Debt Management: Buybacks Can Enhance Treasury's Capacity to Manage under Changing Market Conditions [Reissued on March 21, 2012]
Highlights
What GAO Found
Debt buybacks can help advance Treasury’s goals under a variety of budget and market conditions. For example, Treasury currently faces rollover peaks—large increases in the amounts of maturing debt that must be refinanced at a given time—which expose Treasury to the risk of refinancing large amounts of debt when interest rates are less favorable. All four of our case study countries use debt buybacks to mitigate rollover risk. Buybacks can also be used to enhance liquidity, which can be adversely affected when the growth in borrowing slows rapidly and issue sizes decline significantly. GAO’s illustrative analysis of Treasury’s past buyback program showed that, had Treasury refinanced the debt by simultaneously issuing new debt, it could have captured a liquidity premium—the additional price investors are willing to pay for securities that can be easily traded—which would reduce interest costs.
Implementing a well-designed buyback program could help Treasury minimize borrowing costs over time. Other countries have used both reverse auctions—a process in which participants submit competitive offers to sell particular securities—and bilateral trades—transactions between the government and specific holders of a security. Of these, reverse auctions are most consistent with Treasury’s principles. However, if certain features of bilateral trades were modified, they could be useful for responding to unforeseen market disruptions. Participation in a buyback program would be encouraged by a regularly scheduled program, with a clear purpose and timely announcement of operations. Also, because greater participation fosters competition, broadening the eligibility to participate beyond primary dealers should be explored.
Switches and debt exchanges—tools similar to buybacks that involve early redemption of securities in exchange for liquid benchmark securities—could also be used to manage rollover peaks and help maintain liquidity. They could also have the added advantage of broadening Treasury’s investor base by appealing to investors that want to maintain the average maturity of their portfolios in ways that minimize market risk.
Why GAO Did This Study
The U.S. Treasury market is the deepest and most liquid debt market in the world. Liquidity is important to a well-functioning Treasury market and for lowest cost borrowing over time. Exploring various debt management tools can assist Treasury in maintaining liquidity as budget and market conditions change.
To help maintain an efficient Treasury market, Treasury needs the ability and flexibility to actively manage the mix of outstanding securities and respond to market disruptions. Debt buybacks—the redemption of marketable securities prior to their maturity dates—were used to manage declining debt during a time of budget surpluses. However, other countries use buybacks and similar tools even during times of deficit. GAO assessed: (1) the budget and market conditions under which debt buybacks could help Treasury achieve its debt management goals, (2) the operational features of buyback programs that would support these goals, and (3) other debt management tools used by case study countries to achieve similar objectives. GAO examined both the U.S. program and those of Canada, France, Germany, and the United Kingdom and analyzed the costs and benefits.
Reissued on March 21, 2012
Recommendations
To have flexibility to respond to potential changes in market conditions, GAO recommends that Treasury build the capacity for buyback and switch auction programs as well as bilateral trades or debt exchanges.
Treasury concurred with the findings and said the report would be very useful in analyzing tools that increase their flexibility.
Recommendations for Executive Action
| Agency Affected | Recommendation | Status |
|---|---|---|
| Department of the Treasury | Treasury should build the capacity for a buyback program that could be used to respond to potential changes in market conditions during times of deficit. Such a program should allow for broader direct participation beyond the primary dealers. In conducting any buyback operations Treasury should (1) clearly articulate the purpose of the buyback program, (2) conduct the buyback reverse auctions on a regular and predictable schedule consistent with the purpose of the buyback program, and (3) target a few securities in narrow maturity bands at each reverse auction. |
In October 2014, Treasury conducted a small-scale buyback operation to test the information technology infrastructure to ensure that its buyback functionality remains operational. In the reverse auction operation, Treasury bought back $22 million of a note maturing on 2/29/2016. In November 2014, Treasury announced that the operation was successful. Since that time, Treasury has conducted regular small-scale, reverse-auction buyback operations to ensure operational readiness of its buyback infrastructure. In April 2015, Treasury bought back $25 million across three securities with a maturity date range of just over one month. Beginning in 2016, Treasury has held an operation each spring and fall, buying back $25 million across five securities with a maturity date range of less than three years at each reverse auction. In announcing the buyback operations, Treasury noted that they should not be viewed by market participants as a precursor or signal of any pending policy changes regarding Treasury's use of buybacks. In August 2017, Treasury officials told us that eligibility to participate in buyback operations is limited to primary dealers because of constraints of the current trading systems. With its most recent buyback operation on May 18, 2018, Treasury has demonstrated that it has built the capacity for a buyback program that could be used to respond to potential changes in market conditions. The small-scale, reverse auctions have clearly articulated the purpose of the buybacks, operated on a regular and predictable schedule consistent with the purpose of the buybacks, and have targeted a few securities in narrow maturity bands. Although operational constraints have precluded direct participation beyond the primary dealers, the steps Treasury has taken meet the key elements of our recommendation.
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| Department of the Treasury | To further increase Treasury's flexibility to respond to potential changes in market conditions and improve its ability to continuously maintain liquidity among outstanding securities, Treasury should build the capacity for a switch auction program. In building this capacity, Treasury should allow for direct participation beyond the primary dealers. If Treasury chooses to implement a switch auction program, it should (1) clearly articulate the purpose of the switch auction program and (2) conduct the switch auctions on a regular and predictable schedule consistent with the purpose of the program. |
For the 7/30/2013 meeting of the Treasury Borrowing Advisory Committee, Treasury officials asked the Committee to comment on the need, if any, for Treasury to implement other types of debt management tools. Switch auctions were among the tools the Committee discussed. Consistent with our recommendations, Treasury said that all discussions and suggestions are intended to adhere to Treasury's core principle of regular and predictable issuance. As of June 2016, Treasury officials told us that even though discussion regarding a potential switches program is ongoing, Treasury has not taken other steps to build the capacity for a switch auction program.
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| Department of the Treasury | To ensure that Treasury has the flexibility to respond to sudden and wide-scale market disruptions, Treasury should develop the capacity to use bilateral trades or debt exchanges. It would be especially important to carefully consider the design of such a program to ensure that the features of the program are consistent with our recommendations related to buybacks and switch auctions and consistent with Treasury's long-standing debt management principles. For example, the price-setting principle should be transparent and results of any activities should be reported to the market. |
For the 7/30/2013 meeting of the Treasury Borrowing Advisory Committee, Treasury officials asked the Committee to comment on the need, if any, for Treasury to implement other types of debt management tools. Consistent with our recommendations, Treasury said that all discussions and suggestions are intended to adhere to Treasury's core principle of regular and predictable issuance. As of September 2015, Treasury officials told us that Treasury is continuing to examine the cost and benefits of buybacks or bond exchanges as debt management tools. As of June 2016, Treasury officials told us that Treasury has not taken other steps to build the capacity to use bilateral trades or debt exchanges.
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