financing gaps over the long run
because, in a steady state, most, if not all, of the cash raised at
each issuance would be needed to pay maturing securities. As a result,
Treasury would not raise large amounts of new cash. In addition,
Treasury generally sets the issue amount for longer-term securities to
cover long-term deficit needs, not short-term cash shortfalls, and thus
the new cash raised with the 5-year note may not cover the full amount
of cash needs in the beginning of the month. Although Treasury will
likely raise new cash at the end of the month with the 5-year note
until 2011 when 5-year notes issued in 2006 begin to mature, the change
in the auction schedule is not likely to eliminate the need for CM
bills.
Treasury Also Relies on CM Bills When Approaching the Debt Ceiling:
When debt is nearing the statutory limit, Treasury has to take a number
of extraordinary steps to meet the government's obligation to pay its
bills while keeping debt under the ceiling.[Footnote 25] Treasury also
issues CM bills, among other actions, to accomplish these goals. CM
bills, like other Treasury securities, are subject to the debt limit.
However, CM bills allow Treasury to borrow cash for shorter time
periods than regular bills. On occasion, Treasury has changed scheduled
auctions for its regular securities and instead issued CM bills so that
the debt ceiling will not be reached. For example, because of debt
limit constraints Treasury delayed the 4-week bill auction scheduled
for Tuesday, November 16, 2004. Treasury then auctioned a 5-day CM bill
for $7 billion on November 17, 2004. In another example, Treasury said
that inaction on the debt ceiling in 2002 led to reduced issuance of 4-
week bills and larger, more frequent CM bill issuance than it would
have done otherwise. During the five DISPs within the last decade,
Treasury issued 19 CM bills totaling $300 billion. As table 2 shows,
Treasury issued most of these CM bills during the lengthy DISPs in
fiscal years 1996 and 2003.[Footnote 26]
Table 2: DISPs over the Last Decade (Fiscal Years 1996-2005):
Fiscal year: 1996;
DISP beginning date: November 15, 1995;
DISP ending date: March 29, 1996;
Length (days): 135;
Number of CM bills issued: 8;
Amount (billions of dollars): $130.
Fiscal year: 2002;
DISP beginning date: April 4, 2002;
DISP ending date: April 16, 2002;
Length (days): 12;
Number of CM bills issued: 2;
Amount (billions of dollars): $39.
Fiscal year: 2002;
DISP beginning date: May 16, 2002;
DISP ending date: June 28, 2002;
Length (days): 43;
Number of CM bills issued: 2;
Amount (billions of dollars): $41.
Fiscal year: 2003;
DISP beginning date: February 20, 2003;
DISP ending date: May 27, 2003;
Length (days): 96;
Number of CM bills issued: 6;
Amount (billions of dollars): $83.
Fiscal year: 2005;
DISP beginning date: October 14, 2004;
DISP ending date: November 19, 2004;
Length (days): 36;
Number of CM bills issued: 1;
Amount (billions of dollars): $7.
Total;
Number of CM bills issued: 19;
Amount (billions of dollars): $300.
Source: GAO analysis of BPD data.
[End of table]
CM bills will continue to be a useful tool for Treasury when it
approaches the debt ceiling, but, as discussed on page 20 of this
report, Treasury pays a premium for the flexibility CM bills provide.
CM Bills Cannot Be Used in All Circumstances and Other Alternatives No
Longer Exist or Are Limited:
Although CM bills offer a means to raise cash in as little as a day, CM
bills, like other Treasury securities, cannot be used when financial
markets are closed or not functioning properly. Previously, Treasury
could obtain cash on short notice outside financial markets, but this
capability ceased more than twenty years ago. Treasury was also able to
draw on compensating balances when financial markets closed after
September 11, 2001, but these balances were terminated in 2004.
In the past, Treasury had access to a cash draw authority.
Intermittently between 1942 and 1981, Treasury was able to directly
sell (and purchase) certain short-term obligations from the Federal
Reserve in exchange for cash. Treasury used the cash draw authority
infrequently and mostly in times of war or armed conflict. The Federal
Reserve held special short-term certificates purchased directly from
Treasury on 228 days between 1942 and 1981. In the years Treasury used
this authority, it borrowed on about 11 days on average per year. The
Treasury Draw Policy, as amended in 1979, stated that Treasury could
use the cash draw authority only in "unusual and exigent
circumstances."[Footnote 27] Congress allowed this authority to expire
in 1981.[Footnote 28]
Prior to March 2004 Treasury could use compensating balances--
noninterest bearing cash balances that were used to compensate banks
for various services--as a source of short-term funding when markets
were closed or during DISPs. Treasury officials said that compensating
balances were not viewed as a substitute backup facility for Treasury
to obtain cash in the short term and were only used in extraordinary
circumstances. For example, on September 11, 2001, Treasury had to
cancel the auction of 4-week bills, which would have settled on
Thursday, September 13, 2001. Because of the auction cancellation,
Treasury lacked sufficient cash to pay about $11 billion of maturing 4-
week bills on Thursday, September 13. Treasury obtained sufficient cash
by drawing down compensating cash balances. However, in March 2004,
compensating balances were replaced with direct payments to the banks.
More recently, in the aftermath of Hurricane Katrina, when cash
balances fell more than expected, Treasury obtained cash by canceling a
planned cash investment. Treasury periodically auctions excess cash to
banks through its Term Investment Option (TIO) program. Treasury
invests cash through TIOs for a fixed term at a rate determined through
a competitive auction process.[Footnote 29] Treasury intended to award
a $5.5 billion investment option on Friday, November 25, 2006. However,
additional spending in response to Hurricane Katrina caused Treasury's
cash balance to fall to an unexpected low level on November 23, 2005.
In response, Treasury did not follow through on the planned investment
option.
Using these investments as a source of cash in the future requires that
Treasury actually have excess cash to invest and that it knows it will
need the cash before investment. Reliance on excess cash is limited
since Treasury has placed increased emphasis on minimizing cash
balances in order to reduce overall borrowing costs. One possible
consequence of this practice is an increased risk that incorrect cash
flow predictions or emergencies could lead to Treasury overdrawing its
Federal Reserve Bank account. As a result, an important issue for
future consideration is how Treasury might obtain funds to finance
government operations should normal financial market operations be
degraded significantly or closed because of a catastrophic emergency.
CM Bills Generally Had Higher Yields than Outstanding Bills of Similar
Maturity but Lower Borrowing Costs than Currently Available
Alternatives:
CM bills provide Treasury with flexibility to obtain cash outside its
regular borrowing schedule, but Treasury generally paid a higher yield
on CM bills than outstanding bills of similar maturity paid in the
secondary market. The differential between CM bill yields and similar
maturing outstanding bills--hereafter called the "yield differential"-
-varied greatly from fiscal year 1996 through 2005.[Footnote 30] We
found several factors, both within and outside Treasury's control that
affected the yield differential. Despite their higher yield, CM bills
are generally less costly than maintaining higher cash balances or
issuing 4-week bills as means to obtain the cash needed to make large
payments, such as Social Security and federal retirement, at the
beginning of the month.
CM Bill Yields Closely Track Other Short-Term Rates:
CM bill yields closely track the level of short-term interest rates
prevailing at the time of auction. This is because investors see other
short-term instruments as close substitutes for CM bills. They can
either buy new bills or buy existing bills in the secondary market. In
general, investors will not accept a lower yield (bid a higher price)
for a new bill than that available on an existing bill. Conversely,
investors would not offer a lower price to obtain a higher yield than
prevailing in the market since they would likely be underbid. As a
result, CM bill yields follow other short-term yields within a narrow
range.
Short-term yields change over time in response to changes in economic
activity, the demand for credit, investors' expectations, and monetary
policy as set by the Federal Reserve. CM bill yields declined from
about 5.8 percent in 2000 to 1.1 percent in 2004. This decline
reflected the overall reduction in short-term rates driven largely by
the Federal Reserve's monetary actions and other market forces. The
Federal Reserve started lowering the federal funds rate--the interest
rate at which banks lend reserves to other banks overnight--in early
2001, and by 2002 the federal funds rate was at levels not seen since
the early 1960s. Beginning in the summer of 2004, the Federal Reserve
began to increase the federal funds rate. At the same time, CM bill
yields increased to an average 2.5 percent in fiscal year 2005 (see
fig. 5).
Figure 5: Annualized Federal Funds Rate and CM Bill Yields (Fiscal
Years 1996-2005):
[See PDF for image]
[A] Annualized number based on average of federal funds rates on days
of CM bill auctions. CM bill rates converted to money market yields for
comparability.
[End of figure]
CM Bill Yields Were Generally Higher than Yields on Outstanding Bills
of Similar Maturity:
Treasury paid a higher yield on most CM bills issued during our study
period than outstanding bills of similar maturity paid in the secondary
market. The average yield differential fell from 47 basis
points[Footnote 31] in fiscal year 2001 to 5 basis points in fiscal
year 2004 (see fig. 6). In fiscal year 2005, yield differentials grew
and CM bill yields were about 14 basis points higher on average than
outstanding bills of similar maturity.
Figure 6: Yield Differential (Fiscal Years 1996-2005):
[See PDF for image]
Note: The yield differential compares CM bill yields with the weighted
average of yields on outstanding Treasury bills maturing before and
after the CM bill. For more information, see app. I, pp. 53-54.
[End of figure]
Our analysis identified two important factors behind the yield
differential decline: lower short-term Treasury yields and reduced CM
bill issuance. The first effect was somewhat temporary while the latter
effect could last. The level of short-term interest rates is largely
driven by Federal Reserve policy and market forces rather than by
Treasury. Treasury bill yields have risen and may continue to rise and
eventually reach levels that prevailed in the late 1990s, thereby
erasing the portion of the decline in the yield differential caused by
lower interest rates. However, because the 4-week bill is now a
permanent feature of Treasury's auction schedule and has reduced
Treasury's reliance on CM bills, the portion of the decline in the
yield differential attributable to relatively lower CM bill issuance is
likely to endure. The experience during fiscal years 2002-2005 as a
whole suggests that the yield differential could remain about 13 basis
points below pre-2002 levels. These findings are discussed in more
detail later in this report.
The large reduction in the yield differential has helped reduce
borrowing costs associated with CM bills. The daily cost associated
with the 47-basis-point yield differential in fiscal year 2001 was
about $12,900 per $1 billion. In fiscal year 2001, Treasury borrowed
$19.2 billion (annualized amount outstanding) using CM bills.[Footnote
32] Of the $1.06 billion in total borrowing costs associated with CM
bills in that year, $70 million was associated with the yield
differential. Since then, the average yield differential has declined
and was 14 basis points, or about $3,800 a day per $1 billion borrowed,
in fiscal year 2005. During fiscal year 2005, Treasury borrowed about
$8 billion (annualized amount outstanding) using CM bills. Total
borrowing costs were $215 million and the borrowing cost associated
with the yield differential was about $12.8 million. Treasury could
achieve savings by further reductions in the yield
differential.[Footnote 33]
CM Bill Yields Were Similar to Yields on Overnight Repurchase
Agreements:
CM bills may have higher yields because, according to Treasury
officials and market participants, they are bought for a different
purpose than regular bills. According to market participants, some
money market funds and foreign central banks purchase CM bills but for
the most part they are not widely used as an investment tool because of
their irregularity and short-term nature. Instead, CM bills are
primarily used by primary dealers as collateral for repurchase
agreements. A repurchase agreement is a form of short-term
collateralized borrowing used by dealers in government securities.
Figure 7 describes repurchase agreements in more detail.
Figure 7: Repurchase Agreements:
[See PDF for image]
[A] Agency securities are financing instruments of federal government
agencies, such as the Tennessee Valley Authority, or government-
sponsored enterprises, such as the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation
(Freddie Mac). Agency securities are not considered risk free but are
considered to have high credit quality in part because of the agencies'
government affiliation.
[End of figure]
We found the yields of CM bills to be near the yields of overnight
repurchase agreements. In fiscal year 2005, CM bill yields were within
2 basis points of overnight repurchase agreement yields.[Footnote 34]
Although repurchase agreements and CM bills are both short-term
investments, there are some differences. For example, repurchase
agreements are subject to federal, state, and local taxes whereas CM
bills are exempt from state and local taxation. Also, CM bills, like
regular Treasury bills, are risk free whereas repurchase agreements
issued by private borrowers involve some risk. The high-quality
collateral in a repurchase agreement (e.g., Treasury securities or
agency securities) reduces the credit risk faced by the lender and
allows borrowers to obtain cash at a lower cost than they would obtain
otherwise.[Footnote 35] However, the lender is still exposed to credit
risk because if the borrower fails to repay the loan, the market value
of the collateral may be less than the amount owed. Repurchase
agreements are structured carefully to reduce this credit risk
exposure, for example, by lending less than market value of the
security used as collateral. Nevertheless, repurchase agreements have
more risk than securities issued by Treasury and accordingly have
higher yields than Treasury securities of similar maturity, which are
risk free and are the floor for short-term rates in the money market.
Our Analysis Identified Some Features That Affect the Yield
Differential:
Our statistical analysis found that, all other things equal, the amount
of CM bills issued was positively correlated with the yield
differential, meaning that increases in the amount of CM bills issued
relative to the amount of similar-maturing Treasury bills outstanding
increased the yield differential, and decreases in the amount issued
reduced the yield differential.[Footnote 36] We also found that CM
bills that were part of a "multiple tranche"--successively issued CM
bills maturing on the same day--tended to have higher yield
differentials,[Footnote 37] and CM bills maturing around large tax
payment dates tended to have lower yield differentials. Changes in the
general level of short-term yields also affected the yield
differential. While the amount and timing of CM bills is somewhat under
Treasury's control, the general level of short-term yields in the
economy is not.[Footnote 38]
Although CM bill yields are determined in auctions, we did not find a
statistically significant relationship between the auction performance
measures we examined--such as participation, distribution of auction
awards, and preauction activity in the when-issued market[Footnote 39]-
-and the yield differential. However, we found that in more
concentrated auctions Treasury was less likely to pay more than the
yield indicated in the when-issued market at the time of auction, which
is a positive auction result.[Footnote 40]
The Amount of CM Bills Issued Was Positively Correlated with the Yield
Differential:
While an increase in the relative amount of CM bills might enhance
liquidity and thereby reduce their yields, investors might require a
higher yield to acquire relatively large amounts of CM bills. Our
statistical analysis found that increases in the amount of CM bills
issued relative to outstanding bills with similar maturity increased
the yield differential. For example, if Treasury had increased its
fiscal year 2005 CM bill issuance by $10 billion, the average yield
differential would have been about 4.2 basis points higher according to
our analysis. Conversely, reducing the amount of CM bills issued tended
to reduce the yield differential. Earlier research by others had
similar findings.[Footnote 41]
According to our analysis, the reduced use of CM bills since the 4-week
bill was introduced contributed to the overall decline in the yield
differential. From fiscal years 1996-2001, the amount of CM bills
issued was almost 70 percent of outstanding bills with similar
maturity. In fiscal year 2002, the share declined to 30 percent. At the
same time, the yield differential declined from about 35 basis points
(fiscal year 1996-2001 average) to 4 basis points in 2002. According to
our analysis, about 35 percent of the yield differential decline can be
attributed to Treasury's reduced use of CM bills. CM bill issuance has
remained low relative to outstanding bills with similar maturity since
2002. These results suggest that the 4-week bill reduced both the use
and cost of CM bills as Treasury intended.
Issuing CM Bills in Multiple Tranches May Increase the Yield
Differential but Reduce Overall Borrowing Costs:
We also found that consecutive CM bills maturing on the same day--
called "multiple tranches"--tended to increase the yield differential.
In recent years, Treasury has increasingly issued consecutive, small CM
bills with the same maturity date--rather than one larger CM bill--
which reduces the average amount outstanding and ultimately reduces
borrowing costs. In 2005, three-quarters of the CM bills issued were
part of a multiple tranche. Our analysis suggests that issuing
consecutive CM bills that mature on the same date might increase the
yield differential by 6 basis points over a single CM bill. Market
participants suggested if they suspect Treasury might reopen the CM
bill later, they may bid less aggressively on a CM bill, which would
result in lower prices and higher yields for CM bills.
The evidence that issuing in multiple tranches increases the yield
differential should be viewed with caution. The estimated coefficient
is only significant at the 10 percent level and is sensitive to the
inclusion of other explanatory variables.[Footnote 42] For example,
with the inclusion of a variable representing the number of days
advance notice before auction, the coefficient of multiple tranche CM
bills is no longer significant even at the 10 percent level. Moreover,
the lower cost of multiple tranches resulting from smaller average
issues and shorter term to maturities most likely offsets any increase
in the yield. For more information on the cost-saving effects of
multiple tranches, see pages 38-39.
CM Bills Maturing on Large Tax Payment Dates May Have Lower Yield
Differentials:
Increasingly Treasury has issued CM bills that mature on individual and
corporate tax payment dates and, according to our analysis, this
practice may be leading to lower yields and borrowing costs. Our
statistical analysis shows the yield differential on CM bills maturing
on or near April 15 or on other tax payment dates (generally the 15th
of March, June, September, and December) is 12 basis points lower than
other CM bills. This may be explained by empirical evidence suggesting
that regular Treasury bills whose maturity dates immediately precede
corporate tax payment dates have special value because corporate
treasurers may wish to invest excess cash in securities whose cash
flows can be used to liquidate cash liabilities.[Footnote 43]
Almost 50 percent (27 of 55) of CM bills Treasury issued over the last
4 fiscal years matured on large tax payment dates. In the last 2 fiscal
years, Treasury set at least one CM bill to mature on each of the large
tax payment dates. So, to a large extent, Treasury has already captured
the cost-savings from this feature. It is also important to note,
however, that the 12-basis point difference is unlikely to offset even
an extra day of borrowing. CM bills maturing on dates other than large
tax payment dates with shorter maturities are likely to cost less than
CM bills maturing on a corporate tax payment date with longer
maturities because debt is outstanding for a shorter period of time.
Yield Differential Rises and Falls with Short-term Yields:
Our analysis showed that the yield differential rises and falls with
the overall level of Treasury bill yields. Figure 8 shows short-term
Treasury yields declined from an average of about 4.8 percent in fiscal
year 2001 to 1.05 percent in fiscal year 2004. At the same time, the
average yield differential fell from 47 basis points to 5 basis points.
Our analysis suggests the decline in short-term yields explained about
35 percent of the decline. Since mid-2004 when short-term rates started
to increase consistent with Federal Reserve actions, the yield
differential has started to widen again to about 14 basis points in
fiscal year 2005. Thus, absent Treasury actions, further increases in
short-term rates are likely to lead to higher CM bill yield
differentials in the future. If short-term Treasury yields return to
the 1996-2001 average of approximately 5 percent, we found that the
yield differential could exceed 20 basis points and the additional cost
of CM bills--assuming current issuance patterns--could increase from
$11 million to about $19 million a year.
Figure 8: Yield Differential and the Average Level of Short-term
Treasury Yields (Fiscal Years 2001-2005):
[See PDF for image]
[End of figure]
CM Bills Are Innately Less Predictable than Regular Bills:
The yield differential may also be attributable in part to variables
that are hard to measure, such as predictability. According to Treasury
officials, a regular and predictable borrowing schedule is attractive
to investors and helps to achieve Treasury's objective of lower
borrowing costs over time. However, both the timing and amount of CM
bill auctions are by nature less predictable than regular Treasury
bills. Providing too much advanced notice of CM bill issuance would
reduce Treasury's flexibility to adjust the amount and timing of
issuance to best meet cash needs. It could also cause Treasury to use
conservative estimates of its cash needs and borrow more than it
actually needs. Treasury's challenge is to provide market participants
enough notice to avoid paying too high a premium for uncertainty
without reducing its flexibility. Improving cash forecasting could help
Treasury determine the amount of CM bills to be issued sooner rather
than later and thus provide market participants more notice of CM bill
auctions.
Treasury provides limited information on the timing and amount of CM
bill auctions ahead of the announcement. The Quarterly Refunding
process is Treasury's way to provide market participants with
information and get their feedback about changes to its auction
schedule and the issues actively under discussion by Treasury. As part
of each Quarterly Refunding, Treasury usually issues a statement
indicating that it plans to issue CM bills in the coming quarter.
Treasury provides general information on the timing of CM bills, such
as "early March" or "early April" but does not provide the actual date
it expects to issue CM bills.[Footnote 44] In contrast, Treasury
publishes the auction schedule, including announcement, auction, and
issue dates for its regular bills up to 6 months in advance. Treasury
typically does not provide an estimated issue amount for CM bills or
regular bills in its Quarterly Refunding statements.
Despite the general notice given by Treasury and the somewhat regular
pattern of CM bill issuance in recent years, market participants cannot
always predict the timing of CM bill auctions with certainty. For
example, in fiscal year 2005, a prominent money market analyst
predicted the exact date of 6 (out of 21) CM bill auctions at least 1
week ahead of the auction announcement and was off by 1 or 2 days for 9
CM bill auctions. However, the analyst's predicted dates for 2 CM bill
auctions were off by 6 days, and the analyst did not predict the
remaining four CM bill auctions.
Not only the timing, but also the amount of CM bill issues cannot be
predicted with certainty. Treasury uses CM bills to manage cash balance
swings and as a result, the amount of CM bills issued varies more than
regular and predictable securities. Thus, it is not surprising that
market participants cannot predict with certainty the amount of CM bill
issuance. Issuing in multiple tranches may exacerbate the issue. For
example, one market analyst predicted Treasury would auction one CM
bill in the first week of December 2004 for $28 billion and one CM bill
the following week for $7 billion. Instead, Treasury auctioned three CM
bills totaling $42 billion in the first week and none the following
week. Several market participants we spoke with said that uncertainty
surrounding the amount offered affects their bidding and ultimately
Treasury's borrowing terms. If market participants are uncertain of the
amount, they may not bid as aggressively, which potentially reduces the
price and increases the yield Treasury pays on CM bills. In addition,
the relative inflexibility of Treasury's demand for cash to avoid a
negative cash balance might explain the higher yields on CM
bills.[Footnote 45]
Most Measures We Examined Suggest CM Bill Auctions Perform Less Well
Than 4-week Bill Auctions:
Given that CM bill auctions are less predictable than regular Treasury
bill auctions, it is not surprising that CM bill auctions do not
perform as well as regular bill auctions by some measures. Better
auction performance can be characterized by greater participation and
more preauction activity in the when-issued market. These factors
theoretically reduce Treasury's borrowing costs. By most measures of
participation and activity we examined, CM bill auctions perform less
well than 4-week bill auctions. However, some other measures indicate
that Treasury obtained a better price at CM bill auctions compared with
4-week bill auctions and that there is stronger demand for CM bills
than 4-week bills.
In order to lower borrowing costs, Treasury seeks to encourage more
participation in auctions. In general, large, well-attended auctions
improve competition and lead to lower borrowing costs for Treasury. We
found that fewer bidders in total are awarded CM bills than 4-week
bills. For example, of the 55 CM bill auctions held between 2002 and
2005, more than half had 16 or fewer awarded bidders. In contrast, only
about 4 percent of the 209 4-week bill auctions had 16 or fewer awarded
bidders while about 50 percent had at least 22 awarded bidders.
We also found that preauction trading activity is sparse before CM bill
auctions. Treasury auctions are preceded by forward trading in markets
known as "when-issued" markets. The when-issued market is important
because it serves as a price discovery mechanism that potential
competitive bidders look to as they set their bids for an auction. When-
issued trading reduces uncertainty about bidding levels surrounding
auctions and also enables dealers to sell securities to their customers
in advance of the auction so they are better able to distribute the
securities and bid more aggressively, which results in lower costs to
Treasury. We counted the number of preauction trades on the day of CM
bill auctions and found that when-issued trading is lower prior to CM
bill auctions than regular 4-week bill auctions.
A broad range of participants generally improves competition and
theoretically maximizes the price investors pay for Treasury
securities. Alternatively a higher concentration--a large share of the
auction awarded to few participants--could reduce competition and
restrict a security's supply in the secondary market, preventing its
efficient allocation among investors. We evaluated the share of the
auction awarded to the top five bidders--a measure used by Treasury in
its own studies of auction performance--and found that the share was 60
percent or higher in over half (34 of 55) of CM bill auctions from
fiscal year 2002 through 2005. In contrast, the share exceeded 60
percent in only 18 percent (37 of 209) of 4-week bill auctions in the
same period. While a higher concentration theoretically reduces
competition and the price investors pay, according to Treasury a high
concentration ratio in CM bill auctions may imply some bidders really
want a particular bill, which may drive the price up and yield down.
Although greater participation, a broader distribution of awards, and
more preauction activity in the when-issued market theoretically
improves Treasury's borrowing costs, we did not find a statistically
significant relationship between these factors and the yield
differential. However, we did find that concentration was negatively
correlated with the auction spread. The auction spread is the
difference between the yield Treasury obtains at auction and the yield
in the when-issued market at the time of auction. A positive spread
(where the auction yield is more than the contemporaneous when-issued
yield) indicates Treasury paid a higher yield than expected, which is a
negative auction result. Our statistical analysis suggests that
Treasury was less likely to pay more than the expected yield indicated
in the when-issued market in more concentrated auctions. In other
words, higher concentration seemed to improve Treasury's auction
results. App. II provides more information on our CM bill auctions
analysis.
CM Bills Are Generally Less Costly than Currently Available
Alternatives:
Treasury could maintain higher cash balances or issue regular Treasury
bills (e.g., the 4-week bill) to avoid issuing a CM bill to meet short-
term cash shortfalls. When evaluating CM bills relative to other
alternatives, it is important to look at total borrowing costs--not
just the yield. Treasury's borrowing costs are based on the amount
borrowed, the yield it pays to borrow, and the time the debt is
outstanding. We found that CM bills are generally less costly than
currently available alternatives despite their higher yield.
CM Bills Are Generally Less Costly than Running Higher Cash Balances:
To avoid issuing a CM bill, Treasury could run higher cash balances to
bridge cash financing gaps. However, it is generally more cost-
efficient to repay debt and then issue a CM bill than run higher cash
balances because the interest earned on excess cash balances is
generally insufficient to cover borrowing costs. Treasury's current
cash balance target is $5 billion, which represents the amount to be
held at the Federal Reserve. Treasury invests excess cash above the $5
billion target in Treasury Tax and Loan (TT&L) accounts.[Footnote 46]
TT&L accounts are held at financial institutions and earn interest
rates equal to the federal funds rate less 25 basis points.[Footnote
47] The rate earned on TT&L accounts is generally less than the average
rate Treasury pays on CM and regular short-term bills. As a result,
Treasury faces a negative funding spread. The funding spread varies
over time and depends on Treasury bill rates relative to the federal
funds rate--increases in Treasury bill yields relative to the federal
funds rate increase Treasury's negative funding spread, and declines in
Treasury bill yields relative to the federal funds rate reduce
Treasury's negative funding spread.
As a result of the negative funding spread, Treasury strives to
minimize cash balances in order to reduce overall borrowing costs. To
do this, Treasury has worked toward improving cash forecasting.
Treasury has reduced the average cash forecasting error by one-half
over the last 6 years according to Treasury officials. They credited
improvements to better technology and communication with their "lockbox
banks" that process certain tax payments. For example, the Electronic
Federal Tax Payment System provided actual cash flow information to
Treasury forecasters through electronic notification of pending tax
payments, replacing imperfect forecasts.
Increasing the earnings on excess cash balances is another way to
narrow the negative funding spread. Figure 9 below describes steps
Treasury has taken to increase earnings on its excess cash balances.
Figure 9: Steps Taken in Recent Years to Increase the Rate Paid on
Treasury's Cash Balances:
[See PDF for image]
[A] Federal Register, vol. 64, no. 146 (July 30, 1999), pp. 41748-
41749.
[B] Federal Register, vol. 67, no. 51 (Mar. 15, 2002), pp. 11573-11577.
[C] Kenneth D. Garbade, John C. Partlan, and Paul J. Santoro, "Recent
Innovations in Treasury Cash Management," Current Issues in Economics
and Finance, vol. 10, no. 11, Federal Reserve Bank of New York
(November 2004).
[End of figure]
CM Bills Are Generally Less Costly than Issuing Longer-term Regular
Securities:
To make large payments when cash balances are low, Treasury can issue a
CM or a regular Treasury bill, although as explained earlier Treasury
tries to limit changes in the size of regular bill issuance from week
to week. When comparing the cost of a CM bill with the cost of a 4-week
bill--the regular bill with the shortest maturity--we see that the CM
bill is generally less costly for shorter-term needs (i.e., less than
28 days) despite its higher yield. While the 4-week bill may have a
lower yield, the amount borrowed is generally outstanding for a longer
period. For example, Treasury issued a CM bill on June 3, 2005, for $16
billion. The daily cost of borrowing was about $1.3 million. If
Treasury had borrowed $16 billion using the 4-week bill issued the day
before, the daily borrowing cost would have been only $1.2 million but
the amount would have been outstanding for 16 days longer and cost an
additional $18.4 million (see table 3). However, the extra cost of the
4-week bill would be partially offset by the amount earned on cash
balances.
Table 3: Illustrative Comparison of 4-week and CM Bill Borrowing Costs:
4-week bill;
Amount borrowed (billions of dollars): $16;
Term (days): 28;
Yield: (percent): 2.784;
Daily cost of borrowing (millions of dollars): $1.2;
Total cost of borrowing[A] (millions of dollars): $34.1.
CM bill;
Amount borrowed (billions of dollars): $16;
Term (days): 12;
Yield: (percent): 2.979;
Daily cost of borrowing (millions of dollars): $1.3;
Total cost of borrowing[A] (millions of dollars): $15.7.
Difference (4-week bill - CM bill);
Total cost of borrowing[A] (millions of dollars): $18.4.
Source: GAO analysis of BPD data.
[A] This refers only to interest payments and excludes earnings on any
excess cash balances.
Note: The illustrative example shown above uses the actual yields paid
on the 4-week bill issued on June 2, 2005, and the CM bill issued on
June 3, 2005. However, for comparability, we assumed bills of equal
amounts (the actual amount of the 4-week bill issued on June 2, 2005,
was $20 billion). In reality, the yield would be affected by the amount
offered.
[End of table]
To compare the total cost of the 4-week bill with the cost of a CM bill
requires also looking at what happens to the cash that would have been
used to pay the maturing CM bill. CM bills are typically issued in
months with midmonth cash inflows. If Treasury issued a 4-week bill
instead of a CM bill in these months, these midmonth cash flows could
be held in TT&L accounts.[Footnote 48] However, since Treasury
generally earns less on excess cash balances than it pays to borrow,
the additional borrowing costs associated with the 4-week bill may not
be completely offset.
Treasury Has Refined Its Use of CM Bills but Costs Have Begun to
Increase:
Treasury has taken steps to reduce use and overall cost of CM bills.
Lowering borrowing costs of CM bills could be achieved by combinations
of reducing the dollar amount issued or reducing the term to maturity
(i.e., the number of days outstanding). Recognizing that CM bills were
a relatively costly way to absorb cash balance swings, Treasury
introduced the 4-week bill in 2001 to help reduce the use of CM bills.
Treasury has also increasingly issued CM bills in multiple tranches,
which contributes to smaller average issues, shorter terms to maturity,
and lower total borrowing costs. Borrowing costs declined in 2002 as
Treasury reduced the use of CM bills for longer-term borrowing (i.e.,
28 days or more) and short-term rates declined. However, borrowing
costs associated with CM bills have increased since 2003.
Treasury Initially Reduced the Amount of CM Bill Issuance Following the
Introduction of the 4-week Bill:
Treasury has reduced reliance on CM bills since 2001. Initially,
Treasury reduced the total amount of CM bills issued by more than half
from $346 billion in fiscal year 2001 to only $124 billion in fiscal
year 2002 (see fig. 10). This was the lowest amount issued in the
previous 6 years. The decline in CM bill issuance, however, was only
temporary. Since 2002, Treasury has increased its use of CM bills and
in fiscal year 2005, Treasury issued $268 billion in CM bills.
Figure 10: Amount of CM Bill Issuance (Fiscal Years 1996-2005):
[See PDF for image]
[End of figure]
In 2001, Treasury said that CM bills were not the most cost-efficient
means to absorb cash balance swings. At that time, the yield
differential was about 47 basis points and the amount of CM bills
issued was about 20 percent of Treasury's short-term financing.
Treasury introduced the 4-week bill in 2001 to help reduce the need for
CM bills by helping to smooth swings in cash balances. In general,
shorter-term securities provide Treasury greater flexibility to adjust
cash balances and outstanding debt in response to actual cash needs.
From fiscal year 2002 through 2005, CM bills represented only 7 percent
on average of Treasury's short-term debt issuance. However, according
to Treasury, the ability of the 4-week bill to absorb cash balance
swings is limited to swings in cash balances that are longer than the
two-week cash financing gap at the beginning of most months.
Issuing CM Bills in Multiple Tranches Has Helped Reduce Borrowing
Costs:
Treasury has taken steps to borrow cash closer to the day it is needed,
which contributes to smaller average issues, shorter terms to maturity,
and lower borrowing costs. Since 2003, Treasury has increasingly issued
CM bills in multiple tranches--successive shorter-term CM bills that
mature on the same day. For example, instead of issuing one $30 billion
or $40 billion CM bill on the 1st that matured on the 15th, Treasury
might issue three smaller CM bills on the 1st, 3rd, and 7TH (all
matured on the 15th). As mentioned earlier, issuing in multiple
tranches may increase the rate paid, but it allows Treasury to borrow
closer to the time when cash is needed and ultimately reduces borrowing
costs by reducing the average term to maturity and annualized amount
outstanding. Table 4 shows how issuing in multiple tranches would have
reduced borrowing costs in June 2005.
Table 4: Illustrative Effect of Issuing CM Bills in Multiple Tranches
on Borrowing Costs:
Multiple tranches: June 1, 2005;
Amount borrowed: (billions of dollars): $10;
Term (days): 14;
Borrowing cost (millions of dollars): $11.
Multiple tranches: June 3, 2005;
Amount borrowed: (billions of dollars): $16;
Term (days): 12;
Borrowing cost (millions of dollars): $16.
Multiple tranches: June 7, 2005;
Amount borrowed: (billions of dollars): $12;
Term (days): 8;
Borrowing cost (millions of dollars): $8.
Total;
Amount borrowed: (billions of dollars): $38;
Term (days);
Borrowing cost (millions of dollars): $34.
Single tranche: June 1, 2005;
Amount borrowed: (billions of dollars): $38;
Term (days): 14;
Borrowing cost (millions of dollars): $43.
Total difference (Multiple-Single);
Amount borrowed: (billions of dollars);
Term (days);
Borrowing cost (millions of dollars): -$8.
Source: GAO analysis.
Note: The illustrative example shown above assumed Treasury would pay
the same discount rate on one CM bill as it did on the first part of
the multiple tranche. In reality, the discount rate would be different
because the rate depends on the amount auctioned, among other things.
When considering Treasury's total borrowing cost, the earnings on
excess cash balances held from the 1st-7TH would partially offset
borrowing costs.
[End of table]
The move toward multiple tranches has led to smaller CM bill issues on
average. Figure 11 shows that the average CM bill issue has declined by
more than half since 2001.
Figure 11: Average Size of CM Bills Issued (Fiscal Years 1996-2005):
[See PDF for image]
[End of figure]
Following introduction of the 4-week bill in 2001, Treasury reduced the
use of CM bills for longer-term borrowing (i.e., 28 days or more).
Figure 12 shows that Treasury has reduced the average term to maturity
(i.e., length of time outstanding) for CM bills issued by about half
since 2001. Prior to fiscal year 2002, Treasury issued CM bills with
terms as long as 83 days. Since 2002, the longest maturing CM bill was
19 days.
Figure 12: Weighted Average Term to Maturity of CM Bills (Fiscal Years
1996-2005):
[See PDF for image]
Note: Term to maturity of each CM bill is weighted by the amount
issued. Because CM bill issuance amounts vary, the weighted average
maturity of CM bills was calculated in order to reflect each CM bill's
relative importance in the total amount issued during the period.
[End of figure]
Lower average issue sizes together with the reduced term to maturity
contributed to lower borrowing on an annual basis (see fig. 13). After
Treasury introduced the 4-week bill in 2001, the annualized amount of
CM bills outstanding declined dramatically from $19.2 billion in fiscal
year 2001 to $3.3 billion in fiscal year 2002. However, since then the
amount has generally increased as Treasury increased the use of CM
bills to finance intramonth cash financing gaps. From fiscal year 2003
to fiscal year 2004, the annual amount outstanding more than doubled to
$8.1 billion. Treasury issued a similar amount of CM bills in fiscal
year 2005.
Figure 13: Annualized Amount Outstanding[A] (Fiscal Years 1996-2005):
[See PDF for image]
[A] The annualized amount outstanding is derived by spreading each CM
bill across the 365-day year. So, for example, a 14-day CM bill with a
face value of $25 billion is multiplied by 0.038 (= 14/365) resulting
in an annualized amount outstanding of $959 million.
[End of figure]
Borrowing Costs Declined Dramatically in 2002 but Have Since Increased:
While Treasury's actions from fiscal years 2001 to 2002 reduced CM bill
borrowing costs, overall declining interest rates also helped.
Borrowing costs began declining in 2001 and dropped dramatically in
2002 (see fig. 14). Treasury's smaller CM bill issuances and reduced
term to maturity helped reduce the annual amount outstanding. According
to our analysis, these actions taken by Treasury contributed to about
$610 million of the reduction in borrowing costs from 2001 to 2002. We
estimated that the remaining decline was due to reductions in the yield
paid on CM bills. As noted earlier the yield differential varies with
the overall level of short-term yields in the economy. As these yields
declined so did the yield differential--by 43 basis points from fiscal
year 2001 to 2002.
Figure 14: Total Borrowing Costs Associated with CM Bills (Fiscal Years
1996-2005):
[See PDF for image]
[End of figure]
However, since 2003 the borrowing costs associated with CM bills have
increased. Our analysis indicates that almost all of the increase in CM
bill borrowing costs is due to increasing rates. While Treasury cannot
control the overall level of short-term interest rates in the economy,
it can continue to take steps to reduce the use of CM bills and,
according to our analysis, the CM bill yield differential.
Options Exist That May Reduce the Use and Cost of CM Bills:
We identified a range of options that may reduce the use or cost of CM
bills. The most promising options in our view--exploring ways to better
align cash flows and increasing the earnings on cash balances--are
discussed first. Other options, such as introducing a new shorter-term
regular bill and enhancing the transparency of CM bill auctions, are
discussed later.
Better Aligning Cash Flows Might Reduce Cash Financing Gap:
Given that Treasury has increasingly used CM bills to fill regular cash
financing gaps, taking steps to better align large cash flows might
help reduce the use of CM bills. There are three ways to do this:
smoothing the payment of large federal expenditures, smoothing the
payments of corporate and nonwithheld individual tax payments, and
aligning increased debt issuance with large payments. If cash flows had
been aligned to better fill the frequent cash financing gaps, Treasury
may not have needed the 11 CM bills it issued on the 1st through the
3rd of the month that matured on the 15th of the month during fiscal
year 2005 and could have reduced CM bill borrowing cost by as much as
$174 million or about 80 percent in fiscal year 2005.[Footnote 49]
Statutory and regulatory changes would be required to change the timing
of federal benefit payments and tax collections. While implementing any
changes is outside debt managers' control, Treasury could start a
discussion with other agencies and Congress to identify the costs and
benefits of alternatives to align or more evenly distribute federal
expenditures and tax receipts and seek any statutory authority
necessary to better smooth them. However, changing the timing of
benefits and tax collections, either jointly or independently, will
have direct and indirect effects not only on borrowing costs but also
on individuals, nonfederal entities, and federal government operations.
These of course, would have to be considered when making decisions
about whether and how to smooth federal cash flows. Looking at SSA's
experience with spreading the payments for new Social Security
beneficiaries throughout the month may be useful.
Treasury could also explore aligning increased borrowing capacity with
large payments in the beginning of the month to help reduce the cash
financing gap and reduce the use of some CM bills. Overall borrowing
needs are projected to be significant and grow over the long term and
Treasury will need to consider changes to its debt portfolio and
auction schedule to increase borrowing. Cash flow considerations can be
a tiebreaker when choosing between equally attractive alternatives. In
the past, when making changes to the range of maturities offered,
Treasury has considered aligning cash inflows with outflows in the
beginning of the month. Going forward, Treasury may reduce its reliance
on CM bills--at least temporarily--by continuing to consider
adjustments that would better align its increased debt issuance with
its largest cash payments in the beginning of the month.
Increasing Earnings on Cash Balances Would Reduce the Costs Associated
with Running Higher Cash Balances to Avoid Issuing CM Bills:
Currently, Treasury faces a negative funding spread and as a result it
is more costly to maintain high cash balances to meet upcoming payments
than issue a CM bill. However, increasing the earnings on cash balances
would reduce the costs associated with running higher cash balances and
may ultimately reduce the use of some CM bills. Treasury previously
explored increasing the rate earned on TT&L accounts; however, banks
objected. Since then, Treasury introduced the TIO program,[Footnote 50]
which pays higher rates on cash balances than the TT&L program.
Increasing balances in TIOs relative to the TT&L accounts would help
Treasury increase earnings on its cash balances. However, Treasury
would lose some flexibility because TIO balances are not callable in
the event cash balances unexpectedly fall below cash needs.
Treasury could also explore broader options to increase earnings on
cash balances. For example, some countries' debt management offices
engage in reverse repurchase agreements. In a reverse repurchase
agreement, Treasury would lend market participants cash to purchase
securities in the secondary market. The borrower would then return the
cash borrowed plus interest at a specified time, usually overnight.
Reverse repurchase agreements could potentially narrow Treasury's
negative funding spread because repurchase agreement rates are
generally higher than rates earned on TT&L accounts. Treasury could
explore the benefits and cost of designing a new system to perform
these transactions but implementing reverse repurchase agreements would
require legislative authority according to Treasury.
Shorter-term Regular Bills Might Reduce the Need for Some CM Bills:
Another way to smooth cash flows would be to introduce a shorter-term
instrument. The 4-week bill was partially successful in smoothing cash
flows throughout the year and reducing the use of CM bills. However, in
recent years, Treasury has increasingly used CM bills to fill cash
financing gaps that frequently occur in the first two weeks of the
month. Introducing a regular shorter-term bill might help fill the
frequent cash financing gap and reduce the use of CM bills further. A
new bill that matures on Thursdays like other regular bills would not
give the Treasury the same flexibility as CM bill issuance because the
beginning-of-month outflows and midmonth inflows often fall on
different days of the week. Alternatively, a new short-term security
with specific issue and redemption dates (rather than day of the week)
might help the Treasury manage cash flow gaps.
In Treasury's view, a shorter-term security would not likely generate
market interest in a way that would distinguish it, on a cost basis,
from CM bills. However, our analysis of CM and similar-maturing
outstanding bills in the secondary market shows that buyers pay higher
prices (or accept a lower yield) for short-term bills than Treasury
currently accepts (or pays) for CM bills. Market participants we spoke
with expressed mixed views on the demand for another short-term
Treasury security. While some said there may not be enough demand for a
short-term instrument, others said that bills maturing on the 15th, for
example, would have natural buyers and give investors more flexibility
by offering another maturity date for short-term instruments. Our
analysis shows that CM bills maturing on the 15th of months when tax
payments are due likely have lower yields than CM bills maturing on
other days. Treasury can examine whether it would obtain better prices
on a shorter-term bill with issue and maturity dates on specific days
of the month.
Enhancing Transparency of CM Bill Auctions May Reduce CM Bill Yields:
Increased transparency on the potential size of CM bills might improve
bidding in CM bill auctions and potentially reduce the yield Treasury
pays on CM bills. While market participants might expect Treasury to
issue CM bills in the beginning of the month, market participants told
us that they do not always know the size of the CM bill offering. As a
result, they may not bid as aggressively. However, there are tradeoffs
to consider. In order to provide market participants more advanced
notice on the general size and timing of CM bills, Treasury would have
to improve its own cash forecasting. Also, Treasury achieves lowest-
cost financing in part by providing the market with certainty. Trying
to add certainty to CM bill issuance would eliminate the benefit of
flexibility they provide and may actually increase borrowing costs.
Relaxing the 35-percent Cap on CM Bill Auction Awards May Reduce CM
Bill Yields:
Treasury limits the maximum auction award to a single bidder to 35
percent of the total amount offered to the public.[Footnote 51] The 35-
percent cap is intended, in part, to foster a liquid secondary market
for a new issue by ensuring adequate and wide distribution of the
supply of a security among investors and prevent temporary shortages or
"short squeezes." However, our analysis suggests that relaxing the 35-
percent rule for CM bill auctions (and thus allowing higher
concentration) might promote more aggressive bidding, improve auction
prices for Treasury, and thus reduce the borrowing costs associated
with CM bills. There are a number of issues to explore. For example,
market participants may come to expect poorer liquidity for CM bills,
which may lead to less aggressive bidding over time. Further, there
would be a higher risk of a squeeze in the CM bills market, although
the risk would be relatively small in our view because CM bill trading
is sparse both before auctions and after auctions according to our
analysis. (See app. II for more information.) Treasury could explore
adjusting the per-bidder cap on an experimental basis and determine
whether there are benefits of relaxing the existing 35-percent rule in
CM bill auctions.
Exploring Other Countries' Short-term Cash and Debt Management
Practices May Provide Useful Insights:
Lastly, exploring other countries' practices may provide useful
insights. For example, other countries' debt management offices use
repurchase agreements as a tool to support their cash management.
Exploring other countries' experiences may provide insights on the
benefits and costs of repurchase agreements for a central government.
Although repurchase agreements generally have slightly higher yields
than CM bills, they provide an alternative way to obtain cash for short
periods, usually overnight. In fiscal year 2005, Treasury announced
that it was examining the feasibility of a securities lending facility,
which would operate much like a repurchase agreement. Although this
facility is still in its early proposal process, Treasury generally
intends to lend securities that are in such short supply that they may
threaten the settlement of Treasury market transactions in a timely
manner. In return, Treasury would receive cash or bonds. While Treasury
intends borrowers to use this facility at their discretion and does not
plan to use it for Treasury's own cash needs, it might also consider
how the facility would affect its cash balances and whether the lending
facility could be used to obtain cash for very short periods.
Conclusion:
In the face of persistent federal deficits and growing net interest
costs, reexamining debt management practices is warranted. Treasury has
made progress toward reducing the cost of CM bills, but it may be
possible to do more. This report presents options worth exploring that
taken alone or in combination may further reduce federal borrowing
costs by reducing either the use or the cost of unscheduled CM bills.
CM bills will continue to be a necessary debt management tool to meet
unexpected cash needs when Treasury has low cash balances or when
Treasury is nearing the debt ceiling. However, in recent years,
Treasury has increasingly used CM bills to fill cash financing gaps
that frequently occur in the first two weeks of the month. Our analysis
indicates that the yield differential between CM bills and outstanding
bills of similar maturity has increased as short-term rates have risen.
If these rates rise further, as market participants expect, and return
to levels consistent with a longer-term historical average, the CM bill
yield differential is likely to rise above levels seen in recent years.
While Treasury does not vary its debt management strategy in response
to changing interest rates, it should be mindful that increasing rates
are likely to raise the relative cost of unscheduled CM bills. As a
result, Treasury should consider options, including better aligning
cash flows and increasing earnings on cash balances, that may reduce
the frequent use of CM bills and ultimately overall borrowing costs.
Recommendation for Executive Action:
We identified options that could potentially reduce the use and cost of
CM bills. We recommend that Treasury explore options such as those
discussed in this report and any others it identifies that may help
Treasury meet its objective of financing the government's borrowing
needs at the lowest cost over time. We recognize that there are a
number of tradeoffs to consider. In its exploration, Treasury should
consider the costs and benefits of each option and determine whether
the benefits--in the form of lower borrowing costs--to the federal
government (and so to taxpayers) outweigh any costs imposed on
individuals, businesses, and other nonfederal entities. Treasury should
also consider how options may be combined to produce more beneficial
outcomes.
Implementing some of these options would require changes to statute or
regulations. If Treasury determines that any of these changes would be
beneficial, we encourage Treasury to begin discussions with relevant
federal agencies and the Congress about obtaining the necessary
authorities.
Agency Comments:
We requested comments on a draft of this report from Treasury and the
Federal Reserve. In oral and written comments, Treasury generally
agreed with our findings, conclusions, and recommendations. Treasury
said that it is committed to continuing to explore ways to further
reduce financing costs through changes in the use of CM bills and that
many of the options we identified are embodied in its current debt
management policy. Treasury emphasized that statutory authority is
needed for some options, particularly changing the timing of receipts
and expenditures and improving earnings on excess cash balances.
Treasury also suggested some technical changes throughout the report
that we have incorporated as appropriate. Treasury's comments appear in
appendix IV. In addition, the Federal Reserve Board provided technical
comments that we incorporated as appropriate.
As you know, 31 U.S.C. § 720 requires the head of a federal agency to
submit a written statement on actions taken to address our
recommendations to the Senate Committee on Homeland Security and
Governmental Affairs and to the House Committee on Government Reform
not later than 60 days after the date of this report. A written
statement must also be submitted to the House and Senate Committees on
Appropriations with the agency's first request for appropriations made
more than 60 days after the date of this report. Because agency
personnel serve as the primary source of information on the status of
recommendations, we request that the agency also provide it with a copy
of your agency's statement of action to serve as preliminary
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Sincerely yours,
Signed by:
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Director, Federal Budget Analysis Strategic Issues:
Signed by:
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Applied Research and Methods:
[End of section]
Appendixes:
Appendix I: Detailed Methodology and Findings of Statistical Analysis
of Cash Management Bill Yield Differential:
To identify which cash management bill (CM bill) features, if any,
explained the higher yields paid on CM bills, we performed a
statistical analysis of CM bills issued during fiscal years 1996-2005.
The dependent variable in the regressions was the difference between a
CM bill's investment yield at the time of auction and the investment
yield on similar-maturity Treasury bills (i.e, the "yield
differential"), where the latter is measured by the weighted average
yield on Treasury securities that mature immediately before and after
the CM bill.[Footnote 52] We regressed the yield differential on key CM
bill features including announcement period, term to maturity, issuance
amount, and whether the CM bills were off-cycle or a reopening of a
previous issue. We also examined the effects of CM bills with different
issue and maturity dates, such as whether the CM bills were issued on
the 1st-3rd, matured on a large tax payment date, or were issued during
a debt issuance suspension period (DISP). While we analyzed the yield
differential for all CM bills issued during fiscal years 1996-2005, we
focused on the 55 CM bills issued during fiscal years 2002-2005 because
the introduction of the 4-week bill in 2001 led to a significant
reduction in the amount and term to maturity of CM bills and caused a
structural change in the CM bill market.
Our empirical results suggest that several variables affected the yield
differential during the period studied. Lower yield differentials
appeared to be associated with lower short-term interest rates,
relatively low CM bill auction amounts, and maturity around large tax
payment dates. There is also some evidence that CM bills have higher
yields when issued in multiple tranches, which are successively issued
CM bills with the same maturity date. Despite these findings, the
opportunity for Treasury to achieve additional savings by further
exploiting characteristics that affect CM bill yields appears limited.
Previous Research Based on Earlier Data Suggests Some CM Bill Features
May Reduce Costs:
The existing literature on CM bills and their costs is limited. In an
early study of CM bills issued from 1980 through 1988, Simon found that
from 1 day before to 1 day after announcement, the average interest
rate differential between CM bills and adjacent-maturity Treasury bills
increased by 20 basis points to a statistically significant 28 basis
points.[Footnote 53] An analysis of variance demonstrated that the
increase in the differential was greater for CM bills that had shorter
maturities, were part of larger issues, or had shorter when-issued
periods.[Footnote 54] In a later study, Simon found that from January
1985 through October 1991 CM bills cost about 6 basis points more than
regular bills.[Footnote 55] There have been many fundamental changes in
the way Treasury raises short-term cash since the article's publication
that may make its findings less applicable now. These changes include
the move from multiple-price to single-price auctions, the growth of
the repurchase agreement market and the prevalence of off-cycle CM
bills. Most important was the addition of the 4-week Treasury bill to
Treasury's regular borrowing schedule in 2001, which led to a
significant reduction in the amount and term to maturity of CM bills.
In a study of the effect of reopenings on the liquidity of Treasury
bills, Fleming included a binary variable identifying CM bill
reopenings.[Footnote 56] Fleming studied Treasury bills issued from
1996 to 2000 and found that reopenings of any kind had a positive and
significant effect on yields. Moreover, the CM bill variable was
significantly positive for 13-week bills, demonstrating that regular
bills reopened as CM bills tend to have higher yields. Fleming
interpreted the results as showing that the yield-reducing effect of
enhanced liquidity is more than offset by the yield-increasing effect
of an increase in supply.
In a recent paper, Seligman evaluated the differential between CM bill
yields and the yields on Treasury bills with similar maturity
dates.[Footnote 57] Seligman found that CM bills that were issued off-
cycle or were large (relative to outstanding Treasury bills of similar
maturity) had higher yields than other CM bills. In contrast, CM bills
with longer durations or that had 2-day notices before auction had
lower yields than other CM bills. This study suggested that Treasury
could reduce the yields of CM bills by avoiding off-cycle issuances,
reducing their relative size, issuing CM bills with longer terms, and
giving 2 days notice in advance of auctions.
However, the data in Seligman's study covered auctions held between
1990 and 1999. Seligman's sample did not cover more recent CM bill
auctions that occurred since 2001 when the 4-week bill was introduced
and only very short-term CM bills were issued. Hence, the findings of
his study may not apply to the current environment.
In another recent study based predominantly on auctions held before the
introduction of the 4-week Treasury bill, Christopher found that the
cost of CM bills, as measured by the spread between CM bill and
repurchase agreement yields, is negatively influenced by the time
between the sale of a security and the settlement date.[Footnote 58]
The rationale offered for this finding is that the delay allows
administrative efficiencies. Christopher, like Seligman, found that
longer-maturity CM bills have lower yields than shorter maturities. She
suggests that the optimum maturity of a CM bill is nearly 93 days. This
finding highlights the inapplicability of earlier research to the
current environment when 4-week Treasury bills are available to help
meet short-term financing needs.[Footnote 59]
Comparing CM Bill Yields with Secondary Market Yields on Similar-
maturing Treasury Bills:
Choosing the appropriate reference point for CM bill yields is
important, and differed in earlier studies. Christopher focused on the
difference between CM bill and repurchase agreement yields instead of
the difference between yields on CM bills and Treasury bills with
similar maturities, which was the focus of Simon's earlier research,
Seligman's, and our own research. Although repurchase agreements and CM
bills are both means to obtain cash in the short-term, they have a
major difference--CM bills, like regular Treasury bills, are risk free
whereas repurchase agreements issued by private borrowers involve some
risk. As a result, we focus on the difference between CM bill and
outstanding Treasury yields because it provides a more direct indicator
of the higher yield that Treasury pays when issuing CM bills. Financial
market analysts we spoke with agreed that this yield differential
measure was an appropriate focus for our research.
Specifically, our estimate of the yield differential is the difference
between a CM bill's yield and the average secondary-market yield on
other Treasury bills that are most similar (in terms of maturity) to
the CM bill on the day of auction. That is, we compare CM bill yields
with yields on the two nearest-maturing--one before and one after--
Treasury bills.[Footnote 60] CM bill yields were obtained from the
Bureau of the Public Debt (BPD) while rates on similar-maturity
outstanding Treasury bills were obtained from the Wall Street Journal
(WSJ). For each Treasury bill, the bid and ask rates were converted to
yields and averaged. Next, the weighted average yield for the two bills
nearest in maturity to the CM bill was derived. The weights were based
on the relative difference in each bill's maturity date from that of
the CM bill, with the Treasury bill having a closer maturity date
receiving a greater weight and the weights summing to one. In the final
step, the weighted average Treasury bill yield was subtracted from the
CM bill auction yield to obtain the yield differential.
There are limitations of our yield differential estimate. For example,
any effect from the announcement of CM bills on yields for similar-
maturing bills is not captured. If the announcement of a CM bill
increased the yield on similar-maturing bills, then our estimate may be
understated. Also, in some cases, the surrounding Treasury bills we
used could include CM bills that were reopenings of regular Treasury
bills. This would also lead to an understatement of the yield
differential because the yield on the outstanding securities including
CM bills would be higher than outstanding securities that did not
include CM bills. However, few CM bills issued in fiscal years 2002-
2005 were reopenings. Alternatively, if the yield curve were upward
sloping and concave, the curvature of the yield curve would result in a
positive estimate of the spread even before considering the effects of
other factors and create a positive bias in our calculation of the
yield differential.
The Introduction of the 4-week Treasury Bill Reduced CM Bill Maturities
and Their Relative Importance in Short-term Financing:
Table 5 provides data on key attributes of CM bills, many of which we
used in an attempt to explain the yield differential. The table divides
the data into two subperiods. The first subperiod covers auctions held
from fiscal year 1996 through fiscal year 2001 before the introduction
of the 4-week Treasury bill, while the second subperiod includes
auctions held from fiscal year 2002 through fiscal year 2005 after the
4-week bill's introduction.
Table 5: Key Features of CM Bills before and after the 4-week Treasury
Bill's Introduction:
CM bill yield (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 5.36;
Maximum: 6.56;
Minimum: 3.82;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 1.76;
Maximum: 3.52;
Minimum: 0.91.
Yield on outstanding bills with similar maturity (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 5.01;
Maximum: 6.38;
Minimum: 3.34;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 1.67;
Maximum: 3.47;
Minimum: 0.79.
CM bill yield less yield on outstanding bills with similar maturity
(percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 0.350;
Maximum: 1.086;
Minimum: -0.038;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 0.091;
Maximum: 0.553;
Minimum: -0.035.
Percent difference between CM bill yield and yield on outstanding bills
with similar maturity;
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 7.3;
Maximum: 21.2;
Minimum: -0.7;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 6.0;
Maximum: 35.3;
Minimum: -3.7.
Repurchase agreement yield (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 5.39;
Maximum: 6.57;
Minimum: 3.99;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 1.76;
Maximum: 3.53;
Minimum: 0.94.
CM bill term to maturity (days);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 27.4;
Maximum: 83;
Minimum: 1;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 9.6;
Maximum: 19;
Minimum: 2.
Amount of CM bills issued (dollars in billions);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 21.6;
Maximum: 42;
Minimum: 6;
Mean: 14.8;
Maximum: 32;
Minimum: 4.
Ratio of bids tendered to the amount of CM bills issued (i.e., the bid-
to-cover ratio);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 2.9;
Maximum: 5.3;
Minimum: 1.5;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 3.2;
Maximum: 5.9;
Minimum: 1.7.
Average amount of outstanding bills with similar maturity (dollars in
billions);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 33.1;
Maximum: 66.8;
Minimum: 21.1;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 65.9;
Maximum: 86.6;
Minimum: 52.9.
CM bill issued as a percent of outstanding bills with similar maturity;
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 68.7;
Maximum: 136.7;
Minimum: 17.2;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 23.0;
Maximum: 50.4;
Minimum: 5.6.
Number of days from announcement to auction;
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 2.4;
Maximum: 9;
Minimum: 1;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 1.5;
Maximum: 4;
Minimum: 0.
Portion of CM bills auctioned during DISP[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 12.1;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 20.0;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills issued on 1st-3rd days of month[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001): Number of CM bill
auctions: 66:
Mean: 63.6;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 49.1;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills maturing on tax due date[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 21.2;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 49.1;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills issued on 1st-3rd days of month that mature on tax
due date[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 18.2;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 30.9;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills maturing April 15-30[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 33.3;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 20.0;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills maturing on tax days other than April 15[A]
(percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 18.2;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 38.2;
Maximum: n.a;
Minimum: n.a.
Portion of CM bills issued off-cycle[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 39.4;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 85.5;
Maximum: n.a;
Minimum: n.a.
Number of days from CM bill maturity to end of month;
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 8.2;
Maximum: 14;
Minimum: 1;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 10.3;
Maximum: 17;
Minimum: 3.
Days from auction to settlement;
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 1.6;
Maximum: 5;
Minimum: 0;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 1.3;
Maximum: 3;
Minimum: 1.
Portion of CM bills in a multiple tranche[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 30.3;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 49.1;
Maximum: n.a;
Minimum: n.a.
Tail: high minus median discount rate (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: .022;
Maximum.100;
Minimum.000;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: .013;
Maximum: .040;
Minimum: .000.
Portion of CM bills auctioned on Wednesday and maturing after end of
month[A] (percent);
Pre-4-week Treasury Bill (Fiscal years 1996-2001):
Number of CM bill auctions: 66:
Mean: 12.1;
Maximum: n.a;
Minimum: n.a;
Post-4-week Treasury Bill (Fiscal years 2002-2005):
Number of CM bill auctions: 55:
Mean: 7.3;
Maximum: n.a;
Minimum: n.a.
Source: GAO analysis of data from BPD and WSJ.
Note: n.a. = not applicable.
[A] Binary variable.
[End of table]
Table 5 highlights the significant difference in CM bill maturities
between the two subperiods. For the 66 CM bills auctioned in fiscal
years 1996 through 2001, the average maturity exceeded 27 days while
the longest-maturity CM bill had a term of 83 days. In contrast, in the
55 CM bill auctions held from fiscal year 2002 through 2005 the average
maturity of the CM bills was only 9.6 days while the longest-maturity
CM bill had a term of 19 days. In the more recent period even the
maximum maturity of 19 days was much shorter than the average maturity
of 27.4 days during the 6 years before 4-week Treasury bills were
introduced.
Treasury also reduced its reliance on CM bills for short-term financing
after 2001. The average dollar amount of CM bills issued at each
auction declined from $21.6 billion in fiscal years 1996 through 2001
to only $14.8 billion in fiscal years 2002 through 2005. In contrast,
Treasury increased issuance of regular short-term Treasury bills.
Before fiscal year 2002 the average amount of outstanding Treasury
bills with similar maturities to newly auctioned CM bills was $33.1
billion. The average rose to $65.9 billion in the more recent period.
As a result, newly auctioned CM bills averaged less than one-fourth of
the average amount of outstanding Treasury bills with similar
maturities during the more recent subperiod compared with three-fourths
during the earlier subperiod. This reflects the importance of 4-week
Treasury bills during the later period.
Many of the features listed in table 5 were represented by binary
variables set equal to 1 if a CM bill had the characteristic and 0 if
it did not. Binary variables include: auction during a DISP, issuance
on the 1st-3rd days of the month, maturation on a tax due date and a
combination of issuance on the 1st-3rd days and maturation on a large
tax due date. Additional binary variables capture whether or not a CM
bill matured between April 15 and the end of the month and whether or
not a CM bill was part of a multiple tranche. For each binary variable,
table 5 shows the percentage of CM bills that had a particular feature.
Among the most notable change in these characteristics between the two
subperiods was the more than twofold increase in the share of CM bills
issued off-cycle from 39 percent to 86 percent.
Our Study Focused on CM Bills Issued during Fiscal Years 2002-2005:
Because of the dramatic decrease in CM bill maturities and reduced
reliance on CM bills for short-term financing after the introduction of
the 4-week bill, our effort to identify characteristics that might
affect the yield differential focused on CM bill auctions held from
fiscal years 2002 through 2005. Column A of table 6 provides the
estimated coefficients and summary statistics for an equation that
includes attributes that have a significant effect on the yield
differential. Using the same specification for the 66 CM bill auctions
for the earlier period that extended from fiscal years 1996 through
2001 produced results that differ significantly from the estimates for
the more recent period. Testing this specification for structural
change using a Chow test resulted in an F-statistic of 5.18, which
permitted us to reject the hypothesis that the relationship remained
stable between the two periods at the .01 level of confidence. This
test result provided support for our decision to focus on auctions held
after the 4-week Treasury bill was introduced.
Table 6: Regressions Explaining the Yield Differential (Fiscal Years
2002-2005):
Variable: C;
A: Coefficient: 0.001;
A: t-stat: 0.04;
B: Coefficient: -0.009;
B: t-stat: -0.24;
C: Coefficient: -0.005;
C: t-stat: -0.13;
D: Coefficient: 0.019;
D: t-stat: 0.37;
E: Coefficient: -0.040;
E: t-stat: -1.21.
Variable: CM bill issued as a percent of the average amount of similar-
maturity Treasury bills outstanding;
A: Coefficient: 0.282[A];
A: t-stat: 3.30;
B: Coefficient: 0.253[A];
B: t-stat: 3.50;
C: Coefficient: 0.281[A];
C: t-stat: 3.31;
D: Coefficient: 0.268[A];
D: t-stat: 2.59;
E: Coefficient: 0.250[B];
E: t-stat: 3.14.
Variable: CM bills maturing April 15-30;
A: Coefficient: -0.118[A];
A: t-stat: -3.99;
B: Coefficient: -0.122[A];
B: t-stat: -3.72;
C: Coefficient: -0.116[A];
C: t-stat: -4.20;
D: Coefficient: -0.115[A];
D: t-stat: -3.54;
E: Coefficient: - 0.125[A];
E: t-stat: -4.29.
Variable: CM bills maturing on large tax due dates other than April 15;
A: Coefficient: -0.117[A];
A: t-stat: -3.28;
B: Coefficient: - 0.119[A];
B: t-stat: -3.15;
C: Coefficient: -0.115[A];
C: t-stat: -3.52;
D: Coefficient: -0.113[A];
D: t-stat: -2.80;
E: Coefficient: -0.125[A];
E: t-stat: -3.55.
Variable: Treasury yield;
A: Coefficient: 0.038[B];
A: t-stat: 2.28;
B: Coefficient: 0.038[B];
B: t-stat: 2.30;
C: Coefficient: 0.037[B];
C: t-stat: 2.12;
D: Coefficient: 0.038[B];
D: t-stat: 2.20;
E: Coefficient: 0.044[B];
E: t-stat: 3.05.
Variable: Multiple-tranche CM bills;
A: Coefficient: 0.060[C];
A: t-stat: 1.91;
B: Coefficient: 0.055[B];
B: t-stat: 2.00;
C: Coefficient: 0.059[C];
C: t-stat: 1.92;
D: Coefficient: 0.058[C];
D: t-stat: 1.77;
E: Coefficient: 0.042;
E: t-stat: 1.48.
Variable: Term to maturity;
B: Coefficient: 0.002;
B: t-stat: 0.66.
Variable: Days from auction to settlement;
C: Coefficient: 0.005;
C: t-stat: 0.25.
Variable: Off-cycle;
D: Coefficient: -0.018;
D: t-stat: -0.54.
Variable: Number of days from announcement to auction;
E: Coefficient: 0.034[B];
E: t-stat: 2.56.
Variable: Included observations:
A: Coefficient: 55;
B: Coefficient: 55;
C: Coefficient: 55;
D: Coefficient: 55;
E: Coefficient: 55.
Variable: R-squared;
A: Coefficient: 0.379;
B: Coefficient: 0.386;
C: Coefficient: 0.380;
D: Coefficient: 0.383;
E: Coefficient: 0.448.
Variable: Adjusted R-squared;
A: Coefficient: 0.316;
B: Coefficient: 0.309;
C: Coefficient: 0.303;
D: Coefficient: 0.306;
E: Coefficient: 0.379.
Variable: S.E. of regression;
A: Coefficient: 0.081;
B: Coefficient: 0.082;
C: Coefficient: 0.082;
D: Coefficient: 0.082;
E: Coefficient: 0.078.
Variable: DW-Stat;
A: Coefficient: 1.793;
B: Coefficient: 1.794;
C: Coefficient: 1.810;
D: Coefficient: 1.792;
E: Coefficient: 1.808.
Variable: Mean dependent var;
A: Coefficient: 0.091;
B: Coefficient: 0.091;
C: Coefficient: 0.091;
D: Coefficient: 0.091;
E: Coefficient: 0.091.
Variable: S.D. dependent var;
A: Coefficient: 0.099;
B: Coefficient: 0.099;
C: Coefficient: 0.099;
D: Coefficient: 0.099;
E: Coefficient: 0.099.
Source: GAO analysis.
Notes: Estimated using White heteroskedasticity-consistent standard
errors and covariance.
[A] Significant at the 1 percent level.
[B] Significant at the 5 percent level.
[C] Significant at the 10 percent level.
[End of table]
Yield Differential Is Positively Correlated with Level of Treasury Bill
Yields:
Our analysis suggests that investors may require a proportionate rather
than an absolute differential as compensation for unscheduled CM bills.
While previous research has not examined whether the yield differential
is correlated with the overall level of Treasury bill yields, figure 8
in the main text indicates that the differential may tend to move in
the same general direction as the level of secondary-market yields on
Treasury bills with similar maturity. The estimated coefficient of the
Treasury bill yield shown in column A of table 6 is 0.038, which
suggests that a 1-percentage-point increase in the Treasury bill yield
is associated with a 3.8-basis-point increase in the yield
differential. During fiscal year 2005, for example, the average yield
on Treasury bills with maturities comparable to newly auctioned CM
bills was 2.42 percent and the yield differential averaged 13.5 basis
points. If the yields on comparable-maturity Treasury bills had been 5
percent[Footnote 61] instead of 2.42, the results imply that yield
differentials would have been about 10 basis points higher in fiscal
year 2005 than they actually were. A continuation in the rise in
Treasury bill yields that began in 2004 is therefore likely to result
in an increase in the yield differential.
Yield Differential Is Positively Correlated with Auction Amounts:
Our results show that as the supply of a CM bill rises relative to the
supply of similar investment alternatives, the relative price of the CM
bill declines and the yield differential increases. The results for the
55 auctions held from fiscal years 2002 through 2005 suggest that the
yield differential rises with an increase in the ratio of the amount of
CM bills auctioned to the average amount of similar-maturity Treasury
bills outstanding, as shown by the positive and significant coefficient
of 0.282 for this variable. The variable's significant positive
coefficient is consistent with the results of Simon, Fleming, and
Seligman. In studying the relationship between auction size and yields,
Seligman noted that an increase in the relative amount of CM bills
auctioned could have two opposite effects on their relative yields. On
the one hand, a higher relative amount could increase liquidity and
therefore reduce the yield differential. On the other hand, a higher
yield differential might be necessary to attract sufficient investor
interest when the amount of CM bills being auctioned is large relative
to outstanding Treasury bills with similar maturities. Our results
suggest the supply effect dominates.
The estimated coefficient--0.282--of the average amount of similar-
maturity Treasury bills outstanding implies that a $1 billion increase
in the amount of CM bills auctioned would raise the yield differential
0.43 basis points in 2005, other things constant.[Footnote 62] This
coefficient can also be used to indicate how much higher the yield
differential might have been if CM bills had remained as important a
source of short-term Treasury financing in fiscal year 2005 as they
were in the years before the 4-week Treasury bill was introduced.
Multiplying the coefficient of 0.282 by 0.687, which was the average
ratio of the amount of CM bills to the average amount of similar-
maturity Treasury bills from 1996 through 2001, rather than the actual
2005 ratio of 0.190 raises the yield differential 14 basis points. In
other words, if CM bills were used as intensively in fiscal year 2005
as they were during earlier years before the 4-week Treasury bill's
introduction, the yield differential might have been 28 basis points in
2005 instead of the actual differential of 14 basis points.[Footnote
63]
Maturity on or around Large Tax Payment Dates Reduces Yield
Differential:
Our work suggests that maturity on or around a tax due date, which is a
feature not studied in previous research, reduces the yield
differential. Table 6 shows that there is a 12 basis point reduction
for CM bills that mature from the 15th to the end of April. Similarly,
CM bills that mature on tax due dates other than April 15 (i.e., the
15th of March, June, September, or December) tend to have lower yield
differentials by nearly 12 basis points.[Footnote 64] This may be
explained by empirical evidence suggesting that regular Treasury bills
whose maturity dates immediately precede corporate tax payment dates
have special value because corporate treasurers may wish to invest
excess cash in securities whose cash flows can be used to liquidate
cash liabilities.[Footnote 65]
CM Bills Issued in Multiple Tranches May Require Higher Yield
Differentials:
Financial market participants informed us that CM bills issued in
several tranches may lead to cautious bidding and therefore require
higher yields to attract investors. Multiple-tranche CM bills are CM
bills that are issued on different days within a short period that have
the same maturity date. Previous research has not studied this feature
of CM bills. Reliance on multiple-tranche CM bills increased from
slightly less than one-third of issues in the earlier subperiod to
approximately one-half of CM bills issued during fiscal years 2002-
2005. To test whether multiple-tranche issues affect CM bill yields, we
included a variable identifying this type of CM bills in the equation
shown in table 6, column A.
The results suggest that CM bills that are part of a multiple tranche
might have yields that are 6.0 basis points higher than other CM bills.
However, while the coefficient is significant at the 10 percent level,
it is not significant at the 5 percent level.[Footnote 66] Moreover,
the estimated multiple-tranche coefficient is not as robust as other
coefficient estimates. For example, with the inclusion of a variable
representing the number of days advance notice before auction in column
E, the coefficient of multiple-tranche CM bills is no longer
significant even at the 10 percent level. Accordingly, the evidence
that multiple-tranche issues increase the yield differential should be
viewed with caution.
Yield Differential Is Not Affected by Timing of Issuance:
We also tested whether the issuance of CM bills on the 1st-3rd days of
the month or during DISPs affected the yield differential. Because one-
half of all CM bills were issued on the 1st-3rd days of the month in
recent years, these issues might in some sense be considered more
regular and thus require lower yields than CM bills issued at other
times. However, the estimated coefficient of a variable identifying CM
bills issued on the 1st-3rd days of the month was
insignificant.[Footnote 67]
CM bills have been a useful tool for Treasury when approaching the debt
ceiling. From fiscal years 2002 through 2005, 20 percent of CM bills
were issued during DISPs--a period for which the Secretary of the
Treasury has determined that obligations of the United States may not
be issued without exceeding the debt ceiling. While the coefficient of
a variable identifying CM bills issued during DISPs had a negative
sign, it was not significantly different from zero.[Footnote 68]
Several Findings from Earlier Studies Are No Longer Supported:
Studies by Seligman and Christopher identified several other variables
that had significant effects on the differential between yields on CM
bills and either the yield on regular bills with similar maturity or
the yield on repurchase agreements.[Footnote 69] As noted earlier,
however, these studies employed samples consisting either entirely or
mainly of observations from CM bill auctions held before the
introduction of the Treasury bill in fiscal year 2001. The only finding
from earlier studies that appears to remain valid in this new
environment of shorter-maturity CM bills is that an increase in the
ratio of CM bills auctioned to the outstanding amount of similar-
maturing bills tends to increase the yield differential.
Both Seligman and Christopher found that CM bills with longer terms to
maturity were relatively less costly. The equation in Column B of table
6 includes a variable for a CM bill's term to maturity. In contrast to
earlier findings, we found that the coefficient for term to maturity is
positive and insignificant. This may be because CM bills are now
concentrated at the very short end of the maturity spectrum leaving
little room for increases in maturity to affect the yield differential.
Christopher found that the number of days between the auction of a CM
bill and the settlement date reduced the differential between the CM
bill yield and the yield on repurchase agreements. The explanation for
this relationship is that the delay allows administrative efficiencies.
However, the estimated coefficient of the number of days between
auction and settlement (in column C of table 6) is insignificant.
In the sample of CM bill auctions that Christopher studied, CM bills
that were auctioned on a Wednesday and had a maturity date beyond the
end of the month tended to have lower yields. Since the inception of
the 4-week Treasury bill and the truncation of CM bill maturities, only
4 of 55 issues were in this category. In an equation that also included
the other variables in column A of table 6, the coefficient for a
binary variable designating such issues had a t-statistic of only 0.161
which led to the rejection of the hypothesis that CM bills auctioned on
Wednesdays and maturing after the end of the month have lower yields.
Instead of issuing a new security, Treasury may add to, or reopen, an
existing issue, increasing the amount outstanding of the issue. CM bill
reopenings are fungible with previously issued regular bills and may
enjoy their liquidity. Seligman found that CM bills issued off-cycle
were significantly more costly than those that reopened a previous
issue. However, contrary to Seligman's results, our analysis indicates
that off-cycle CM bills are not more costly than reopenings. Column D
of table 6 shows the sign of the coefficient of the off-cycle variable
is negative rather than positive although, more relevantly, the
coefficient is not significantly different from zero. The descriptive
statistics in table 5 show that 86 percent of CM bills issued during
the more recent period were issued off-cycle compared with about 40
percent in the earlier period. Off-cycle issuance has become a regular
feature of CM bills and does not command an extra return.
Seligman also hypothesized that an increase in the number of business
days between CM bill announcement and auction would reduce the yield
differential. While his estimates suggest that 2 business days advanced
notice reduces the yield differential, he found that increasing the
announcement period beyond 2 days did not further reduce the
differential. In contrast, we found that the sign for the coefficient
of the number of days of advance notice was positive and significant,
as shown in column E of table 6. This has the unexpected implication
that increasing the number of business days notice before auction
increases rather than reduces the yield differential. Because markets
usually penalize uncertainty, this result appears counterintuitive and
should be studied further to determine whether it arose because of a
statistical problem such as the correlation between the advanced notice
variable and an omitted variable that may be unobservable.
Selected CM Bill Features Reduce Yields but Opportunities for
Additional Exploitation of These Features May Be Limited:
Our analysis of CM bill yield differentials from fiscal year 2002
through 2005 revealed several features of CM bills that affect the
yield differential; however, Treasury's ability to achieve additional
savings by further exploiting these features may be limited. The
average yield differential was substantially lower during the period
from fiscal years 2002 through 2005 than it was in the preceding
several years. The two most important factors behind the yield
differential decline between the pre-and post-2002 period were (1) the
substantial decline in the general level of short-term rates and (2)
the major reduction in the ratio of CM bills issued to the average
amount of Treasury bills outstanding. The level of short-term interest
rates is largely determined by Federal Reserve policy and market forces
rather than Treasury. Treasury bill yields may continue to rise and
reach levels that prevailed in the early period, thereby erasing the
portion of the decline in the yield differential caused by lower
interest rates. However, because the 4-week bill is now a permanent
feature of Treasury's auction schedule and has reduced Treasury's
reliance on CM bills, the portion of the decline in the yield
differential attributable to the reduced ratio of CM bills to similar-
maturity Treasury bills is likely to endure. The experience from fiscal
year 2002 through 2005 as a whole suggests that the yield differential
could remain about 13 basis points below pre-2002 levels.
While Treasury may have some ability to change the relative amount of
CM and regular bills issued, the mix is affected by cash flow patterns
largely beyond its control. Aligning cash outflows and inflows could
reduce the amount of CM bills issued, but Treasury does not have
authority over the timing of all cash flows. However, Treasury does
have control over debt-related cash flows. Efforts to better align the
timing of net increases in debt with its largest cash payments could
reduce both the size of CM bills and the yield differential.
To the extent that Treasury can increase the share of CM bills that
mature on dates when taxes are due, additional savings might be
achieved. Already more than 60 percent of CM bills met this criterion
in fiscal year 2005, so the possibility of achieving further savings
through this feature may be minimal. Moreover, Treasury's short-term
borrowing needs do not uniformly occur shortly before large tax due
dates.
Nearly one-half of CM bills issued since fiscal year 2002 have been
issued in multiple tranches. Our results provide somewhat limited
evidence that multiple tranche issues may be more costly. Even if such
issues were to require higher yields, however, multiple tranche issues
have the advantage of reducing borrowing costs by minimizing the
duration of the amounts borrowed in later tranches. For example,
instead of borrowing $20 billion for 10 days, Treasury might use two
tranches to borrow $10 billion for 10 days and $10 billion for 9 days,
thereby saving 1 day's interest on the second tranche. Accordingly, the
savings that multiple tranche CM bills provide by reducing the number
of days that interest is paid on later tranches is likely to more than
offset the higher yields such issues might entail.
Finally, the positive correlation found between the number of days of
advanced notice and the yield differential appears counterintuitive and
probably should not be used as a basis for reducing the notification
period.
[End of section]
Appendix II: Analysis of CM Bill Auctions:
Given that CM bill auctions are innately less predictable than regular
Treasury bill auctions, it is not surprising that, by some measures, CM
bill auctions are less successful than regular auctions. Better auction
performance can be characterized by greater participation, a broader
distribution of awards, and more preauction activity in the when-issued
market. These factors theoretically improve Treasury's borrowing costs.
By most measures of participation and activity we examined, CM bill
auctions perform less well than 4-week bill auctions. However, some
other measures indicate that Treasury obtained a better price at CM
bill auctions compared with 4-week bill auctions and that there is
stronger demand for CM bills than 4-week bills. However, we did not
find a statistically significant relationship between any auction
performance measures and yield differentials.[Footnote 70] We did find
that in more concentrated auctions, Treasury was less likely to pay
more than the yield indicated in the when-issued market at the time of
auction.
Trading Activity Was Lower Prior to CM Bill Auctions than 4-week Bill
Auctions:
Treasury auctions are preceded by forward trading in markets known as
"when-issued" markets. The when-issued market is important because it
serves as a price discovery mechanism that potential competitive
bidders look to as they set their bids for an auction. When-issued
trading reduces uncertainty about bidding levels surrounding auctions
and also enables dealers to sell securities to their customers in
advance of the auction so they are better able to distribute the
securities and bid more aggressively, which results in lower costs to
Treasury.
However, we found that trading activity is sparse before CM bill
auctions. We counted the number of preauction trades on the day of CM
bill auctions and found that when-issued trading is lower prior to CM
bill auctions compared with regular 4-week bill auctions (see table 7).
There is generally more activity after CM bill auctions than before the
auction.
Table 7: Pre-and Postauction Trading Activity in CM Bills and 4-week
Bills (Fiscal Years 2002-2005):
Average number of trades.
2002;
CM bills: Preauction: 250;
CM bills: Postauction: 283;
4-week bills: Preauction: 419;
4-week bills: Postauction: 315.
2003;
CM bills: Preauction: 63;
CM bills: Postauction: 144;
4-week bills: Preauction: 271;
4-week bills: Postauction: 218.
2004;
CM bills: Preauction: 94;
CM bills: Postauction: 154;
4-week bills: Preauction: 226;
4-week bills: Postauction: 220.
2005;
CM bills: Preauction: 97;
CM bills: Postauction: 149;
4-week bills: Preauction: 322;
4-week bills: Postauction: 290.
Average 2002-2005;
CM bills: Preauction: 112;
CM bills: Postauction: 173;
4-week bills: Preauction: 309;
4-week bills: Postauction: 261.
Source: GAO analysis of GovPX data.
Note: GovPX data provide information on primary dealer transactions
through the interdealer brokers for all U.S. Treasury securities.
[End of table]
Yield Treasury Paid on CM Bills Generally Reflected Market Information
at the Time of the Auction:
To evaluate the yield obtained at auction, Treasury's auction studies
used the difference between yields at auction and the contemporaneous
when-issued yield at time of an auction, usually 1:00 p.m. We refer to
this measure as the contemporaneous auction spread. According to
Treasury, this is a good benchmark to measure auction yields because
potential bidders have a choice between purchasing securities at
auctions or purchasing securities in the when-issued market. A negative
spread (where the auction yield is less than the contemporaneous when-
issued yield) indicates Treasury paid a lower yield than expected,
which is a positive auction result. Alternatively, a positive spread
(the auction yield is greater than the contemporaneous when-issued
yield) indicates Treasury paid a higher yield than expected from
information in the market at the time of auction. This would indicate a
poor auction result. By this measure, CM bill auctions performed better
than 4-week bill auctions. The contemporaneous auction spread of CM
bill auctions from fiscal year 2002 through 2005 was approximately zero
(see table 8), which implies that the yield Treasury paid on CM bills
generally reflected market information at the time of the auction. In
contrast, the auction spread for 4-week bill auctions averaged a
positive 0.3 basis points for fiscal years 2002 through 2005. The
information derived from the auction spread depends in part on:
whether the when-issued market is liquid around the time of the
auction.[Footnote 71] Because the level of trading activity is
relatively sparse before CM bill auctions, the information provided by
the contemporaneous auction spread may be limited.
Table 8: Average Spread between Auction and When-issued Yields at Time
of Auction (Fiscal Years 2002-2005):
Basis points.
2002;
CM bills: 0.3;
4-week bills: 0.4.
2003;
CM bills: -0.5;
4-week bills: 0.3.
2004;
CM bills: -0.3;
4-week bills: 0.6.
2005;
CM bills: 0.4;
4-week bills: 0.1.
Average 2002-2005;
CM bills: 0.0;
4-week bills: 0.3.
[End of table]
Source: GAO analysis of GovPX data.
CM Bill Auctions Are More Concentrated and Have Fewer Awarded Bidders
than 4-week Bill Auctions:
In order to lower borrowing costs, Treasury seeks to encourage more
participation in auctions. In general, large, well-attended auctions
improve competition and lead to lower borrowing costs for Treasury. For
example, in the 1990s Treasury switched its auctions from multiple-
price to uniform-price format in order to encourage more aggressive
bids and a broader distribution of auction awards. Treasury found that
the share of the auction awarded to the top five competitive bidders
declined under the new auction format to about 35 percent for 2-year
notes and 36 percent for 5-year notes. Using similar estimates of
bidder participation in CM bill auctions, we found that the share of
the auction awarded to the top five bidders was 60 percent or higher in
over half of CM bill auctions held during fiscal years 2002-2005. The
share exceeded 60 percent in only 18 percent (37 of 209) of 4-week bill
auctions held during fiscal years 2002-2005.
Treasury limits the maximum auction award to a single bidder to 35
percent of the offering in part to foster a liquid secondary market for
a new issue.[Footnote 72] A higher concentration could reduce
competition and restrict a security's supply in the secondary market
preventing its efficient allocation among investors and possibly
generating a "short squeeze." The term "short squeeze" is used by
market participants to refer to a shortage of a security relative to
willing buyers for the same security. These squeezes arise because
Treasury allows dealers to sell the security short to its customers (or
other dealers) in the when-issued market before securities are
auctioned. Lack of competition could also result in lower prices
(higher yields) at auction. In contrast, we found generally negative
correlations between concentration measures and auction spreads for CM
bill auctions. In other words, in more concentrated auctions, Treasury
was less likely to pay more than the yield indicated in the when-issued
market at the time of auction. According to Treasury, a high
concentration ratio in CM bill auctions may imply some bidders really
want a particular bill, which drives the price up and yield down.
Not only are CM bill auctions more concentrated, but fewer bidders in
total are awarded CM bills than 4-week bills. According to Treasury
officials, short-term securities have a more limited audience. From
fiscal year 2002 through 2005, about 17 bidders on average were awarded
CM bills in each auction compared with 22 bidders in 4-week bill
auctions. More than half of the CM bill auctions had 16 or fewer
awarded bidders. In contrast, only about 4 percent of 4-week bill
auctions had 16 or fewer awarded bidders.
Although greater participation, a broader distribution of awards, and
more preauction activity in the when-issued market theoretically
improves Treasury's borrowing costs, we did not find a statistically
significant relationship between these factors and the yield
differential.
More Common Performance Measures Indicate High Demand for CM Bills but
Greater Uncertainty in CM Bill Auctions Compared with 4-week Bill
Auctions:
More commonly cited measures of auction performance, such as bid-to-
cover ratios and auction tails (difference between the high and average
discount rates) provide information on the demand for Treasury
securities and the dispersion of bids, but these measures are
limited.[Footnote 73] The bid-to-cover ratio is the ratio of the amount
of bids received in a Treasury security auction compared with the
amount of accepted bids. In general, higher ratios signal higher demand
for the security being auctioned. From fiscal year 2002 to 2005, the
bid-to-cover ratio for CM bill auctions averaged 3.17 (see table 9). In
contrast, the bid-to-cover ratio for 4-week bills averaged only 2.30.
This suggests a stronger demand for CM bills than regular 4-week bills;
however, these results should be interpreted with caution. Some market
participants suggested that a high bid-to-cover ratio may arise because
many dealers participate in CM bill auctions to fulfill auction
requirements that are less costly to meet by participating in short-
term CM bills auctions than in auctions of longer-term securities.
Table 9: Bid-to-cover Ratios for CM and 4-week Bills (Fiscal Years 2002-
2005):
Average ratio of amount tendered to amount accepted.
2002; Average ratio of amount tendered to amount accepted: CM bills:
3.12; Average ratio of amount tendered to amount accepted: 4-week
bills: 2.34.
2003; Average ratio of amount tendered to amount accepted: CM bills:
3.45; Average ratio of amount tendered to amount accepted: 4-week
bills: 2.32.
2004; Average ratio of amount tendered to amount accepted: CM bills:
3.18; Average ratio of amount tendered to amount accepted: 4-week
bills: 2.23.
2005; Average ratio of amount tendered to amount accepted: CM bills:
3.02; Average ratio of amount tendered to amount accepted: 4-week
bills: 2.32.
Average 2002-2005; Average ratio of amount tendered to amount accepted:
CM bills: 3.17; Average ratio of amount tendered to amount accepted: 4-
week bills: 2.30.
[End of table]
Source: GAO analysis of BPD data.
Auction tails--the number of basis points between the high and average
discount rates--are a measure of the dispersion of the bids. Auction
theory suggests that the more diverse the beliefs of the bidders and
the more uncertain they are about the demand for the bills, the more
dispersed the bids submitted. In contrast, narrower tails indicate
strong bidding and therefore lower costs to Treasury. When evaluating
the auction tails of CM bills compared with regular Treasury
securities, we found that CM bill tails were slightly larger than 4-
week bill auctions (see table 10).
Table 10: Auction Tails for CM and 4-week Bill Auctions (Fiscal Years
2002-2005):
Basis points.
2002;
CM bills: 1.71;
4-week bills: 1.66.
2003;
CM bills: 1.33;
4-week bills: 1.00.
2004;
CM bills: 1.00;
4-week bills: 0.80.
2005;
CM bills: 1.29;
4-week bills: 1.21.
Average 2002-2005;
CM bills: 1.27;
4-week bills: 1.17.
Source: GAO analysis of BPD data.
Note: Auction tails are measured as the difference between high and
average discount rates.
[End of table]
In summary, most measures suggest CM bill auctions perform less well
than 4-week bill auctions. However, the low participation and high
concentration of CM bill auctions do not explain why Treasury paid
higher yields on CM bills than investors paid for similar-maturing
bills in the secondary market.
[End of section]
Appendix III: Selected Bibliography:
Bikhchandani, Sushil, Patrik L. Edsparr, and Chif-fu Huang. "The
Treasury Bill Auction and the When-Issued Market: Some Evidence." Draft
(Aug. 30, 2000).
Christopher, Jan E. "Determinants of the Spread between Repo and Cash
Management Bill Yields: Technical Report." Unpublished manuscript
(2005).
Fleming, Michael J. "Are Larger Treasury Issues More Liquid? Evidence
from Bill Reopenings." Journal of Money, Credit, and Banking, vol. 34,
no. 3 (August 2002): 707-35.
Garbade, Kenneth D. "Treasury Bills with Special Value." Fixed Income
Analytics (Cambridge, Mass.: MIT Press, 1996): 181-197.
Garbade, Kenneth D., and Jeffrey F. Ingber, "The Treasury Auction
Process: Objectives, Structure and Recent Adaptations." Current Issues
in Economics and Finance, vol. 11, no. 2, Federal Reserve Bank of New
York (February 2005).
Garbade, Kenneth D., John C. Partlan, and Paul J. Santoro. "Recent
Innovations in Treasury Cash Management." Current Issues in Economic
and Finance, vol. 10, no. 11, Federal Reserve Bank of New York
(November 2004).
Malvey, Paul F. and Christine M. Archibald. Uniform-Price Auctions:
Update of the Treasury Experiences. Department of the Treasury, Office
of Market Finance (Oct. 26, 1998).
Nyborg, Kjell G. and Suresh Sundaresan. "Discriminatory versus Uniform
Treasury Auctions: Evidence from When-issued Transactions." Journal of
Financial Economics, vol. 42 (1996): 63-104.
Seligman, Jason. "Does Urgency Affect Price at Market? An Analysis of
U.S. Treasury Short-Term Finance." Journal of Money, Credit, and
Banking (forthcoming).
Simon, David P. "Segmentation in the Treasury Bill Market: Evidence
from Cash Management Bills." Journal of Financial and Quantitative
Analysis, vol. 26, no. 1 (March 1991): 97-108.
Simon, David P. "Further Evidence on Segmentation in the Treasury Bill
Market." Journal of Banking and Finance, vol. 18 (1994): 139-51.
[End of section]
Appendix IV: Comments from the Department of the Treasury:
DEPARTMENT OF THE TREASURY:
ASSISTANT SECRETARY:
WASHINGTON:
March 16, 2006:
Susan J. Irving:
Director, Federal Budget Analysis:
General Accountability Office:
Washington, D.C.
Dear Ms. Irving:
Thank you for your letter of February 21 to Secretary Snow enclosing
the draft report entitled Debt Management. Treasury Has Refined Its Use
of Cash Management Bills But Should Explore Options That May Reduce
Cost Further. As discussed during our teleconference on March 9, we
wish briefly to respond to several of the larger issues raised in the
report.
First, the report recommends that the Department of the Treasury
explore options for reducing the use and cost of cash management bills
to fund short term cash needs. Treasury is committed to minimizing
financing costs. It has been Treasury's long-standing debt management
practice to hold discussions with market participants about the costs
and benefits of shorter-term instruments, to examine the value of
additional transparency of cash management bill issuance, and to
explore alternative approaches to debt management like those used in
other countries. While Treasury's current debt issuance practices
reflect this policy, consistent with the thoughtful recommendations in
your report we will continue to evaluate ways to further reduce
financing costs through changes in the use of cash management bills.
Second, the report recommends that Treasury explore the feasibility of
aligning cash flows, and increasing earnings on cash balances. As noted
in the report, there are statutory, regulatory, and practical
constraints limiting Treasury's ability to change the timing of large,
recurring receipts and expenditures. Nevertheless, when there is an
opportunity to better align any of our major cash flows, either
receipts, expenditures or marketable debt issuances, we will certainly
explore doing so. In addition, we are currently exploring opportunities
to increase the capacity and flexibility of our investment program and
improve earnings on our excess cash. As these improvements would
broaden Treasury's investment authority, legislative action will be
needed to implement the changes.
Thank you for the opportunity to review and comment on the draft
report, and we look forward to a continuing dialogue with you on these
topics.
Sincerely yours,
Signed by:
Emil W. Henry, Jr.
Assistant Secretary for Financial Institutions:
[End of section]
Appendix V: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Susan J. Irving (202) 512-9142 Thomas J. McCool (202) 512-2700:
Acknowledgments:
In addition to the contacts named above, Jose Oyola (Assistant
Director), Richard Krashevski, Naved Qureshi, and Melissa Wolf made
significant contributions to this report. Jennifer Ashford also
provided key assistance.
(450390):
FOOTNOTES
[1] For more information on these trends and our nation's fiscal
challenges, see GAO, 21st Century Challenges: Reexamining the Base of
the Federal Government, GAO-05-325SP (February 2005).
[2] Bills are short-term securities that mature in 1 year or less from
their issue date. Bills are sold at a discount from their face value.
When the bill matures, Treasury pays the investor the face value of the
bill. The difference between the purchase price and face value is the
interest paid by Treasury or conversely the return to the investor.
Treasury notes and bonds are securities that pay a fixed rate of
interest every 6 months until they mature and then pay their face
value. Treasury notes mature in at least 1 year but not more than 10
years from their issue date. Bonds mature in more than 10 years from
their issue date. TIPS are issued in terms of 5, 10, and 20 years. The
principal value of TIPS is tied to inflation. TIPS pay interest twice a
year, at a fixed rate that is applied to the adjusted principal. At
maturity, Treasury pays the adjusted principal or original principal,
whichever is greater.
[3] The statutory debt limit established by 31 U.S.C. Section 3101 is
the legal ceiling on the amount of gross federal debt. The limit
applies to the total of the face amount of obligations issued under
chapter 31 of title 31, United States Code, and the face amount of
obligations whose principal and interest are guaranteed by the U.S.
government that are outstanding at any one time.
[4] Yields are generally equal to the amount of interest divided by the
price paid by investors with an adjustment for the portion of the year
the bill is outstanding. The secondary market is a market in which an
investor purchases a security from another investor rather than the
issuer.
[5] Throughout this report, the yield differential is used as a measure
of the premium Treasury pays to borrow outside its regular schedule. It
is not a measure of the total additional cost of CM bills compared with
other alternatives for raising short-term funds. Total borrowing costs
are based on the amount borrowed, the yield, and the time the debt is
outstanding.
[6] For example, instead of issuing one $30 billion CM bill on the 1st
that matured on the 15th, Treasury has issued three smaller CM bills on
the 1st, 3rd, and 9TH (all maturing on the 15th). Other meanings of
multiple tranche exist. For example, in bond markets a multiple tranche
refers to a package of investments offered at the same time. Unlike
this definition, Treasury does not announce the tranches together.
[7] Treasury invests its excess cash--funds that would otherwise cause
its balance at the Federal Reserve to rise above the target level of $5
billion--in Treasury Tax and Loan (TT&L) accounts. TT&L accounts are
held at financial institutions and earn interest rates equal to the
federal funds rate less .25 percentage points, or 25 basis points.
[8] Treasury's authorities are codified in chapter 31 of title 31 of
the United States Code.
[9] A liquid debt issue is one that is large enough for market
participants to trade easily, and one for which the offer and purchase
prices differ only slightly.
[10] Prior to February 2006, Treasury issued the 5-year note in the
middle of each month.
[11] Instead of issuing a new security, Treasury may add to, or reopen,
an existing issue, increasing the amount outstanding of the issue.
Larger issues tend to be more liquid and attractive to investors. In
addition to the 10-year note, Treasury reopens 30-year bonds 6 months
after their initial issuance. It also reopens the 5-and 20-year TIPS 6
months after initial issuance and the 10-year TIPS 3 months after
initial issuance. Moreover, shorter-term bills are fungible with
previously issued bills, so that every 13-week bill is a reopening of a
previously issued 26-week bill and every 4-week bill is a reopening of
previously issued 13-and 26-week bills.
[12] Treasury suspended issuance of the 30-year bond in October 2001
and resumed issuance in February 2006.
[13] Treasury's current tentative auction schedule can be viewed at:
http://www.treas.gov/offices/domestic-finance/debt-
management/auctions/.
[14] A DISP is any period for which the Secretary of the Treasury has
determined that obligations of the United States may not be issued
without exceeding the public debt limit. During DISPs, the Secretary of
the Treasury has statutory authority to depart from Treasury's normal
investment and redemption procedures for certain federal government
accounts. See GAO, Debt Ceiling: Analysis of Actions Taken During the
2003 Debt Issuance Suspension Period, GAO-04-526 (Washington, D.C.: May
20, 2004) for additional information on DISPs and the public debt
limit. CM bills may also be issued by Treasury prior to a DISP.
[15] Treasury's quarterly refunding process, during which debt
management policy is examined and sometimes changed, is held near the
middle of each calendar quarter (i.e., February, May, August, and
November). As part of this process, Treasury solicits advice and views
from the private sector, including primary dealers and the Borrowing
Advisory Committee. Primary dealers are banks and securities broker-
dealers that trade in U.S. government securities with the Federal
Reserve Bank of New York. The Borrowing Advisory Committee is a
committee of the Bond Market Association governed by federal statute
and comprising senior representatives from firms that actively trade or
make large investments in Treasury securities.
[16] Similar measures, also called butterfly spreads, were used by
Jason Seligman, "Does Urgency Affect Price at Market? An Analysis of
U.S. Treasury Short-Term Finance," Journal of Money, Credit, and
Banking (forthcoming), pp. 6-8 and Michael J. Fleming, "Are Larger
Treasury Issues More Liquid? Evidence from Bill Reopenings," Journal of
Money, Credit, and Banking, vol. 34, no. 3 (August 2002), p. 707.
[17] For example, see Paul F. Malvey and Christine M. Archibald,
Uniform-Price Auctions: Update of the Treasury Experience (Washington,
D.C.: Department of the Treasury, Oct. 26, 1998).
[18] Treasury must also repay regular bills that mature on Thursdays
and notes that mature in the middle and end of each month. However,
Treasury generally pays them by rolling over debt (i.e., issuing new
debt to repay maturing debt).
[19] Withheld taxes include personal income, Social Security, and
Medicare taxes withheld from employee paychecks by employers.
Nonwithheld taxes, such as estimated individual income taxes, and
corporate income taxes are paid on a periodic basis. Generally, a
corporation must make four payments a year, which are due by the 15th
day of the 4TH, 6TH, 9TH, and 12TH months of the corporation's tax
year, which may vary. So, for corporations with a tax year ending
December 31, payments are due on April 15, June 15, September 15, and
December 15. If the corporation's year ends June 30, payments are due
on the 15th of October, December, March, and June. If any due date
falls on a Saturday, Sunday, or legal holiday, the payment is due on
the next business day.
[20] Our calculation of total corporate income tax deposits for fiscal
year 2005 does not include the $4.5 billion payment received on Oct. 1,
2004, that was caused by Congress's postponement of the corporate tax
payment date in mid-September 2004.
[21] All 21 CM bill issuances in fiscal year 2005 matured between the
14TH and the 18TH of the month, except one CM bill that matured on Nov.
23, 2004.
[22] It may seem counterintuitive for Treasury to borrow to pay Social
Security benefits when the Social Security trust funds are running
surpluses. When the Social Security trust funds receive payroll taxes
or other contributions that are not needed to pay benefits, the excess
cash is invested in special Treasury securities and Treasury uses the
cash for other government purposes. Thus, this cash is not on hand to
pay Social Security benefits at the beginning of each month.
[23] However, agencies must give Treasury 5 business days notice for
disbursements of $500 million or more and 2 business days notice for
disbursements of between $50 million and $500 million. See Treasury
Financial Manual, Vol. I, Part 6, Chapter 8500 (Washington, D.C.:
Department of the Treasury, April 1996).
[24] 26 U.S.C. § 6654(c) and § 6655(c).
[25] For information on actions taken during DISPs, see GAO-04-526 and
earlier GAO debt ceiling reports.
[26] Treasury also used cash management bills during the DISP that
occurred in fiscal year 2006. The DISP began on February 16, 2006 and
lasted until March 20, 2006, when Congress increased the debt limit to
$8,965 billion.
[27] Pub. L. No. 96-18.
[28] In 1979 Congress also authorized a securities draw authority,
which permitted Treasury to borrow securities from the Federal Reserve,
sell them, and then repurchase the securities in the open market and
return the securities to the Federal Reserve within a specified period,
but it was never used. The securities draw authority also expired in
1981.
[29] For more information on Treasury cash investment, see pages 34-35.
[30] The yield differential is the difference between a CM bill yield
and the weighted average yield of outstanding Treasury bills maturing
before and after the CM bill. The weights on the Treasury bill yields
were based on the relative difference in each bill's maturity date from
the CM bill's maturity date, with the Treasury bill having a closer
maturity date receiving a greater weight and the weights summing to
one. For more information, see app. I, pages 53-54.
[31] One basis point is equal to 1/100TH of 1 percent. Thus, 47 basis
points is 0.47 percentage points.
[32] The annualized amount outstanding is derived by spreading the
amount of each CM bill across the 365-day year. So, for example, a 14-
day CM bill with a face value of $25 billion is multiplied by 0.038 (=
14/365) resulting in an annualized amount outstanding of $959 million.
[33] We identified several features of CM bills within Treasury's
control that affect the yield differential. These are discussed on
pages 26-29.
[34] Based on overnight repurchase agreement rates on the day of CM
bill auctions published in the WSJ.
[35] Repurchase agreement rates are less than federal funds rates
because a federal funds transaction has no collateral.
[36] While we analyzed the yield differential for all CM bills issued
during fiscal years 1996-2005, we focused on the 55 CM bills issued
during fiscal years 2002-2005 because the introduction of the 4-week
bill in 2001 substantially reduced CM bill maturities and caused a
structural change in the CM bill market.
[37] However, this is only significant at the 10 percent level and it
is sensitive to the inclusion of other explanatory variables--namely,
the announcement day variable.
[38] App. I provides more detail on our methodology for analyzing the
CM bill yield differential and our findings.
[39] Treasury auctions are preceded by forward trading in markets known
as "when-issued" markets. The when-issued market is important because
it serves as a price discovery mechanism that potential competitive
bidders look to as they set their bids for an auction.
[40] App. II provides more information on our analysis of CM bill
auctions.
[41] David P. Simon, "Segmentation in the Treasury Bill Market:
Evidence from Cash Management Bills," Journal of Financial and
Quantitative Analysis, vol. 26, no. 1 (March 1991), pp. 97-108; David
P. Simon, "Further Evidence on Segmentation in the Treasury Bill
Market," Journal of Banking and Finance, vol. 18 (1994), pp. 139-51;
Fleming, "Are Larger Treasury Issues More Liquid?" p. 707; and
Seligman, "Does Urgency Affect Price at Market?"
[42] The probability value for the coefficient estimate is .06.
[43] See Kenneth D. Garbade, "Treasury Bills with Special Value," in
Fixed Income Analytics (Cambridge, Mass.: MIT Press, 1996), pp. 181-
197.
[44] The Treasury Borrowing Advisory Committee recommends amounts for
each Treasury security, including CM bills, to be issued in the
upcoming 2 quarters. However, Treasury is not obligated to follow the
committee's recommendations and the actual timing and amount of CM bill
issuance has varied from the committee's recommendations. These
recommendations are publicly available on Treasury's website. See
http://www.treas.gov/offices/domestic-finance/debt-management/adv-
com/reports/.
[45] See Seligman, "Does Urgency Affect Price at Market?"
[46] Established by Pub. L. No. 95-147, 913 Stat. 1227 (1977), the TT&L
program helps stabilize the supply of reserves in the banking system.
If Treasury held all its cash in its Federal Reserve account, increases
in its cash position would drain reserves from the banking system, and
decreases would add reserves. Thus, the Federal Reserve would have to
conduct frequent and perhaps large open market operations to mitigate
undesired fluctuations in bank reserves and the federal funds rate. The
TT&L program also helps Treasury manage federal tax receipts and earn
interest on public funds.
[47] Set in 1978, the TT&L rate was originally intended to reflect the
rate paid on overnight repurchase agreements, a similar transaction.
See fig. 9 for more information.
[48] Excess cash balances could also be invested in TIOs, which
typically earn more than TT&L accounts. As discussed later in this
report, increasing balances in TIOs relative to the TT&L accounts would
help Treasury increase earnings on its cash balances and may ultimately
reduce the use of some CM bills. Excess cash balances could also be
used to reduce other Treasury debt, however, in general, Treasury
limits week-to-week changes in the issue size of its regular bills.
[49] This interest savings estimate does not take into account all the
benefits and costs that should be considered including costs imposed on
individuals, businesses, and other nonfederal entities.
[50] Fig. 9 provides more information on Treasury's TIO program.
[51] This is based on a complicated formula that takes into account the
bidder's "reportable net long position" in the security. For more
information on this and auction mechanics, see Kenneth D. Garbade and
Jeffrey F. Ingber, "The Treasury Auction Process: Objectives, Structure
and Recent Adaptations," Current Issues in Economics and Finance,
Federal Reserve Bank of New York, vol. 11, no. 2 (February 2005).
[52] Similar measures, also called butterfly spreads, were used by
Jason Seligman, "Does Urgency Affect Price at Market? An Analysis of
U.S. Treasury Short-Term Finance," Journal of Money, Credit, and
Banking (forthcoming), pp. 6-8 and Michael J. Fleming, "Are Larger
Treasury Issues More Liquid? Evidence from Bill Reopenings," Journal of
Money, Credit, and Banking, vol. 34, no. 3 (August 2002), p. 717.
[53] David P. Simon, "Segmentation in the Treasury Bill Market:
Evidence from Cash Management Bills," Journal of Financial and
Quantitative Analysis, vol. 26, no. 1 (March 1991), pp. 97-108.
[54] The when-issued period runs from the CM bill's announcement to its
issuance.
[55] David P. Simon, "Further Evidence on Segmentation in the Treasury
Bill Market," Journal of Banking and Finance, vol. 18 (1994), pp. 139-
51.
[56] Fleming, "Are Larger Treasury Issues More Liquid?" pp. 707-35.
[57] Seligman, "Does Urgency Affect Price at Market?"
[58] Jan E. Christopher, "Determinants of the Spread between Repo and
Cash Management Bill Yields: Technical Report," unpublished manuscript
(2005).
[59] Christopher (ibid., p. 21) uses principal components analysis to
estimate the share of the variation in the yield differential explained
by different factors from 2001 through 2004, but does not show the
effect on the yield differential in terms of basis points or whether
the effect is positive or negative.
[60] In some cases the surrounding Treasury bills we used could include
CM bills. In this sense, our methodology differs from Seligman's, which
always compared CM bills with the two nearest-maturity regular bills
that did not include CM bills. By including some CM bills, the yield
differential may be slightly understated because the yield on the
outstanding securities including CM bills would likely be higher than
outstanding securities that did not include CM bills.
[61] The yield on comparable-maturity Treasury bills averaged 5.01 from
fiscal years 1996 through 2001.
[62] This is the product of the coefficient and the inverse of $67.5
billion (average amount of similar-maturing Treasury bills for fiscal
year 2005).
[63] Because of the structural change in the relationship determining
the yield differential, similar calculations cannot be applied to the
period before the introduction of the 4-week Treasury bill.
[64] If the 15th fell on a holiday or weekend, the tax due date was the
following business day.
[65] See Kenneth D. Garbade, "Treasury Bills with Special Value," in
Fixed Income Analytics (Cambridge, Mass.: MIT Press, 1996).
[66] The probability value for the coefficient estimate is .06.
[67] The probability value of the coefficient for CM bills issued on
the 1st-3rd days of the month was .42.
[68] The probability value for the coefficient of the DISP variable was
.292.
[69] See Seligman, "Does Urgency Affect Price at Market" and
Christopher, "Determinants of the Spread between Repo and Cash
Management Bill Yields."
[70] The yield differential is measured as the difference between CM
bill yields and the weighted average of yields on outstanding Treasury
bills maturing before and after the CM bill.
[71] Kjell G. Nyborg and Suresh Sundaresan, "Discriminatory versus
Uniform Treasury Auctions: Evidence from When-issued Transactions,"
Journal of Financial Economics, vol. 42 (1996), pp. 63-104.
[72] This is based on a complicated formula that also takes into
account the bidder's "reportable net long position" in the security.
For more information on this and auction mechanics, see Kenneth D.
Garbade and Jeffrey F. Ingber, "The Treasury Auction Process:
Objectives, Structure and Recent Adaptations," Current Issues in
Economics and Finance, vol. 11, no. 2, Federal Reserve Bank of New
York, (February 2005).
[73] The difference between the highest and lowest winning tender is
also used. For example, see Sushil Bikhchandani, Patrik L. Edsparr, and
Chif-fu Huang, "The Treasury Bill Auction and the When-Issued Market:
Some Evidence," draft (Aug. 30, 2000).
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