Debt Management:

Treasury Inflation Protected Securities Should Play a Heightened Role in Addressing Debt Management Challenges

GAO-09-932: Published: Sep 29, 2009. Publicly Released: Sep 29, 2009.

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The 2008 financial market crisis and the economic recession led to a rapid and substantial increase in federal debt. This report, part of a line of work on debt management, was conducted under the Comptroller General's authority. It describes current debt management challenges and examines the role of a program that could benefit Treasury--Treasury Inflation Protected Securities (TIPS). GAO analyzed market data and interviewed experts as well as the two largest holders of Treasury securities in each of six sectors.

In January 1997, Treasury introduced an inflation-indexed security--TIPS. Treasury's stated objectives were to both raise the national savings rate and to reduce the federal government's cost of borrowing. TIPS offer inflation protection to investors who are willing to pay a premium for this protection in the form of a lower interest rate. In a functioning TIPS market, the difference between the interest rate on nominal Treasury securities and the interest rate on TIPS is expected to be approximately equal to the expected inflation rate. Federal government actions in response to both the financial market crisis and the economic recession have added significantly to Treasury's borrowing needs. Since the onset of the recession in December 2007, Treasury has borrowed more than $2.3 trillion, largely by issuing short-term nominal debt, which significantly changed the composition of Treasury's debt portfolio. The challenges presented by increasing debt and the change in its composition take place in the context of the medium and longer term fiscal outlook and will not recede with the return of financial market stability and economic growth. The Congressional Budget Office (CBO) projects that, absent changes in current policy, debt held by the public will double in 5 years (from 2008 to 2013) and almost triple in 11 years (from 2008 to 2019)--reaching 82 percent of GDP. In order to meet these challenges Treasury needs to diversify its funding sources and lengthen the term-to-maturity of its debt portfolio. TIPS can contribute to this effort. Treasury's TIPS program has had varying degrees of liquidity (the ease with which investors can trade the security) since its inception. The major institutional investors that GAO interviewed perceived Treasury's commitment to the TIPS program as having wavered in recent years, decreasing the liquidity of TIPS in the market. Investors demand a premium for holding less-liquid TIPS, which increases Treasury's borrowing costs. TIPS offer benefits to Treasury and measuring the cost against which to weigh these benefits requires both forward-looking and after-the-fact analysis. A more robust TIPS program could benefit Treasury by diversifying and expanding its funding sources and reducing the cost of nominal securities. Governments are well suited to bear inflation risk because periods of inflation are often associated with increased revenues. TIPS auctions also help provide a measure of market inflation expectations. On July 1, 2009, GAO briefed Treasury's Office of Debt Management on the findings from our analysis and interviews with major institutional investors. Treasury later posed questions about ways to improve the TIPS program to the Primary Dealers and the Treasury Borrowing Advisory Committee (TBAC). At the August 2009 TBAC meeting, members discussed TIPS. Following the meeting, Treasury's Deputy Assistant Secretary for Federal Finance reaffirmed Treasury's commitment to TIPS and announced plans to gradually increase issuance of TIPS.

Status Legend:

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  • Review Pending-GAO has not yet assessed implementation status.
  • Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.
  • Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.
  • Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.
    • Review Pending
    • Open
    • Closed - implemented
    • Closed - not implemented

    Recommendations for Executive Action

    Recommendation: The Secretary should continually review the appropriate composition of the TIPS program, and consider the ways in which the TIPS program can diversify Treasury's investor base and funding sources.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: In a letter to GAO, Treasury stated that they will continue to evaluate the cost and composition of the TIPS portfolio based on a variety of analyses and techniques and that Treasury continues to study other potential benefits of TIPS including their ability to diversify its investor base and the impact of TIPS issuance on nominal security costs.

    Recommendation: The Secretary should continually review the appropriate composition of the TIPS program, and consider how both ex-ante (before the fact) and ex-post (after the fact) analyses are valuable for evaluating the cost of TIPS, recognizing the anomalous nature of market data from periods such as the 2008 financial market crisis.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: In a letter to GAO, Treasury stated that Treasury will continue to evaluate the cost and composition of the TIPS portfolio based on a variety of analyses and techniques including both ex-ante and ex-post methods.

    Recommendation: The Secretary should continually review the appropriate composition of the TIPS program, and consider the impact of Treasury's public statements and TIPS issuances on TIPS liquidity.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: At both of the two second quarterly refunding meetings, Treasury reaffirmed its commitment to the TIPS program and stated that they are committed to issuing TIPS in a regular and predictable manner across the yield curve. They identified TIPS as an important part of their overall debt management strategy and stated that market participants could expect to see issuance gradually increase in FY2010. Additionally, Treasury replaced the 20-year TIPS with a 30-year TIPS to potentially improve liquidity. In November 2009, Treasury announced that they are considering making further changes to the TIPS calendar to provide more frequent TIPS auctions. In a letter to GAO, Treasury stated that they continuously review the appropriate issuance amounts and composition of its entire portfolio, including TIPS. Since August 2009, Treasury has been consistent in public statements concerning the TIPS program. Treasury's strong commitment to the TIPS program was made clear by maintaining issuance sizes during the recent global financial crisis, when dislocations in the fixed income markets caused other sovereign issuers to pull back from inflation-linked debt issuance. Since August 2009, Treasury has also made a commitment to the market to expand the TIPS program.

    Recommendation: To improve TIPS liquidity in the context of projected sustained increases in federal debt, the Secretary of the Treasury should conduct more frequent TIPS auctions.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: At both of the two second quarterly refunding meetings, Treasury reaffirmed its commitment to the TIPS program and stated that they are committed to issuing TIPS in a regular and predictable manner across the yield curve. They identified TIPS as an important part of their overall debt management strategy and stated that market participants could expect to see issuance gradually increase in FY2010. Additionally, Treasury replaced the 20-year TIPS with a 30-year TIPS to potentially improve liquidity. In November 2009, Treasury announced that they are considering making further changes to the TIPS calendar to provide more frequent TIPS auctions.

    Recommendation: To improve TIPS liquidity in the context of projected sustained increases in federal debt, the Secretary of the Treasury should issue TIPS with longer-dated maturities.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: At Treasury's August 2009 refunding, Treasury announced that with the goal of potentially improving liquidity in the TIPS program and to better capture the premium associated with inflation protection, Treasury would consider replacing the 20-year TIPS with a 30-year TIPS. The first 30-year TIPS auction was held in February 2010.

    Recommendation: To improve TIPS liquidity in the context of projected sustained increases in federal debt, the Secretary of the Treasury should increase TIPS issuance.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: Our September 2009 report on Treasury Inflation Protected Securities (TIPS) found that TIPS should play a heightened role in addressing debt management challenges. On July 1, 2009 we briefed officials and staff from Treasury's Office of Debt Management on our findings, including that Treasury's TIPS program has had varying degrees of liquidity (the ease with which investors can trade the security) since its inception and that Treasury actions impact TIPS liquidity. We reported that the major institutional investors that we interviewed perceived Treasury's commitment to the TIPS program as having wavered in recent years, decreasing liquidity of TIPS in the market. Following our briefing, Treasury posed questions about ways to improve the TIPS program to the Primary Dealers and the Treasury Borrowing Advisory Committee (TBAC). At the August 2009 TBAC meeting, members discussed TIPS. In part, based on the presentations at the August 2009 TBAC meeting on TIPS, Treasury's Deputy Assistant Secretary for Federal Finance publicly reaffirmed Treasury's commitment to TIPS and announced plans to gradually increase issuance of TIPS. Increasing TIPS issuance could contribute to Treasury's goal of the lowest cost of borrowing over time. Treasury's Deputy Assistant Secretary for Federal Finance confirmed that the questions posed at the August 2009 TBAC meeting had been influenced by our statements at the July 1, 2009, briefing.

    Recommendation: The Secretary should continually review the appropriate composition of the TIPS program, and consider the degree to which TIPS impact the cost of nominal securities.

    Agency Affected: Department of the Treasury

    Status: Closed - Implemented

    Comments: In a letter to GAO, Treasury stated that they will continue to evaluate the cost and composition of the TIPS portfolio based on a variety of analyses and techniques and consider the impact of TIPS issuance on nominal security costs.

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