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Report to Congressional Committees:
May 2004:
DEBT CEILING:
Analysis of Actions Taken during the 2003 Debt Issuance Suspension
Period:
GAO-04-526:
GAO Highlights:
Highlights of GAO-04-526, a report to congressional committees
Why GAO Did This Study:
GAO is required to review the steps taken by the Department of the
Treasury (Treasury) to avoid exceeding the debt ceiling during the 2003
debt issuance suspension period. The committee also directed GAO to
determine whether all major accounts that were used for debt ceiling
relief have been properly credited or reimbursed. Accordingly, GAO
determined whether Treasury followed its normal investment and
redemption policies and procedures for the major federal government
accounts with investment authority, analyzed the financial aspects of
actions Treasury took during this period, and analyzed the impact of
policies and procedures Treasury used to manage the debt during the
period.
What GAO Found:
On February 20, 2003, Treasury determined that a debt issuance
suspension period was in effect. A debt issuance suspension period 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 debt ceiling. During this period, which lasted until May 27, 2003,
the Secretary took actions related to the Government Securities
Investment Fund of the Federal Employees’ Retirement System (the G-
Fund), the Civil Service Retirement and Disability Fund (the Civil
Service fund), and the Exchange Stabilization Fund (ESF) to avoid
exceeding the debt ceiling. Also, during fiscal year 2003, the
Secretary initiated several actions involving the Civil Service Fund,
FFB, and the Treasury general fund that related to Treasury’s efforts
to manage the amount of debt subject to the debt ceiling. The Secretary
took other actions to avoid exceeding the debt ceiling, such as
suspending the sales of State and Local Government Series Treasury
obligations and recalling non-interest-bearing deposits held by
commercial banks as compensation for banking services provided to
Treasury.
The actions taken, which were consistent with legal authorities
provided to the Secretary and related to the G-Fund, the Civil Service
fund, and ESF, initially resulted in interest losses to the G-Fund and
ESF and principal and interest losses to the Civil Service fund. When
the debt ceiling was increased to $7.4 trillion on May 27, 2003, the
Secretary fully invested the G-Fund’s investments and on May 28, 2003,
fully restored the interest losses, as required by law. On June 30,
2003, the Secretary fully compensated the Civil Service fund for
principal and interest losses, as required by law. The losses related
to ESF could not be restored without special legislation. As a result,
related ESF losses of $3.6 million were not restored.
The actions initiated by Treasury in fiscal year 2003 that involved the
early redemption of FFB debt obligations held by the Civil Service fund
and exchanges of obligations among the Civil Service fund, FFB, and the
Treasury general fund resulted in all three parties realizing gains or
incurring losses. In some cases, GAO has been able to quantify the
gains or losses that occurred as a result of these transactions. For
example, according to FFB estimates, the Civil Service fund lost more
than $1 billion in interest because of FFB’s redemption of FFB
obligations held by the Civil Service fund before their maturity date
and unforeseen interest rate changes. In other cases, however,
information needed to understand the potential consequences of these
actions will not be available for a number of years. The Secretary
currently lacks the statutory authority to restore such losses and has
not developed documented policies and procedures that can be used to
minimize such losses in future actions that may be taken by Treasury
that involve FFB and an account with investment authority such as the
Civil Service fund.
GAO recommends that the Secretary of the Treasury (1) seek statutory
authority to restore Civil Service fund losses associated with the
October 2002 early redemption of Federal Financing Bank (FFB)
obligations and (2) direct the Under Secretary for Domestic Finance to
document necessary policies and procedures for exchange transactions
between FFB and a federal government account with investment authority
and seek any statutory authority necessary to implement the policies
and procedures. Treasury agreed with our recommendations and has
already taken certain steps to document the policies and procedures.
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[End of section]
Contents:
Letter:
Background:
Results in Brief:
Objectives, Scope, and Methodology:
Chronology of Events:
Normal Investment and Redemption Policies Used on Major Federal
Government Accounts with Investment Authority:
Actions Related to the G-Fund:
Actions Related to ESF:
Actions Related to the Civil Service Fund:
Effects of Exchange of Debt Obligations between the Civil Service Fund,
FFB, and Treasury:
Documented Policies and Procedures Needed for Civil Service and FFB
Exchange Transactions:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Gains and Losses on Federal Accounts with Investment
Authority:
Gains and Losses Associated with Normal Investment and Redemption
Activity:
Gains and Losses Associated with Unusual Events:
Appendix II: Limitations of the Present Value Analysis Approach to
Determining Economic Gains and Losses:
Appendix III: Gains and Losses Associated with Transactions between the
Civil Service Fund, FFB, and the Treasury General Fund:
Civil Service Fund Interest Losses Associated with the October 18,
2002, FFB Early Redemption:
Civil Service Fund Gains and Losses Associated with the 2003 Exchange
Transaction:
FFB and Treasury General Fund Gains and Losses Associated with the 2003
Exchange Transaction:
Appendix IV: Transactions between FFB and the Civil Service Fund:
1985 Debt Ceiling Crisis:
1995/1996 Debt Ceiling Crisis:
2003 Debt Issuance Suspension Period:
Appendix V: Comments from the Department of the Treasury:
Related GAO Products:
Tables:
Table 1: Chronology of Events:
Table 2: Balance of Obligations Held by the Selected 25 Major Federal
Government Accounts with Investment Authority as of January 31, 2003:
Table 3: Gains, Losses, and Changes in Portfolio Balances Related to
Exchanges between the Civil Service Fund and FFB:
Table 4: Example of the Impact on a $1 Million 6 Percent Obligation
Using Different Present Value Discount Factors and Maturity Dates:
Table 5: Example of Effects of Changing Interest Rates on Present Value
Analyses:
Table 6: Maturity Dates and Interest Rates Associated with FFB 9(a) Debt
Obligations Redeemed before Maturity on October 18, 2002:
Table 7: Comparison of Expected Interest Earnings on October 18, 2002,
Redemption Using Different Rates:
Table 8: How the March 5, 2003, Transactions between the Civil Service
Fund, FFB, and the Treasury General Fund Generated a Gain for FFB:
Table 9: Example of How Differing Interest Rates Affect Gains and Losses
Recognized by FFB and the Treasury General Fund on the Exchange of Par
Value Specials for FFB Obligations:
Figures:
Figure 1: Debt Subject to the Debt Ceiling, 1984-2003:
Figure 2: Debt Exchange Process Used for Fiscal Year 2003 Debt Ceiling
Relief:
Letter May 20, 2004:
The Honorable Richard Shelby
Chairman
The Honorable Patty Murray
Ranking Minority Member
Subcommittee on Transportation/Treasury and General Government
Committee on Appropriations
United States Senate:
The Honorable Ernest J. Istook, Jr.
Chairman
The Honorable John W. Olver
Ranking Minority Member
Subcommittee on Transportation and Treasury, and Independent Agencies
Committee on Appropriations
House of Representatives:
Historically, the Congress and the President have enacted laws to
establish a limit on the amount of public debt that can be outstanding
(debt ceiling).[Footnote 1] On various occasions over the years, normal
government financing has been disrupted because the Department of the
Treasury (Treasury) had borrowed up to, or near, the debt ceiling and
legislation to increase the debt ceiling had not been enacted. On
February 20, 2003, Treasury determined that a debt issuance suspension
period was in effect. A debt issuance suspension period 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 debt
ceiling.[Footnote 2] This debt issuance suspension period lasted until
May 27, 2003, when the Congress and the President raised the debt
ceiling to the current $7.4 trillion. During the 2003 debt issuance
suspension period, Treasury took several actions to raise funds to meet
federal obligations without exceeding the debt ceiling.
We are required to review the steps taken by Treasury to avoid
exceeding the debt ceiling and to determine whether all major accounts
that were used for debt ceiling relief have been properly credited or
reimbursed.[Footnote 3] Accordingly, we (1) developed a chronology of
significant events, (2) determined whether Treasury followed its normal
investment and redemption policies and procedures for the major federal
government accounts with investment authority,[Footnote 4] (3) analyzed
the financial aspects of actions Treasury took during the debt issuance
suspension period and assessed the legal basis of these actions, and
(4) analyzed the impact of the policies and procedures Treasury used to
manage the debt during the debt issuance suspension period. This report
presents the results of our review of the actions taken and the
policies and procedures Treasury implemented during the 2003 debt
issuance suspension period.
Background:
The federal government began with a debt of about $75 million in 1790.
In February 1941, the Congress and the President enacted a law that set
an overall limit of $65 billion on Treasury debt obligations that could
be outstanding at any one time.[Footnote 5] The law was amended to
raise the debt ceiling several times between February 1941 and June
1946. The ceiling established in June 1946, $275 billion, remained in
effect until August 1954. At that time, the first temporary debt
ceiling was enacted, which added $6 billion to the $275 billion
permanent ceiling.
The Congress and the President have enacted numerous temporary and
permanent increases in the debt ceiling. As shown in figure 1, the
amount of outstanding debt subject to the debt ceiling[Footnote 6] has
increased from $1.6 trillion on September 30, 1984, to $6.7 trillion on
September 30, 2003.
Figure 1: Debt Subject to the Debt Ceiling, 1984-2003:
[See PDF for image]
Note: At no point did the amount of outstanding debt exceed the debt
ceiling at the end of the above-noted fiscal years. However, at the end
of fiscal years 1984, 1985, and 1986, the difference between the amount
of debt subject to the debt ceiling and the debt ceiling was about $25
million-the smallest amount for the period shown in the figure. The 3
years with the next-smallest differences were 1995 (about $15 billion),
1990 (about $34 billion), and 1989 (about $40 billion).
[End of figure]
The total amount of debt subject to the debt ceiling as of January 31,
2003, the month before Treasury entered into the 2003 debt issuance
suspension period, was about $6.4 trillion. About 44 percent, or $2.8
trillion, was held by federal government accounts with investment
authority, such as the Social Security trust funds,[Footnote 7] the
Civil Service Retirement and Disability Trust Fund (Civil Service
fund), the Exchange Stabilization Fund (ESF), and the Government
Securities Investment Fund of the Federal Employees' Retirement System
(G-Fund). The remaining $3.6 trillion represents marketable and
nonmarketable obligations held by the public.
The Secretary of the Treasury has several responsibilities related to
the federal government's financial management operations, including
paying the government's obligations and investing receipts of federal
government accounts with investment authority not needed for current
benefits and expenses. To meet these responsibilities, the Secretary of
the Treasury is authorized by law to issue the necessary
obligations[Footnote 8] to federal government accounts with investment
authority for investment purposes and to borrow the necessary funds
from the public to pay government obligations.
Under normal circumstances, the debt ceiling is not an impediment to
carrying out these responsibilities. Treasury is notified by the
appropriate agency (such as the Office of Personnel Management for the
Civil Service fund) of the amount that should be invested (or
reinvested), and Treasury makes the investment. In some cases, the
agency may also specify the obligation that Treasury should purchase.
The Treasury obligations issued to federal government accounts with
investment authority count against the debt ceiling. If these accounts'
receipts are not invested, the amount of debt subject to the debt
ceiling does not increase.
We have previously reported on aspects of Treasury's actions during the
2002 debt issuance suspension period and the 1995/1996 and other debt
ceiling crises[Footnote 9] (see Related GAO Products).
Statutory Authorities Specifically Enacted to Help Treasury Avoid
Exceeding the Debt Ceiling:
When Treasury is unable to borrow because the debt ceiling has been
reached, the Secretary of the Treasury is unable to fully discharge his
financial management responsibilities using normal methods. In 1985,
the federal government experienced a debt ceiling crisis from September
3 through December 11. During that period, Treasury took several
actions that were similar to those discussed later in this report. For
example, Treasury redeemed Treasury obligations held by the Civil
Service fund earlier than normal in order to borrow sufficient cash
from the public to meet the fund's benefit payments and did not invest
some of the fund's receipts. In 1986 and 1987, after Treasury's
experiences during prior debt ceiling crises, the Congress enacted
several authorities authorizing the Secretary of the Treasury to use
the Civil Service fund and the G-Fund[Footnote 10] to help Treasury
manage its financial operations during a debt ceiling crisis. Those
authorities, which Treasury used during the 2003 debt issuance
suspension period, addressed (1) redemption of Civil Service fund
obligations, (2) suspension of Civil Service fund investments, and (3)
suspension of G-Fund investments.
1. Redemption of obligations held by the Civil Service fund. Subsection
8348(k) of title 5, United States Code, authorizes the Secretary of the
Treasury to redeem obligations or other invested assets of the Civil
Service fund before maturity to prevent the amount of public debt from
exceeding the debt ceiling.[Footnote 11] The Secretary of the Treasury
must determine that a debt issuance suspension period exists in order
to redeem Civil Service fund obligations early. The statute authorizing
the debt issuance suspension period and its legislative history are
silent as to how the Secretary of the Treasury should determine the
length of a debt issuance suspension period.
2. Suspension of Civil Service fund investments. Subsection 8348(j) of
title 5, United States Code, authorizes the Secretary of the Treasury
to suspend additional investment of amounts in the Civil Service fund
if the investment cannot be made without causing the amount of public
debt to exceed the debt ceiling.[Footnote 12] Subsection (j) also
authorizes the Secretary of the Treasury to make the Civil Service fund
whole after the debt issuance suspension period has ended.
3. Suspension of G-Fund investments. Subsection 8438(g) of title 5,
United States Code, authorizes the Secretary of the Treasury to suspend
the issuance of additional amounts of obligations of the United States
to the G-Fund if issuance cannot occur without causing the amount of
public debt to exceed the debt ceiling. Subsection (g) also authorizes
the Secretary of the Treasury to make the G-Fund whole after the debt
issuance suspension period has ended.
Other Authorities Relied on by Treasury to Avoid Exceeding the Debt
Ceiling:
During the 2003 debt issuance suspension period, Treasury relied upon
authorities in addition to those mentioned above to help manage the
amount of debt subject to the debt ceiling. Treasury has also relied on
these other authorities during prior periods when it needed to take
special actions to avoid exceeding the debt ceiling.
Suspension of ESF Investments:
Section 5302 of title 31, United States Code, authorizes the Secretary
of the Treasury to determine when and if excess funds for ESF will be
invested. During previous debt ceiling difficulties, Treasury used this
authority to suspend reinvestment of maturing ESF investments to ensure
that the debt ceiling was not exceeded.
FFB 9(a) Obligations Exchanged with the Civil Service Fund:
In addition to obligations issued under subsection 8348(d) of title 5,
United States Code, other obligations are lawful investments by the
Civil Service fund. For example, subsection 8348(e) of title 5, United
States Code, authorizes the Secretary of the Treasury to invest surplus
Civil Service funds in other interest-bearing obligations of the United
States or obligations guaranteed as to both principal and interest by
the United States, if the Secretary of the Treasury determines that the
purchases are in the public interest. Further, obligations issued by
other agencies, such as the Tennessee Valley Authority,[Footnote 13]
the United States Postal Service,[Footnote 14] and the Federal
Financing Bank (FFB),[Footnote 15] are lawful investments for all
fiduciary, trust, and public funds whose investments are under the
control of the United States, and such obligations are suitable
investments for the Civil Service Fund.[Footnote 16] Treasury relied on
such authorities during the 1985 and 1995/1996 debt ceiling crises to
exchange obligations issued (commonly referred to as FFB 9(a)
obligations) or held by FFB[Footnote 17] that were not subject to the
debt ceiling for Treasury obligations held by the Civil Service fund
that were subject to the debt ceiling.
Other Special Authorities:
In addition to the authorities previously discussed, Treasury has on
occasion received special authorities that pertained to specific
situations.[Footnote 18] These special authorities are discussed in our
report on the 1995/1996 debt ceiling crisis.[Footnote 19]
Impact of Gains and Losses on Accounts with Investment Authority:
Gains and losses associated with federal government accounts with
investment authority and Treasury's general fund can occur for a
variety of reasons.[Footnote 20] For example, (1) the type of
obligation held may be more susceptible to changes in interest rates
and (2) the procedures used to make adjustments can have significant
consequences for an account's earnings. Whether these gains and losses
affect an account's recipients depends on whether the fund balance is
used to determine recipients' benefits. One example where the fund
balance has a direct impact on participants is the G-Fund.
Specifically, G-Fund earnings are directly related to the amount that
G-Fund participants will receive when they redeem their investments. On
the other hand, the fund balance in the Civil Service fund does not
affect the ultimate payments that retirees and their surviving
dependents will receive because the payments will be made from the
Treasury general fund even if the Civil Service fund's assets are fully
liquidated. Appendix I provides additional information on how gains and
losses may occur in accounts with investment authority.
Results in Brief:
In February 2003, Treasury entered into a debt issuance suspension
period because certain receipts of federal government accounts with
investment authority could not be invested without exceeding the $6.4
trillion debt ceiling in effect at the time. This debt issuance
suspension period began on February 20, 2003, and lasted until May 27,
2003. It involved Treasury's departure from normal investment and
redemption procedures for the G-Fund, ESF, and the Civil Service fund,
including exchanging FFB debt obligations for Treasury obligations held
by the Civil Service fund. Treasury also took other actions to avoid
exceeding the debt ceiling, such as suspending sales of State and Local
Government Series (SLGS) Treasury obligations[Footnote 21] and
recalling non-interest-bearing deposits held by commercial banks as
compensation for banking services provided to Treasury.
We found that during the 2003 debt issuance suspension period, Treasury
used its normal investment and redemption policies and procedures to
handle receipts and maturing investments and to redeem Treasury
obligations for all but 1 of the 25 major federal government accounts
with investment authority that we reviewed. These 25 accounts
constituted about 77 percent, or about $2.1 trillion, of the $2.8
trillion in Treasury obligations held by federal government accounts
with investment authority on January 31, 2003. The departure from
normal investment policy and procedures involving one Highway Trust
Fund transaction occurred when Treasury erroneously redeemed certain
Highway Trust Fund obligations and held the redeemed funds until they
were needed to pay fund expenses rather than reinvesting them when the
error was detected. We determined that the Highway Trust Fund did not
incur any losses due to this error and that the debt ceiling would not
have been exceeded even if (1) the error had never been made or (2)
Treasury had reinvested the funds when the error was detected.
Consistent with available legal authorities, Treasury departed from its
normal investment and redemption procedures for 3 other major federal
government accounts with investment authority--the G-Fund, ESF, and the
Civil Service fund--that accounted for about $640 billion of Treasury
obligations outstanding on January 31, 2003. During the 2003 debt
issuance suspension period, Treasury took the following actions related
to the 3 accounts:
* Treasury did not reinvest some of the maturing obligations held by
the G-Fund, causing a loss to the G-Fund of about $362.5 million in
interest. On May 27, 2003, when the debt ceiling was raised, the
Secretary of the Treasury fully invested the G-Fund's available funds
and on May 28, 2003, fully restored the lost interest on the G-Fund's
uninvested funds in accordance with subsection 8438(g) of title 5,
United States Code. Consequently, the G-Fund was fully compensated for
its interest losses.
* Treasury did not reinvest some of the maturing obligations held by
ESF. As a result, ESF incurred interest losses of about $3.6 million.
Treasury does not have statutory authority to restore these interest
losses.
* Treasury redeemed about $32.4 billion of Treasury obligations held by
the Civil Service fund before they were needed to pay Civil Service
fund benefits and expenses and suspended investment of about $2.5
billion in certain Civil Service fund receipts. On May 27, 2003, when
the debt ceiling was raised, Treasury invested about $30.8 billion of
uninvested receipts of the Civil Service fund. These receipts were
associated with (1) collections made by the Civil Service fund that had
not been invested and (2) funds associated with the early redemptions
that had not been used for Civil Service fund benefit payments and
expenses. As a result of these transactions, the Civil Service fund
lost about $100.8 million. On June 30, 2003, Treasury fully restored
this loss on the Civil Service fund's uninvested funds in accordance
with subsection 8348(j) of title 5, United States Code.
In addition to the actions described above, Treasury initiated the
following actions involving the Civil Service fund, FFB, and the
Treasury general fund during fiscal year 2003:
* On October 18, 2002, FFB exercised its right to redeem about $15
billion of FFB 9(a) obligations held by the Civil Service fund prior to
their maturity.
* On March 5, 2003, FFB issued an FFB 9(a) obligation of about $15
billion to the Civil Service fund in exchange for about $15 billion in
Treasury obligations held by the Civil Service fund. FFB used these
Treasury obligations to purchase FFB 9(b) debt obligations held by
Treasury. Consequently, Treasury canceled the FFB 9(b) debt obligations
that FFB had purchased as well as the Treasury obligations originally
issued to the Civil Service fund. These transactions made about $15
billion of additional borrowing authority available under the debt
ceiling because FFB 9(a) obligations are not subject to the debt
ceiling.
* On June 30, 2003, FFB redeemed the FFB 9(a) obligation issued to the
Civil Service fund and borrowed the necessary funds from Treasury using
FFB 9(b) obligations. FFB redemption proceeds were reinvested in the
Civil Service fund in accordance with Treasury's normal investment
policies and procedures.
Gains or losses on the exchange of obligations between the Civil
Service fund and FFB can result when (1) the exchange occurs or (2) the
underlying assumptions used to determine the exchange price are not
realized. Although we found that the exchange transactions that we
reviewed were fair to both parties on the date of the exchange,
quantifying the long-term effects of these transactions on the parties
involved is difficult and complex because the exchanges were structured
to last many years. In some cases, we were able to quantify the gains
or losses that have occurred or can be expected to occur that relate to
the fiscal year 2003 exchange transactions. In other cases, however,
the information needed to understand the potential consequences of
these actions will not be available for a number of years. Regardless
of whether they sustain any additional gains or losses over the long
term, the Civil Service fund, FFB, and the Treasury general fund
incurred increased risks of gains and losses that they would not have
incurred if these transactions had not occurred.
More important, risks, such as unforeseen interest rate changes,
related to the transactions between FFB and the Civil Service fund are
not typically incurred by these organizations during their normal
operations. History has shown, however, that the risks may be
substantial. For example, according to FFB estimates, the Civil Service
fund lost interest of over $1 billion on a $15 billion transaction in
October 2002 when FFB decided to redeem early its 9(a) obligations that
were issued to the Civil Service fund.[Footnote 22] These obligations
related to Treasury's efforts to manage the debt during the 1985 debt
ceiling crisis, and the losses occurred because of (1) the unexpected
early redemption by FFB and (2) unforeseen interest rate changes.
Although the Secretary of the Treasury has statutory authority to
restore losses resulting from not investing Civil Service fund receipts
or from early redemption of Treasury obligations held by the Civil
Service fund during a debt issuance suspension period, the Secretary of
the Treasury does not have statutory authority to restore the types of
losses that can result from exchange transactions between FFB and a
federal government account with investment authority. Accordingly,
Treasury needs statutory authority to restore the losses associated
with the October 2002 early redemption of FFB 9(a) obligations.
As we noted in our report on the fiscal year 2002 debt issuance
suspension periods,[Footnote 23] documented policies and procedures
would allow Treasury to better determine the potential impacts
associated with the policies and procedures it implements to manage the
amount of debt subject to the debt ceiling. Although Treasury adopted
our recommendation and developed policies and procedures for managing
investment and redemption activities of the Civil Service fund and the
G-Fund during a debt issuance suspension period, such policies and
procedures do not address how exchange transactions between the Civil
Service fund and FFB should be handled. It is the process of
documenting the policies and procedures that (1) allows Treasury
management to ascertain the effects of these policies and procedures
and whether those effects introduce any additional risks to the parties
involved, (2) allows Treasury to understand whether it may need
additional statutory authority to ensure that all funds are adequately
protected, and (3) reduces the chance for confusion and risk of errors
should Treasury need to use the policies and procedures in the future.
We are recommending that the Secretary of the Treasury (1) seek the
statutory authority to restore the losses associated with FFB's early
redemption of FFB 9(a) obligations, with restoration computed in a
manner that maintains equity between the Civil Service fund and
Treasury, and (2) direct the Under Secretary for Domestic Finance to
document the necessary policies and procedures that should be used for
exchange transactions between FFB and a federal government account with
investment authority during a debt issuance suspension period and seek
any statutory authority necessary to implement the policies and
procedures.
Treasury agreed with our recommendations and stated that (1) it will
seek statutory authority to restore losses incurred by federal
government accounts with investment authority and by FFB as a result of
actions taken for the purpose of fiscal management during a "debt limit
impasse" and (2) it will document appropriate policies and procedures
that should be used for exchange transactions between FFB and a federal
government account with investment authority to ensure the long-term
fairness to all parties. Treasury also noted that it has already taken
certain steps in documenting the policies and procedures that should be
used in future exchange transactions.
Objectives, Scope, and Methodology:
Our objectives were to:
* develop a chronology of significant events related to the 2003 debt
issuance suspension period,
* evaluate the actions taken during the 2003 debt issuance suspension
period in relation to the normal policies and procedures Treasury uses
for investments and redemptions for major federal government accounts
with investment authority,
* analyze the financial aspects of Treasury's actions taken during the
2003 debt issuance suspension period and assess the legal basis of
these actions, and:
* analyze the impact of the policies and procedures Treasury used to
manage the debt during the 2003 debt issuance suspension period.
To develop a chronology of the significant events related to the 2003
debt issuance suspension period, we obtained and reviewed applicable
documents. We also discussed Treasury's actions during the debt
issuance suspension period with senior Treasury officials.
To evaluate the actions taken during the 2003 debt issuance suspension
period in relation to the normal policies and procedures Treasury uses
for certain federal government accounts with investment authority, we
obtained an overview of the policies and procedures used and reviewed
selected investment and redemption activity to determine whether those
transactions were processed in accordance with Treasury's normal
policies and procedures. Over 200 different federal government accounts
with investment authority hold Treasury obligations, and Treasury
officials stated that normal investment and redemption policies and
procedures were used for all but 3 of these accounts.
From the federal government accounts with investment authority for
which Treasury used its normal investment and redemption policies and
procedures, we selected for review accounts with (1) investments in
Treasury obligations that exceeded $10 billion on January 31, 2003 (17
accounts), or (2) recurring investment or redemption transactions of $1
billion or more from February through May 2003 (8 accounts). For 18 of
these 25 accounts, we reviewed selected investment and redemption
transactions from February through May 2003. For the remaining 7
accounts, which are managed by the Bureau of the Public Debt, we
reviewed all investment and redemption transactions from February
through May 2003 except those related to 1 account. For this account,
we reviewed all investment and redemption transactions that exceeded
$250 million.[Footnote 24]
The 25 selected federal government accounts with investment authority
accounted for about 77 percent, or about $2.1 trillion, of the $2.8
trillion in Treasury obligations held by federal government accounts
with investment authority on January 31, 2003.[Footnote 25] For all 25
selected accounts in our review, we confirmed with personnel from the
respective agencies the total amount of investment and redemption
activity reported by Treasury from February 1, 2003, through May 31,
2003.[Footnote 26] In any case where normal investment and redemption
policies and procedures were not followed, we obtained documentation
and other information to help us understand the basis for and impact of
the alternative policies and procedures that were used.
To analyze the financial aspects of Treasury's actions that departed
from normal investment and redemption policies and procedures, we (1)
reviewed the methodologies Treasury developed to minimize the impact of
such departures on the G-Fund, ESF, and the Civil Service fund; (2)
quantified the impact of the departures; (3) assessed whether any
principal and interest losses were fully restored; and (4) assessed
whether any losses were incurred that could not be restored under
Treasury's current statutory authority.
To assess the legal basis for Treasury's departures from its normal
policies and procedures, we identified the applicable legal authorities
and determined how Treasury applied them during the 2003 debt issuance
suspension period. Our evaluation included authorities related to
issuing and redeeming Treasury obligations during a debt issuance
suspension period and restoring losses after such a period has ended.
To analyze the impact of the policies and procedures used by Treasury
to manage the debt during a debt issuance suspension period, we
reviewed the actions taken and the Treasury policies and procedures
used during the 2003 debt issuance suspension period. To determine the
stated policies and procedures used that related to the Civil Service
fund and FFB exchange transactions, we discussed with Treasury
officials the actions taken during this period and examined the support
for these actions. We also compiled and analyzed source documents
relating to previous debt issuance suspension periods, including
executive branch legal opinions, memorandums, and correspondence.
We performed our work from February 2003 through March 2004, in
accordance with U.S. generally accepted government auditing standards.
We requested comments on a draft of this report from the Secretary of
the Treasury or his designee. The written response from Treasury's
Under Secretary for Domestic Finance is reprinted in appendix V.
Chronology of Events:
In June 2002, the debt ceiling was raised to $6.4 trillion. In December
2002, Treasury concluded that this amount might be reached in the
latter half of February 2003. Table 1 shows the significant actions the
Congress and the executive branch took from June 28, 2002, through June
30, 2003, that relate to the debt ceiling.
Table 1: Chronology of Events:
Date: June 28, 2002;
Action: The Congress and the President enacted Pub. L. No. 107-199,
which raised the debt ceiling to $6.4 trillion.
Date: October 18, 2002;
Action: FFB repaid about $15 billion of 9(a) obligations it had issued
to the Civil Service fund as a result of the 1985 debt ceiling crisis.
Date: December 24, 2002;
Action: Treasury notified the Congress that debt subject to the limit
might reach the debt ceiling in the latter half of February 2003.
Date: February 19, 2003;
Action: The Secretary of the Treasury announced his intent to suspend
G-Fund investments beginning on February 20, 2003. Treasury suspended
the sales of SLGS Treasury obligations. On May 23, 2003, Treasury
announced that the sale of SLGS Treasury obligations would resume on
May 27, 2003.
Date: March 5, 2003;
Action: FFB exchanged a $15 billion 9(a) obligation for U.S. Treasury
obligations held by the Civil Service fund.
Date: March 25 and 28, 2003;
Action: Treasury called back about $8 billion of Treasury deposits held
by commercial banks as compensating balances. According to Treasury
officials, these funds were returned to the banks on April 28, 2003.
Date: March 31, 2003;
Action: The Secretary of the Treasury began suspending ESF investments.
Date: April 1 and 3, 2003;
Action: Treasury called back about $23.1 billion of Treasury deposits
held by commercial banks as compensating balances. According to
Treasury officials, these funds were returned to the banks on April 22,
2003.
Date: April 4, 2003;
Action: The Secretary of the Treasury declared a debt issuance
suspension period beginning no later than April 11, 2003, and lasting
until July 11, 2003, which allowed Treasury to redeem Treasury
obligations held by the Civil Service fund earlier than normal and to
suspend investments of Civil Service fund receipts.
Date: May 1, 2, and 6, 2003;
Action: Treasury called back about $43.4 billion of Treasury deposits
held by commercial banks as compensating balances. According to
Treasury officials, these funds were returned to the banks on June 16,
2003.
Date: May 15, 2003;
Action: Treasury postponed announcement of its weekly 13-week and 26-
week bill auctions to avoid exceeding the debt ceiling.
Date: May 19, 2003;
Action: The Secretary of the Treasury extended the previously declared
debt issuance suspension period until December 19, 2003, which allowed
Treasury to redeem additional Treasury obligations held by the Civil
Service fund earlier than normal and to continue to suspend investments
of Civil Service fund receipts.
Date: May 22, 2003;
Action: Treasury postponed announcement of its weekly 13-week and 26-
week bill auctions and its monthly 2-year note to avoid exceeding the
debt ceiling.
Date: May 27-28, 2003;
Action: On May 27, 2003, the Congress and the President enacted Pub. L.
No.108-24, which raised the debt ceiling to $7.4 trillion and ended the
debt issuance suspension period. Treasury invested all uninvested funds
of the G-Fund, ESF, and the Civil Service fund on May 27, 2003, and on
May 28, 2003, restored the losses incurred by the G-Fund.
Date: June 30, 2003;
Action: Treasury fully restored the principal and interest losses
incurred by the Civil Service fund that related to (1) the failure to
promptly invest Civil Service fund receipts and (2) redeeming
obligations before they were needed to pay fund benefits and expenses.
FFB also redeemed the $15 billion 9(a) obligation it issued to the
Civil Service fund on March 5, 2003.
Sources: Treasury and GAO.
[End of table]
Normal Investment and Redemption Policies Used on Major Federal
Government Accounts with Investment Authority:
Federal government accounts with investment authority that are
authorized to invest their receipts, such as the Civil Service
fund,[Footnote 27] the G-Fund,[Footnote 28] the Social Security
funds,[Footnote 29] and the Federal Employee Health Benefits
Fund,[Footnote 30] are generally authorized or required to invest them
in nonmarketable Treasury obligations. Under normal conditions,
Treasury is notified by the appropriate agency of the amount that
should be invested or reinvested on its behalf, and Treasury then makes
the investment. In some cases, the actual obligation that Treasury
should purchase is also specified. When a federal government account
with investment authority needs to pay benefits and expenses, Treasury
is normally notified of the amount and the date that the disbursement
is to be made. Depending on the account, Treasury may also be notified
to redeem specific obligations. Based on this information, Treasury
redeems an account's obligations.
Our analysis of the 25 major federal government accounts with
investment authority for which Treasury stated it had followed its
normal investment and redemption policies and procedures during the
2003 debt issuance suspension period showed that for all but 1 account-
-the Highway Trust Fund--Treasury used its normal investment and
redemption policies and procedures to handle receipts and maturing
investments and to redeem Treasury obligations. Table 2 lists the
federal government accounts with investment authority included in our
analysis.
Table 2: Balance of Obligations Held by the Selected 25 Major Federal
Government Accounts with Investment Authority as of January 31, 2003:
Dollars in billions.
Federal Old Age and Survivors Insurance Trust Fund[A];
Obligations held as of January 31, 2003: $1,231.
Federal Hospital Insurance Trust Fund;
Obligations held as of January 31, 2003: 238.
Department of Defense Military Retirement Fund;
Obligations held as of January 31, 2003: 178.
Federal Disability Insurance Trust Fund[A];
Obligations held as of January 31, 2003: 162.
Unemployment Trust Fund;
Obligations held as of January 31, 2003: 57.
Federal Supplemental Medical Insurance Trust Fund;
Obligations held as of January 31, 2003: 34.
Bank Insurance Fund;
Obligations held as of January 31, 2003: 31.
Employee Life Insurance Fund;
Obligations held as of January 31, 2003: 26.
Nuclear Waste Disposal Fund;
Obligations held as of January 31, 2003: 24.
Federal Housing Administration---Liquidating Account;
Obligations held as of January 31, 2003: 23.
Highway Trust Fund;
Obligations held as of January 31, 2003: 19.
Department of Defense Medicare Retirement Fund;
Obligations held as of January 31, 2003: 16.
Airport and Airway Trust Fund;
Obligations held as of January 31, 2003: 13.
Pension Benefit Guaranty Corporation;
Obligations held as of January 31, 2003: 13.
Foreign Service Retirement and Disability Fund;
Obligations held as of January 31, 2003: 12.
National Service Life Insurance Fund;
Obligations held as of January 31, 2003: 11.
Savings Association Insurance Fund;
Obligations held as of January 31, 2003: 11.
Railroad Retirement Account;
Obligations held as of January 31, 2003: 9.
Employees' Health Benefits Fund;
Obligations held as of January 31, 2003: 8.
Guarantees of Mortgage-Backed Securities, Government National Mortgage
Association;
Obligations held as of January 31, 2003: 7.
National Credit Union Share Insurance Fund;
Obligations held as of January 31, 2003: 5.
Federal Savings and Loan Insurance Fund;
Obligations held as of January 31, 2003: 3.
Railroad Retirement Social Security Equivalent Benefit Account;
Obligations held as of January 31, 2003: 2.
Abandoned Mines Reclamation Fund;
Obligations held as of January 31, 2003: 2.
Postal Service Fund;
Obligations held as of January 31, 2003: 1.
Total;
Obligations held as of January 31, 2003: $2,136.
Source: Treasury.
[A] These are Social Security trust funds.
[End of table]
On February 27, 2003, Treasury redeemed about $343 million of Highway
Trust Fund obligations in error. In March 2003, during its normal
reconciliation processes, Treasury identified this error. Although
normally such errors are corrected by investing the funds redeemed in
error on the date the error is detected, Treasury did not do so.
Rather, it decided to hold the excess funds in an uninvested funds
account until they were needed to pay Highway Trust Fund expenses. The
funds were used to pay the fund's expenses through March 24, 2003.
According to Treasury officials, the primary reasons for not making the
necessary reinvestment transaction on the date the error was detected
and validated were that (1) the Highway Trust Fund does not earn
interest on its investments[Footnote 31] and (2) the time necessary to
identify the error and fully understand its impact meant that very
little time actually elapsed when the funds could have been invested.
Therefore, the Highway Trust Fund was not harmed by Treasury's decision
to not invest the funds. However, Treasury officials subsequently
agreed that the over-redemption should have been reinvested on the day
the error was detected and adequate information was available to
understand the amount that should have been invested, regardless of
whether the Highway Trust Fund earns interest on its
investments.[Footnote 32] Holding the excess funds in an uninvested
funds account reduced the amount of debt subject to the debt ceiling by
no more than $343 million for 26 days during the 2003 debt issuance
suspension period.
To determine whether Treasury would have exceeded the debt ceiling if
it had not committed this error or had reinvested the over-redeemed
amount of funds when the error was discovered, we reviewed the invested
balances in the G-Fund during this period. As noted elsewhere in this
report, Treasury used the G-Fund during the 2003 debt issuance
suspension period to ensure that the investment activities associated
with federal government accounts with investment authority, such as the
Highway Trust Fund, do not cause Treasury to exceed the debt ceiling.
Based on our review, we found that the debt ceiling would not have been
exceeded even if Treasury had not made the original error or had
invested these funds when the error was detected, since other policies
and procedures would have ensured a corresponding reduction in the
amount of funds invested on behalf of the G-Fund. For example, on
February 27, 2003, the computation Treasury used to determine the
amount that should be invested in the G-Fund showed that Treasury could
invest about $22.9 billion of G-Fund receipts. If the Highway Trust
Fund error had not been made, this computation would have shown that
Treasury could have invested about $22.6 billion in the G-Fund, or
about $0.3 billion less than what was actually invested. Therefore, the
amount of debt subject to the debt ceiling would have remained
unchanged from its reported $6.4 trillion level.
Actions Related to the G-Fund:
Subsection 8438(g)(1) of title 5, United States Code, authorizes the
Secretary of the Treasury to suspend the issuance of additional amounts
of obligations of the United States to the G-Fund if the issuance
cannot be made without causing the amount of public debt to exceed the
debt ceiling. Each day from February 20, 2003, to May 27, 2003,
Treasury determined the amount of funds that the G-Fund would be
allowed to invest in Treasury obligations and, when necessary,
suspended some investments and reinvestments of the G-Fund receipts and
maturing obligations that would have caused the debt ceiling to be
exceeded.
On February 20, 2003, when the Secretary of the Treasury determined
that a debt issuance suspension period had begun, the G-Fund held about
$48.3 billion of Treasury obligations that would mature that day. To
ensure that it did not exceed the debt ceiling, Treasury did not
reinvest about $8.5 billion of these obligations on that date.
The amount of the G-Fund's receipts that Treasury invested changed
daily, depending on the amount of the federal government's outstanding
debt. Although Treasury can accurately predict the outcome of some
events that affect the outstanding debt, it cannot precisely determine
the outcome of others until they occur. For example, the amount of
obligations that Treasury will issue to the public from an auction can
be determined some days in advance because Treasury can control the
amount that will be issued. On the other hand, the amount of savings
bonds that will be issued and redeemed and the amount of obligations
that will be issued to, or redeemed by, various federal government
accounts with investment authority are difficult to precisely predict.
Because of these difficulties, Treasury needed a way to ensure that the
normal investment and redemption activities associated with Treasury
obligations did not cause the debt ceiling to be exceeded and also to
maintain normal investment and redemption policies for the majority of
these accounts. To do these things, each day during the debt issuance
suspension period, Treasury:
* calculated the amount of debt subject to the debt ceiling, excluding
the receipts that the G-Fund would normally invest;
* determined the amount of G-Fund receipts that could safely be
invested without exceeding the debt ceiling and invested this amount in
Treasury obligations; and:
* suspended investment, when necessary, of the G-Fund's remaining
receipts.
For example, on February 27, 2003, the amount of debt subject to the
debt ceiling, excluding the G-Fund's requested investment of about $49
billion, was about $6,377 billion or about $23 billion below the debt
ceiling. Accordingly, Treasury invested about $23 billion in the G-
Fund. The remaining $26 billion was uninvested. In accordance with law,
interest on the uninvested funds was paid once the debt issuance
suspension period ended.
During the 2003 debt issuance suspension period, the G-Fund lost about
$362.5 million in interest because its excess funds were not fully
invested. Subsection 8438(g)(3) of title 5, United States Code,
requires the Secretary of the Treasury to make the G-Fund whole by
restoring any losses once the debt issuance suspension period has
ended. On May 27, 2003, when the debt ceiling was raised, Treasury
fully invested the G-Fund's receipts and on May 28, 2003, fully
restored the lost interest on the G-Fund's uninvested funds.
Consequently, the G-Fund was fully compensated for its interest losses
during the 2003 debt issuance suspension period. We verified that after
this interest payment, the G-Fund's obligation holdings were, in
effect, the same as they would have been had the debt issuance
suspension period not occurred.
Actions Related to ESF:
On several occasions from March 31, 2003, through May 23, 2003,
Treasury did not reinvest some of the maturing obligations held by ESF.
Because ESF's obligations are considered part of the federal
government's outstanding debt subject to the debt ceiling, that debt is
reduced when the Secretary of the Treasury does not reinvest ESF's
maturing obligations. Since ESF was not fully invested, it incurred
interest losses of $3.6 million during the 2003 debt issuance
suspension period. The Secretary of the Treasury is not authorized by
law to restore these losses.
The purpose of ESF is to help provide a stable system of monetary
exchange rates. The law establishing ESF authorizes the Secretary of
the Treasury to invest ESF's balances not needed for program purposes
in obligations of the federal government. This law also gives the
Secretary of the Treasury the sole discretion for determining when, and
if, the excess funds will be invested. During previous debt ceiling
crises, Treasury exercised the option of not reinvesting ESF's maturing
Treasury obligations, which helped the federal government to stay
within the debt ceiling and enabled Treasury to subsequently raise
additional cash.
Actions Related to the Civil Service Fund:
During the 2003 debt issuance suspension period, the Secretary of the
Treasury redeemed certain Treasury obligations held by the Civil
Service fund earlier than normal and suspended the investment of
certain Civil Service fund receipts. In addition, as discussed later,
the Civil Service fund exchanged Treasury obligations it held for a $15
billion FFB 9(a) obligation.
Obligations Held by the Civil Service Fund Redeemed Earlier Than
Normal:
Subsection 8348(k)(1) of title 5, United States Code, authorizes the
Secretary of the Treasury to redeem obligations or other invested
assets of the Civil Service fund before maturity to prevent the amount
of public debt from exceeding the debt ceiling. The statute does not
require that early redemptions be made only for the purpose of making
Civil Service fund payments. Further, the statute permits early
redemptions even if the Civil Service fund has adequate cash balances
to cover such payments.
Before redeeming Civil Service fund obligations earlier than normal,
the Secretary of the Treasury must determine that a debt issuance
suspension period exists. The statute authorizing the debt issuance
suspension period and its legislative history are silent as to how to
determine the length of a debt issuance suspension period. On April 4,
2003, the Secretary of the Treasury declared that a debt issuance
suspension period, as it relates to the Civil Service fund, would begin
no later than April 11, 2003, and would last until July 11, 2003. On
May 19, 2003, the Secretary of the Treasury extended this period until
December 19, 2003.
On April 8, 2003, and May 20, 2003, Treasury redeemed about $12.2
billion and $20.2 billion, respectively, of the Civil Service fund's
Treasury obligations using its authority under subsection 8348(k)(1) of
title 5, United States Code. The $32.4 billion redemption amount was
determined based on (1) the length of the initial debt issuance
suspension period (April 8 through July 11, 2003) and the related
extension (through December 19, 2003) and (2) the estimated monthly
Civil Service fund benefit payments that would occur during that
time.[Footnote 33] These were appropriate factors to use in determining
the amount of Treasury obligations to redeem early.
Treasury redeemed about $12.2 billion early to cover the obligations
associated with the May, June, and July 2003 estimated benefit payments
on April 8, 2003. As such, when May's benefit payments were due,
Treasury redeemed only the $60 million difference between the amount
that had been redeemed early for the month of May and the actual amount
of benefit payments to be made.
Investment of Civil Service Fund Receipts Suspended:
Subsection 8348(j)(1) of title 5, United States Code, authorizes the
Secretary of the Treasury to suspend additional investment of amounts
in the Civil Service fund if the investment cannot be made without
causing the amount of public debt to exceed the debt ceiling. From
April 8, 2003, through May 26, 2003, the Civil Service fund had about
$2.5 billion in receipts that were not invested. On May 27, 2003, after
the debt ceiling was raised, these receipts were invested.
Civil Service Fund Losses Associated with Early Redemptions and
Suspended Investments Restored:
When the Secretary of the Treasury redeems obligations earlier than
normal or refrains from promptly investing Civil Service fund receipts
because of debt ceiling limitations, the Secretary is required by
subsection 8348(j)(3) of title 5, United States Code, to immediately
restore, to the maximum extent practicable, the Civil Service fund's
obligation holdings to the proper balances when a debt issuance
suspension period ends and to restore lost interest on the next normal
interest payment date. Consequently, Treasury took the following
actions once the debt issuance suspension period had ended:
* Treasury invested about $30.8 billion of uninvested receipts on May
27, 2003. These receipts were associated with (1) collections made by
the Civil Service fund that had not been invested and (2) funds
associated with the early redemptions that had not been used for
benefit payments and expenses.
* Treasury paid the Civil Service fund on June 30, 2003, about $100.8
million as compensation for principal and interest losses incurred
because of the actions it had taken. This was the first semiannual
interest payment date since the debt issuance suspension period ended.
June 30, 2003, was the proper restoration date according to the statute
authorizing the restoration.
We verified that after these transactions the Civil Service fund's
obligation holdings were, in effect, the same as they would have been
had the debt issuance suspension period not occurred.
Effects of Exchange of Debt Obligations between the Civil Service Fund,
FFB, and Treasury:
During fiscal year 2003, Treasury initiated the following actions
involving the Civil Service fund, FFB, and the Treasury general fund
related to its efforts to (1) address FFB cash flow issues resulting
from previously issued FFB 9(a) obligations to the Civil Service fund
and (2) manage the amount of debt subject to the debt ceiling:
* On October 18, 2002, FFB redeemed prior to maturity $15 billion in
FFB 9(a) obligations held by the Civil Service fund. The $15 billion in
FFB 9(a) obligations do not count against the debt ceiling.[Footnote
34] These FFB 9(a) obligations were the result of a series of
transactions stemming from a Treasury-directed exchange of Treasury
obligations held by the Civil Service fund for FFB 9(a) obligations to
assist Treasury in managing the debt during the 1985 debt ceiling
crisis. This early redemption resulted in a loss of over $1 billion on
October 18, 2002, to the Civil Service fund because of lost interest.
[Footnote 35]
* On March 5, 2003, FFB issued an FFB 9(a) obligation of about $15
billion to the Civil Service fund in exchange for about $15 billion in
Treasury obligations that had been held by the Civil Service fund. FFB
used the Treasury obligations to purchase FFB 9(b) obligations held by
the Secretary of the Treasury.[Footnote 36] As a result, the FFB 9(b)
debt obligations were canceled and the Treasury obligations that were
no longer outstanding were canceled.[Footnote 37] Consequently,
Treasury was provided about $15 billion in additional borrowing
authority under the debt ceiling.
* On June 30, 2003, FFB redeemed early the 9(a) obligation it had
issued to the Civil Service fund on March 5. Treasury reinvested the
FFB redemption proceeds in accordance with its normal investment
policies and procedures.
Our review found that on March 5, 2003, and June 30, 2003, the Civil
Service fund received fair value based on a present value
analysis[Footnote 38] for the obligations it surrendered. However,
whether the Civil Service fund will have any long-term gains or losses
associated with these transactions will not be known for some time.
Gains or losses on the exchange of obligations between the Civil
Service fund and FFB can result when (1) the exchange occurs or (2) the
underlying assumptions used to determine the exchange price are not
realized. We have found that the initial transactions between FFB and
the Civil Service fund relating to a given period in which Treasury was
experiencing debt ceiling difficulties[Footnote 39] were fair to both
parties on the date of the exchange. However, quantifying the long-term
effects of these transactions on the parties involved is difficult and
complex because the exchanges were structured to last many years. The
longer the period in the analysis used to evaluate the fairness of a
given transaction, such as a present value analysis, the greater the
probability that the underlying assumptions used to determine the
original exchange price will not accurately reflect the future years'
events. This risk is also incurred when the obligations relating to an
exchange remain outstanding for a long time. When the assumptions used
to determine the initial exchange prices are not realized (e.g., the
obligation is redeemed sooner than expected), gains and losses can
result from interest rate changes and reinvestment of the repayment in
obligations that do not have comparable maturities. For further
discussion on the limitations of using a present value methodology to
determine gains and losses, see appendix II.
In some cases, we have been able to quantify the gains or losses that
have occurred or can be expected to occur that relate to the fiscal
year 2003 transactions. However, in other cases, the information needed
to understand the potential consequences of the actions taken on March
5 and June 30, 2003, will not be available for a number of years, and
we are unable to determine the potential impacts at this time. Table 3
summarizes the gains and losses associated with the fiscal year 2003
transactions between the Civil Service fund, FFB, and the Treasury
general fund that we have been able to quantify and those that cannot
be determined at this time.
Table 3: Gains, Losses, and Changes in Portfolio Balances Related to
Exchanges between the Civil Service Fund and FFB:
Result of FFB's October 18, 2002, early redemption of FFB 9(a)
obligations held by the Civil Service fund: Gains/losses on transaction
date (Oct. 18, 2002);
Effect on Civil Service fund: Result of FFB's October 18, 2002, early
redemption of FFB 9(a) obligations held by the Civil Service fund: The
Civil Service fund lost interest with a present value of over $1
billion on the date of the exchange because FFB redeemed funds early
and they were invested in Treasury obligations at a significantly lower
interest rate than the rates on the FFB 9(a) debt obligations;
Effect on FFB: Result of FFB's October 18, 2002, early redemption of
FFB 9(a) obligations held by the Civil Service fund: Gain unknown;
Effect on Treasury general fund: Result of FFB's October 18, 2002,
early redemption of FFB 9(a) obligations held by the Civil Service
fund: Not applicable.
Result of FFB's October 18, 2002, early redemption of FFB 9(a)
obligations held by the Civil Service fund: Additional gains/losses
through June 30, 2005;
Effect on Civil Service fund: Result of FFB's October 18, 2002, early
redemption of FFB 9(a) obligations held by the Civil Service fund: The
Civil Service fund will lose about $33.4 million in nominal interest
because Treasury invested FFB's repayment to the Civil Service fund on
October 18, 2002, in accordance with its normal investment policies and
procedures rather than using the present value assumptions used to
calculate the over $1 billion of interest;
Effect on FFB: Result of FFB's October 18, 2002, early redemption of
FFB 9(a) obligations held by the Civil Service fund: Not applicable;
Effect on Treasury general fund: Result of FFB's October 18, 2002,
early redemption of FFB 9(a) obligations held by the Civil Service
fund: Not applicable.
Net result of the March 5, 2003, exchange of Treasury obligations held
by the Civil Service fund for FFB 9(a) obligation and FFB's June 30,
2003, early redemption of the obligation: Net gains/losses on
transaction dates (Mar. 5, 2003, and June 30, 2003) and changes in
portfolio balances;
Effect on Civil Service fund: The Civil Service fund's portfolio
balance increased by $1.153 billion. This increase occurred because the
present value of the FFB 9(a) obligation redeemed on June 30, 2003, was
greater than the face amount of the Treasury obligations exchanged on
March 5, 2003. The majority of this increase was necessitated by
Treasury having to invest the June 30, 2003, redemption in obligations
with a lower interest rate than the Treasury obligations used in the
exchange on March 5, 2003. Further, as discussed in app. III, falling
interest rates made the FFB 9(a) obligation more valuable on June 30,
2003, than if the Civil Service fund had maintained the Treasury
obligations exchanged on March 5, 2003, in its portfolio. This increase
was about $139.5 million and resulted in a gain to the Civil Service
fund. This gain was included in the $1.153 billion increase in Treasury
obligations;
Effect on FFB:
* FFB incurred a $633 million net loss caused by the difference between
(1) the additional $1.153 billion payment from FFB to the Civil Service
fund to ensure that the Civil Service fund's future interest earnings
would be comparable to its expected interest earnings if the June 30,
2003, FFB repayment was invested in obligations with maturities that
were consistent with the present value assumptions and (2) the $520
million gain on FFB's sale of the Civil Service fund obligations to
Treasury;
* FFB's loan balance to Treasury increased by about $1.1 billion
because of additional short-term borrowing from Treasury, which was
repaid on April 1, 2004;
Effect on Treasury general fund: The Treasury general fund incurred a
$520 million loss on the purchase from FFB of the Civil Service fund
Treasury obligations because Treasury purchased them at more than their
par value.
Net result of the March 5, 2003, exchange of Treasury obligations held
by the Civil Service fund for FFB 9(a) obligation and FFB's June 30,
2003, early redemption of the obligation: Gains and losses after June
30, 2003, and changes in portfolio balances;
Effect on Civil Service fund: Unknown;
Effect on FFB: FFB has an expected gain of $1.153 billion. This
expected gain results from the fact that FFB's interest costs
associated with its June 30, 2003, borrowings from Treasury that were
used to redeem the FFB 9(a) obligation issued to the Civil Service fund
are significantly lower than its expected interest income from its loan
portfolio;
Effect on Treasury general fund: None.
Sources: Treasury and GAO.
[End of table]
As discussed in the preceding narrative and shown in table 3, it is
difficult to quantify all the losses and gains associated with the
transactions between FFB and the Civil Service fund. A more detailed
explanation of these gains and losses, as well as the reasons why not
all of the effects of these transactions can be quantified at this
time, is provided in appendix III. Regardless of whether they sustain
any additional gains or losses over the long term, the Civil Service
fund, FFB, and the Treasury general fund incurred increased risks of
gains and losses that they would not have incurred if these
transactions had not occurred. More important, the risks related to the
transactions between FFB and the Civil Service fund are not typically
incurred by these organizations during their normal operations.
It is important to remember that the risks associated with these
exchange transactions are not undertaken for programmatic reasons.
Rather, they are made at the direction of the Secretary of the Treasury
to help manage the federal government's operations when debt ceiling
difficulties occur. FFB and Treasury have flexibilities that allow them
to structure transactions that reduce or even eliminate the losses that
FFB can incur. However, similar flexibilities are not available to the
Civil Service fund. Furthermore, although the Secretary of the Treasury
has statutory authority to restore losses resulting from not investing
Civil Service fund receipts or from early redemption of Treasury
obligations held by the Civil Service fund during a debt issuance
suspension period, the Secretary does not have the statutory authority
to restore the types of losses, discussed above, that result from
exchange transactions. Appendix IV discusses transactions between the
Civil Service fund and FFB that related to previous debt management
difficulties.
Documented Policies and Procedures Needed for Civil Service and FFB
Exchange Transactions:
As we noted in our December 2002 report, documented policies and
procedures would allow Treasury to better determine the potential
impacts associated with the policies and procedures it implements to
manage the amount of debt subject to the debt ceiling. Although
Treasury adopted our recommendation and developed policies and
procedures for managing investment and redemption activities of the
Civil Service fund and the G-Fund during a debt issuance suspension
period, such policies and procedures do not address how exchange
transactions between the Civil Service fund and FFB should be handled.
While we recognize that Treasury needs a great deal of flexibility to
structure transactions that fit specific events, we believe that
guidelines related to exchange transactions between the Civil Service
fund and FFB can be developed that minimize the risk to both parties.
It is the process of documenting the policies and procedures that
allows Treasury management to ascertain the effects of these policies
and procedures and whether those effects introduce any additional risks
to the parties involved. In addition, documenting the policies and
procedures allows Treasury to understand whether it may need additional
statutory authority to ensure that all funds are adequately protected.
Furthermore, if effectively implemented, documentation of the policies
and procedures reduces the chance for confusion and risk of errors
should Treasury need to use the policies and procedures in the future.
These points were discussed in our December 2002 report to
Treasury.[Footnote 40] During our review of the actions taken during
the 2003 debt issuance suspension period that were affected by those
policies and procedures, we found that none of the problems or
potential problems that we discovered in the 2002 debt issuance
suspension period had occurred.
Conclusions:
The Secretary of the Treasury can take many actions to manage federal
government operations during a debt issuance suspension period. In some
cases, these actions pose no long-term financial risk to affected
parties because of the statutory authorities currently available to the
Secretary of the Treasury. As noted earlier, Treasury used these
authorities to restore, in total, $463 million in losses incurred by
the G-Fund and Civil Service fund. However, other actions expose the
affected parties to financial risks that are not normally incurred as
part of their programmatic operations. Whether the risks associated
with specific actions result in actual losses or gains may not be known
until many years after the action has been taken. History has shown,
however, that the risks may be substantial. For example, according to
FFB estimates, on October 18, 2002, the Civil Service fund lost
interest of over $1 billion on a $15 billion transaction entered into
in 1985 because of the unexpected early redemption of 9(a) obligations
issued by FFB and unforeseen interest rate changes. Treasury lacks the
statutory authority to restore such losses and has not developed the
documented policies and procedures that can be used to minimize such
losses in future exchanges between FFB and federal government accounts
with investment authority, such as the Civil Service fund.
Recommendations for Executive Action:
We recommend that the Secretary of the Treasury perform the following
two actions:
* Seek the statutory authority to restore the losses associated with
the October 2002 early redemption of FFB 9(a) obligations. The amount
of the restoration should be computed in a manner that maintains equity
between the Civil Service fund and Treasury.
* Direct the Under Secretary for Domestic Finance to document the
necessary policies and procedures that should be used for exchange
transactions between FFB and a federal government account with
investment authority during a debt issuance suspension period and seek
any statutory authority necessary to implement the policies and
procedures.
Agency Comments and Our Evaluation:
In written comments on a draft of this report, Treasury agreed with our
recommendations and stated that (1) it will seek statutory authority to
restore losses incurred by federal government accounts with investment
authority and by FFB as a result of actions taken for the purpose of
fiscal management during a "debt limit impasse" and (2) it will
document appropriate policies and procedures that should be used for
exchange transactions between FFB and a federal government account with
investment authority to ensure long-term fairness to all parties.
Treasury has stated that the authority it will seek includes the
restoration of the losses associated with the October 2002 early
redemption of FFB 9(a) obligations as we recommended. Until Treasury
develops its specific legislative proposal and the policies and
procedures it will use relating to transactions between FFB and federal
government accounts with investment authority, we cannot determine the
scope of the statutory authority it may seek. Treasury also noted that
it has already taken certain steps in documenting the policies and
procedures that should be used in future exchange transactions.
Treasury stated that it plans to use FFB's independent auditor to
"ensure that the terms and structure [of exchange transactions] clearly
achieve the intended accounting result and long-term financial fairness
to all parties, prior to transaction approval and execution." Treasury
and its independent auditor will need to ensure that this arrangement
does not result in a problem with auditor independence under U.S.
generally accepted government auditing standards.[Footnote 41] The
independence standard requires that auditors should avoid situations
that could lead reasonable third parties with knowledge of the relevant
facts and circumstances to conclude that the auditor is not able to
maintain independence in conducting its financial statement audit. For
example, audit organizations should not perform management functions or
make management decisions for entities that they also audit.
Specific technical comments provided orally by Treasury were
incorporated in this report as appropriate.
We are sending copies of this report to the Chairmen and Ranking
Minority Members of the Senate Committee on Appropriations; the Senate
Committee on Governmental Affairs; the Senate Committee on the Budget;
the Senate Committee on Finance; the Subcommittee on Financial
Management, the Budget, and International Security, Senate Committee on
Governmental Affairs; the House Committee on Appropriations; the House
Committee on Government Reform; the House Committee on the Budget; the
House Committee on Ways and Means; the Subcommittee on Government
Efficiency and Financial Management, House Committee on Government
Reform; and the Subcommittee on Civil Service and Agency Organization,
House Committee on Government Reform. We are also sending copies of
this report to the Secretary of the Treasury, the Under Secretary for
Domestic Finance of the Department of the Treasury, the Inspector
General of the Department of the Treasury, the Director of the Office
of Management and Budget, and other agency officials. In addition, the
report will be available at no charge on the GAO Web site at http://
www.gao.gov.
If you need further assistance or if you or your staff have any
questions concerning this report, please contact Chris Martin, Senior
Level Technologist, at (202) 512-9481 or Louise DiBenedetto, Assistant
Director, at (202) 512-6921. Other key contributors to this report were
Wendy M. Albert, Arkelga L. Braxton, and Richard T. Cambosos.
Signed by:
Gary T. Engel:
Director Financial Management and Assurance:
Signed by:
Keith A. Rhodes:
Chief Technologist, Applied Research and Methods:
[End of section]
Appendixes:
Appendix I: Gains and Losses on Federal Accounts with Investment
Authority:
Gains and losses can be broken down into two main categories: (1) gains
and losses associated with normal investment and redemption activity
and (2) gains and losses associated with unusual events, such as a debt
issuance suspension period. Treasury's long-standing position is that
gains and losses associated with normal investment and redemption
activity are borne by the applicable federal government account and
that no special action should be taken to adjust an account's
investment portfolio for these gains and losses. On the other hand,
when the loss is incurred because of unusual events and account
participants have a vested interest in the fund, Treasury has, in many
cases, received the necessary authority to restore such losses.
Gains and Losses Associated with Normal Investment and Redemption
Activity:
Federal government accounts with investment authority generally invest
in interest-bearing nonmarketable Treasury obligations. The investment
and redemption activities related to these obligations can cause gains
and losses from, for example, changing interest rates and certain
errors that are found and corrected. Treasury has a long-standing
position that gains and losses associated with normal investment and
redemption activities are a cost of doing business. Therefore, Treasury
makes no attempt to adjust an account's investment portfolio for such
activities.
Gains and Losses Associated with Security Valuation:
As noted earlier, one of Treasury's basic management policies for
federal government accounts with the authority to invest is to maintain
equity between these accounts and the general fund--the fund used to
pay most government obligations. To do so, Treasury issues two basic
types of nonmarketable obligations--market-based and par value
specials. Most market-based obligations are mirror images of existing
Treasury obligations that are traded on the open market and are
purchased or sold at open market prices.[Footnote 42] Par value
specials, on the other hand, are issued and redeemed at par.
The interest rates for par value specials are specified in the enabling
statute or by administrative action. For example, for the G-Fund, Civil
Service fund, and Social Security funds, the par value rate is based on
the average rate for comparable marketable obligations, as defined by
Treasury, with 4 or more years to maturity. This rate is established
monthly, and all investments for a given month must bear the same rate.
When a federal government account with investment authority needs to
redeem obligations to pay benefits and expenses, Treasury redeems these
obligations and pays the fund the par value plus any accrued interest.
Although only certain accounts are allowed to invest in par value
specials, the majority of the $2.8 trillion of account investments on
January 31, 2003, were invested in par value specials. Equity between
accounts investing in par value specials and the Treasury general fund
is not maintained because (1) the interest rate is determined only
monthly and (2) the term of the investment is not relevant, as shown in
the following examples:
* The interest rate used to invest an account's receipts is determined
only monthly. If market interest rates fall during the month, the
Treasury general fund pays the account more interest than market
conditions dictate; if market interest rates rise during the month, the
investment account receives less interest than market conditions
dictate.
* Many federal government accounts with investment authority holding
par value specials hold these obligations for a number of years.
Accordingly, the interest rates can vary significantly. For example,
the Civil Service fund has obligations that carry interest rates
ranging from 3.5 percent to 8.75 percent in its portfolio that matures
on June 30, 2005. Even the rates for the portfolio that matures on June
30, 2014, range from 3.5 percent to 6.5 percent. However, when the
obligations are needed to pay benefits, they are redeemed at par
regardless of current market rates. In times of high interest rates,
redeeming a low-interest-rate obligation at par benefits the account
redeeming the par value special. On the other hand, during periods of
low interest rates, redeeming obligations at par benefits Treasury's
general fund.
* The interest rate paid on Treasury obligations with 4 or more years
to maturity is based on a statutory formula developed in the 1920s to
ensure equal semiannual interest payments for obligations held for
exactly 1 year. However, as we noted in our 1987 report on the Civil
Service fund, when investments are held for less than a year,
Treasury's method does not ensure that the account is neither
overcompensated nor undercompensated. In the major accounts with
investment authority, such as the Civil Service and Social Security
funds, a large number of investments in par value specials are
subsequently redeemed, sometimes just days later, for benefit payments
and expenses, rather than held to their maturity. Activity associated
with current-year investments that were subsequently redeemed in the
current investment year for program benefits and expenses can be
significant.[Footnote 43] Such activity totaled well over $100 billion
dollars between January 31, 2003, and June 30, 2003, for the Civil
Service and Social Security funds. In addition, as noted elsewhere, the
G-Fund, whose investments receive the par value rate, redeems and
reinvests its entire portfolio each business day.[Footnote 44]
Gains and Losses Associated with Adjustments:
Treasury makes many adjustments to the accounting records to reflect
accounting events. Reasons for adjustments may include (1) information
received late from an account caused by agreed-upon processing delays
such as those associated with the Social Security funds and (2) certain
errors made by either Treasury or the account. We found in a 1987
review that the procedures for making adjustments to accounts holding
par value specials, which are still being used, do not ensure that the
results of adjustments are equitable.[Footnote 45] For example, during
our 1987 review we noted that one error that Treasury made and
corrected cost the Civil Service fund almost $400,000 in lost interest
earnings. Specifically, according to Treasury records, the Office of
Personnel Management (OPM) instructed Treasury to redeem about $400
million of obligations on behalf of the Civil Service fund on July 5,
1984. However, Treasury did not make this redemption until OPM notified
Treasury of the error in August. Treasury then redeemed the lowest-
interest-bearing obligations available at that time, which had rates of
8.75 and 9.75 percent. The interest earnings for this redemption were
computed through July 5 (the original requested redemption date). Had
the redemption taken place on July 5, the obligations bearing interest
rates of 7.5 and 7.625 percent would have been used because the
portfolio held lower-rate obligations at that time. As a result, the
Civil Service fund lost about $400,000 of interest earnings. Treasury
agreed with our methodology for computing the effects of this error and
with the amount of the loss.
Gains and Losses Associated with Unusual Events:
Treasury and the Congress have a long-standing position of obtaining
the necessary authority to restore interest that was not credited to an
account with investment authority because of unusual events. GAO, the
Congress, Treasury, and agencies associated with the accounts commonly
refer to this forgone interest as a loss to the fund. Several examples
follow.
* In OPM's comments on our report on the actions taken during the 1985
debt ceiling crisis, it stated that the Civil Service fund "should be
'made whole' when available funds are not properly invested. This is
especially important for situations [such as] . . . when the [Civil
Service fund] lost interest as the result of debt ceiling
limitations.":
* Section 6002 of the Omnibus Budget Reconciliation Act of
1986[Footnote 46] added subsections (j), (k), and (l) to section 8348
of title 5, United States Code, (1) to authorize the Secretary to
suspend investment of amounts in the Civil Service fund in government
obligations and to redeem prior to maturity government obligations held
by the Civil Service fund when necessary to avoid exceeding the debt
ceiling and (2) to authorize the Secretary to make the fund whole after
the debt issuance suspension period. The joint explanatory statement of
the committee of conference accompanying the Omnibus Budget
Reconciliation Act of 1986 states that the amendment requires the
Secretary "to make the Fund whole for any earnings lost as a result of
the suspension or disinvestment by a combination of special cash
payment actions."[Footnote 47]
* Treasury's July 30, 2003, letter to the Congress concerning the 2003
debt issuance suspension period stated that Treasury has paid interest
"totaling $100,822,854.44, representing the amount that would have been
earned, but for the debt issuance suspension period." Treasury also
noted that this "represents the interest lost" by the Civil Service
fund.
It is also a long-standing practice for the Congress and the President
to provide the necessary authority to restore losses caused by unusual
events. For example, during the 1985 debt ceiling crisis, Treasury was
granted the authority to restore the majority of interest losses
associated with its actions to avoid exceeding the debt ceiling.
Furthermore, as recommended in our report on the 1985 debt ceiling
crisis, Treasury received the authority in 1986 and 1987 to fully
restore the losses associated with certain actions it takes in regard
to the Civil Service fund and G-Fund during debt ceiling difficulties.
[End of section]
Appendix II: Limitations of the Present Value Analysis Approach to
Determining Economic Gains and Losses:
A present value analysis is used to provide a basis for understanding
the value of an obligation using current market conditions when that
obligation is being purchased, sold, or exchanged before maturity. The
present value[Footnote 48] of an obligation depends on (1) the coupon
rate, (2) the length of time the obligation is outstanding, and (3) the
current market rate (commonly referred to as the discount factor).
Table 4 shows a simple example of the present values of three $1
million obligations bearing a coupon rate of 6 percent with three
different maturities and using three different discount factors.
Table 4: Example of the Impact on a $1 Million 6 Percent Obligation
Using Different Present Value Discount Factors and Maturity Dates:
Years to maturity: 5;
Discount factor for a 6 percent coupon rate obligation: 5 percent:
$1,043,295;
Discount factor for a 6 percent coupon rate obligation: 6 percent:
$1,000,000;
Discount factor for a 6 percent coupon rate obligation: 7 percent:
$958,998.
Years to maturity: 10;
Discount factor for a 6 percent coupon rate obligation: 5 percent:
1,077,217;
Discount factor for a 6 percent coupon rate obligation: 6 percent:
1,000,000;
Discount factor for a 6 percent coupon rate obligation: 7 percent:
929,764.
Years to maturity: 25;
Discount factor for a 6 percent coupon rate obligation: 5 percent:
1,140,939;
Discount factor for a 6 percent coupon rate obligation: 6 percent:
1,000,000;
Discount factor for a 6 percent coupon rate obligation: 7 percent:
883,864.
Source: GAO analysis.
Note: In this example, interest is paid annually, the principal balance
is held until maturity, and the present values are computed on an
interest payment date.
[End of table]
As shown in table 4, when the discount factor differs from the coupon
rate, the present value of an obligation will differ from the face
value--the longer the time interval, the greater the increase or
decrease in value.
As noted in our discussion on the effects of exchanges of obligations
between the Civil Service fund, the Federal Financing Bank (FFB), and
the Department of the Treasury (Treasury), Treasury used a present
value analysis to help ensure that the exchange of Treasury obligations
held by the Civil Service Retirement and Disability Fund (Civil Service
fund) for obligations issued by FFB was fair to both parties. The
present value approach was also used to determine the amount of losses
incurred by the Civil Service fund when FFB repaid its obligations
before they were scheduled to mature. A key assumption in making a
present value calculation is that the underlying assumptions on
interest rates and cash flows will not change. For example, if a
present value calculation shows that an obligation's cash flows are
worth $1 billion today assuming that the $1 billion can be invested in
a 4 percent obligation that matures on June 30, Year 2, then it is
critical that the investment be made in an obligation that bears an
interest rate of 4 percent and that the obligation matures on June 30,
Year 2. Otherwise, a gain or loss can occur if interest rates change,
as shown in table 5.
Table 5: Example of Effects of Changing Interest Rates on Present Value
Analyses:
Event: January 5, Year 1;
Present value assumption: $1 billion will be invested in an obligation
maturing on June 30, Year 2, at 4 percent;
Actual: $1 billion is invested in an obligation maturing on June 30,
Year 1, at 4 percent;
Effect on federal government account with investment authority: There
is no adverse effect on the account.
Event: June 30, Year 1, scenario I;
Present value assumption: Not applicable;
Actual: $1 billion obligation at 4 percent purchased on January 5, Year
1, matures and is reinvested in an obligation maturing on June 30, Year
2, at 3.5 percent;
Effect on federal government account with investment authority: The
account will lose about $5 million because of lower interest rate.
Event: June 30, Year 1, scenario II;
Present value assumption: Not applicable;
Actual: $1 billion obligation at 4 percent purchased on January 5, Year
1, matures and is reinvested in an obligation maturing on June 30, Year
2, at 4.5 percent;
Effect on federal government account with investment authority: The
account will gain about $5 million because of higher interest rate.
Source: GAO.
[End of table]
Although the initial exchange was fair, as shown in table 5, since the
actual terms of the obligations issued were not the same as those used
in the present value assumption, the account is subject to risks
associated with interest rate changes.
Another limitation associated with a present value analysis is that it
does not consider reinvestment risk.[Footnote 49] For example, in the
case of the March 5, 2003, exchange between FFB and the Civil Service
fund, the Treasury obligations exchanged matured from June 30, 2004,
through June 30, 2011. However, the FFB 9(a) obligation received had a
different cash flow. Therefore, if the principal and interest payments
associated with the FFB 9(a) obligation could not be invested at the
same discount factor used in the present value analysis, then a gain or
loss would result. If the cash flows can be invested at a higher
interest rate, then a gain will occur. Conversely, if the cash flows
are reinvested at a lower rate, then a loss will occur.
[End of section]
Appendix III: Gains and Losses Associated with Transactions between the
Civil Service Fund, FFB, and the Treasury General Fund:
Civil Service Fund Interest Losses Associated with the October 18,
2002, FFB Early Redemption:
During the 1985 debt ceiling crisis, Treasury for the first time
invested excess receipts of the Civil Service fund in FFB 9(a)
obligations.[Footnote 50] Because FFB 9(a) obligations are not subject
to the debt ceiling, this action allowed Treasury to borrow more cash
from the public. At the time of the purchase, these FFB 9(a)
obligations carried the same terms and conditions as the Treasury
obligations held by the Civil Service fund.[Footnote 51] As such, as
long as FFB did not redeem the debt obligations prior to maturity or
the obligations were not otherwise redeemed before needed to pay Civil
Service fund expenses in accordance with its normal redemption policies
and procedures, the exchange transaction would result in no adverse
consequences for the Civil Service fund. However, on October 18, 2002,
FFB exercised its right to redeem its obligations before maturity,
which resulted in over $1 billion in interest losses to the Civil
Service fund.[Footnote 52]
According to FFB calculations, the present value interest loss to the
Civil Service fund was over $1 billion when FFB redeemed its
obligations.[Footnote 53] FFB appropriately calculated this loss using
a present value methodology that assumed that the Civil Service fund
could invest the $15 billion proceeds from the early redemption of the
FFB 9(a) obligations at 3.875 percent--the October 2002 investment rate
for Civil Service fund investments--and the funds could be invested
with the same maturities as the redeemed FFB 9(a) obligations. Table 6
shows a comparison of the maturity dates and interest rates associated
with the FFB 9(a) obligations that were redeemed early.
Table 6: Maturity Dates and Interest Rates Associated with FFB 9(a)
Debt Obligations Redeemed before Maturity on October 18, 2002:
Dollars in billions.
June 30, 2003;
Principal amount: 5;
Interest rate on FFB 9(a) debt obligations: 9.25%;
October 2002 investment rate: 3.875%.
June 30, 2004;
Principal amount: 5;
Interest rate on FFB 9(a) debt obligations: 8.75%;
October 2002 investment rate: 3.875%.
June 30, 2005;
Principal amount: 5;
Interest rate on FFB 9(a) debt obligations: 8.75%;
October 2002 investment rate: 3.875%.
Source: Treasury.
[End of table]
FFB's present value analysis assumed that the redemption proceeds would
be invested at 3.875 percent using the same maturity dates that were
applicable to the original FFB 9(a) obligations. The redemption
proceeds were actually invested in a 3.875 percent obligation that
matured on June 30, 2003, since Treasury's normal policies and
procedures require that current-year receipts be invested in
obligations that mature on June 30 of the current investment year.
On June 30, 2003, $10 billion of the October 18, 2002, investment was,
in effect, reinvested in obligations bearing an interest rate of 3.5
percent--the rate applicable to Civil Service fund investments for June
2003. Accordingly, Treasury invested $10 billion with $5 billion
maturing on June 30, 2004, and $5 billion on June 30, 2005, at an
interest rate of 3.5 percent. The remaining $5 billion that was
received on October 18, 2002, was used to pay current-year fund
benefits and expenses and therefore was not available for reinvestment
on June 30, 2003. Although FFB redemption proceeds were invested with
the same maturity dates as the original FFB 9(a) obligations, they will
be invested for a time at 3.5 percent rather than the 3.875 percent
assumed in the present value analysis. Therefore, in addition to the
over $1 billion interest loss incurred on October 18, 2002, discussed
above, the Civil Service fund will incur about $33.4 million of
additional interest losses (commonly referred to as a nominal interest
loss) in these future years because of the lower-than-assumed interest
rate on the reinvested amounts.
Table 7 compares the expected interest earnings associated with the
October 18, 2002, FFB 9(a) redemption prior to maturity using the
present value assumptions and the expected interest earnings that would
be received if the obligations were held to maturity.
Table 7: Comparison of Expected Interest Earnings on October 18, 2002,
Redemption Using Different Rates:
Period: October 18, 2002, through June 30, 2003;
Principal balance outstanding: $15 billion;
Nominal interest if invested at assumed 3.875 percent: $406 million;
Nominal interest at actual investment rate of 3.5 percent: Not
applicable since funds were invested at 3.875%;
Nominal interest gain or loss: $22.9 million gain[A].
Period: June 30, 2003, through June 30, 2004;
Principal balance outstanding: $10 billion;
Nominal interest if invested at assumed 3.875 percent: $387.5 million;
Nominal interest at actual investment rate of 3.5 percent: $350
million;
Nominal interest gain or loss: $37.5 million loss.
Period: June 30, 2004, through June 30, 2005;
Principal balance outstanding: $5 billion;
Nominal interest if invested at assumed 3.875 percent: $193.75
million;
Nominal interest at actual investment rate of 3.5 percent: $175
million;
Nominal interest gain or loss: $18.8 million loss.
Period: Total net nominal interest loss;
Nominal interest gain or loss: $33.4 million loss.
Source: GAO.
[A] Since Treasury invested the $15 billion in 3.875 percent
obligations, these obligations became available for redemption to pay
the Civil Service fund's benefits and expenses using Treasury's normal
investment and redemption policies and procedures. However, if Treasury
had invested the FFB repayment in accordance with the present value
analysis, $10 billion of the FFB repayment would not have been
available for use by the Civil Service fund during the investment year
ending on June 30, 2003. Accordingly, Treasury would have redeemed
higher-interest-rate obligations in order to pay the Civil Service
fund's benefit payments and expenses during this period. Although an
exact estimate of this interest rate differential is difficult to
quantify, the amount of benefit to the Civil Service fund by not
redeeming these higher-rate obligations could be as much as $22.9
million.
[End of table]
In our report on the 1985 debt ceiling crisis,[Footnote 54] we noted
that Treasury officials stated that a basic trust fund management
policy is to ensure equity between the various trust funds and the
Treasury general fund--the fund used to pay most government
obligations--and that none of the funds unduly benefit from Treasury's
management. Although the losses discussed in this section resulted from
a transaction between FFB and the Civil Service fund, the transaction
between these two funds was not initially undertaken for programmatic
reasons; rather, it was undertaken by the Secretary of the Treasury to
help manage debt during the 1985 debt ceiling crisis, and the early
redemption in 2002 was undertaken to help manage FFB's cash flow
problems.
Civil Service Fund Gains and Losses Associated with the 2003 Exchange
Transaction:
On March 5, 2003, Treasury exchanged certain Treasury obligations held
by the Civil Service fund for an FFB 9(a) obligation of about $15
billion issued by FFB to the Civil Service fund. The purpose of this
transaction, similar to the purpose of the transaction that occurred
during the 1985 debt ceiling crisis discussed above, was to make about
$15 billion of additional borrowing authority available under the debt
ceiling. Figure 2 shows the process for debt ceiling relief during
fiscal year 2003.
Figure 2: Debt Exchange Process Used for Fiscal Year 2003 Debt Ceiling
Relief:
[See PDF for image]
[End of figure]
However, unlike the terms and conditions of the 1985 exchange
transaction, the terms and conditions of the FFB 9(a) obligation issued
to the Civil Service fund during the 2003 debt issuance suspension
period were different from those of the Treasury obligations
surrendered. Specifically, the terms of the FFB 9(a) obligation held by
the Civil Service fund stated that if FFB redeemed its obligation
before maturity, the redemption price would be based on current market
rates rather than par value, which was the basis used in the 1985
exchange. Therefore, to ensure that the value of the exchange was fair
to both parties on the date of the exchange, Treasury used a present
value analysis to compare the value of future cash flows expected from
the Treasury obligations being exchanged by the Civil Service fund with
the value of future cash flows expected from the FFB 9(a) obligation.
On June 30, 2003, FFB redeemed its March 5, 2003, 9(a) obligation
before the December 2035 maturity date. As discussed below, these
transactions introduced risks to the Civil Service fund that it would
not have incurred had this exchange not taken place.
The transactions between the Civil Service fund and FFB fairly
compensated the Civil Service fund, based on a present value analysis,
on the date of the exchanges. The net result of the March 5, 2003, and
June 30, 2003, transactions between the Civil Service fund and FFB was
that the Civil Service fund had about $1.153 billion more in Treasury
obligations than it did before the March 5, 2003, transaction. This
increase in Treasury obligations held by the Civil Service fund
occurred because the prevailing market interest rates at the time of
the exchanges were lower than the rates of the Treasury obligations
exchanged with FFB. However, the Civil Service fund had a gain of only
about $139.5 million[Footnote 55] because it had to invest the proceeds
from the obligation FFB redeemed on June 30, 2003, at a lower interest
rate. In other words, the Civil Service fund had more principal to
invest but was unable to invest that principal at a rate as high as the
rate of the Treasury obligations it had surrendered. Therefore, the
Civil Service fund needed more principal to generate approximately the
same returns as the obligations it had originally surrendered during
the transaction on March 5, 2003. The long-term economic effect of the
June 30, 2003, transaction on the Civil Service fund depends on the
terms of the obligations in which the proceeds are invested.
In this case, one way to have helped ensure that the Civil Service fund
would not have cash flow gains or losses associated with investment of
the proceeds from the FFB redemption would have been to invest the
proceeds using a methodology that ensured that the fund had cash flows
similar to those from the original Treasury obligations used for the
exchange on March 5, 2003. This methodology is commonly referred to as
a "cash flow" approach. However, the cash flow approach can also result
in gains and losses, since it does not consider the reinvestment risks
[Footnote 56] that may be present. Appendix II discusses how the cash
flow methodology ensures that a cash flow gain or loss does not occur
and how reinvestment risks are not considered in this methodology.
Treasury's approach for investing the June 30, 2003, FFB redemption
proceeds was to apply its normal investment policies and procedures. In
this case, Treasury, in effect, (1) replaced the dollar value of the
obligations used for the March 5, 2003, exchange with 3.5 percent
Treasury obligations and (2) divided the remaining proceeds equally
over a 15-year period. While this approach differs from the cash flow
approach and may result in future gains and losses, the key point is
that Treasury has not yet developed documented policies and procedures
for managing such transactions. The process of documenting the policies
and procedures that should be used for such transactions allows
Treasury's management to understand the impacts of various alternatives
and whether they introduce any additional risks to the parties
involved. It also helps Treasury evaluate whether it may need
additional statutory authority to ensure that all accounts are
adequately protected. Further, if effectively implemented,
documentation of policies and procedures reduces the chance for
confusion and risk of errors should Treasury need to use the policies
and procedures in the future.
FFB and Treasury General Fund Gains and Losses Associated with the 2003
Exchange Transaction:
FFB and the Treasury general fund had gains and losses associated with
the March 5, 2003, and the June 30, 2003, transactions. As shown in
table 3, the net result for FFB of these two transactions was a $633
million loss on June 30, 2003. FFB expects to earn about $1.153 billion
in future years to offset this loss. The Treasury general fund also
lost $520 million, which is not expected to be recovered. Several key
decisions and actions related to the March 5, 2003, and June 30, 2003,
transactions are discussed below.
Treasury Accepted Par Value Specials at Their Present Value:
On March 5, 2003, Treasury purchased from FFB the Treasury obligations
(par value specials) that FFB had acquired from the Civil Service fund.
Treasury agreed to pay FFB about $520 million more than the par value
of these obligations. As payment for this purchase, Treasury sold back
to FFB 9(b) obligations issued by FFB that Treasury held. In effect,
Treasury canceled about $15.7 billion of the FFB 9(b) obligations it
held with about $15.2 billion of Treasury par value specials that FFB
had received from the Civil Service fund. Therefore, FFB had a gain and
the Treasury general fund had a corresponding loss on the exchange.
Table 8 shows how this transaction generated a gain for FFB.
Table 8: How the March 5, 2003, Transactions between the Civil Service
Fund, FFB, and the Treasury General Fund Generated a Gain for FFB:
Description: Value of the canceled FFB 9(b) obligations held by
Treasury (face value of about $15.473 billion and accrued interest of
about $230 million);
Amount: $15.703 billion.
Description: Redemption value of Treasury obligations received from the
Civil Service fund in exchange for FFB 9(a) obligation (about $15.045
billion of principal and about $138 million of accrued interest);
Amount: $15.183 billion.
Description: Debt canceled in excess of redemption value of Treasury
obligations exchanged (gain to FFB and loss to Treasury general fund);
Amount: $520 million.
Source: Treasury.
[End of table]
The March 5, 2003, exchange was in contrast to FFB's October 18, 2002,
early redemption of its 9(a) obligations held by the Civil Service
fund. On October 18, 2002, Treasury decided that the FFB 9(a)
obligations being redeemed prior to maturity that were related to
Treasury's effort to manage the 1985 debt ceiling would be redeemed at
par value and that the Civil Service fund would incur the loss.
Treasury's redemption of par value specials in excess of their par
value is also in contrast to its normal policies and procedures, which
allow agencies holding the par value specials only to redeem them from
Treasury at face value to pay for the fund's benefits and expenses. If
Treasury had accepted the par value specials at par rather than at
current market rates, then the total losses to FFB would have been
about $1.153 billion rather than the $633 million total net loss
resulting:
from the March 5, 2003, and June 30, 2003, transactions.[Footnote 57]
The $1.153 billion is also the amount of the gain FFB expects to make
in future periods.
The key difference between the March 5, 2003, exchange and the normal
exchanges between Treasury and federal government accounts with
investment authority related to their investments in par value specials
is that for the March 5, 2003, exchange between Treasury and FFB, a
present value analysis was used to calculate the amount of debt that
should be removed from Treasury's books--the same analysis that
Treasury used to ensure that the exchange between FFB and the Civil
Service fund was fair. Whether FFB or the Treasury general fund incurs
a gain or loss when par value specials are used to cancel FFB 9(b)
obligations depends greatly on the value of the Treasury obligations
held by the Civil Service fund that are selected for the exchange. For
example, if the interest rates on the Treasury obligations held by the
Civil Service fund had been 3.875 percent rather than 5.25 percent,
Treasury would have exchanged par value specials with a value of about
$16.2 billion held by the Civil Service fund with FFB, and FFB would
have provided these to Treasury to cancel the $15.7 billion of FFB 9(b)
obligations. In this case, Treasury would have recognized a gain rather
than the loss that was recorded because 5.25 percent par value specials
were used in the exchange. Table 9 provides a simplified example of how
this works.
Table 9: Example of How Differing Interest Rates Affect Gains and
Losses Recognized by FFB and the Treasury General Fund on the Exchange
of Par Value Specials for FFB Obligations:
Interest rate associated with Civil Service fund's par value specials:
3.875 percent;
Principal and accrued interest of Civil Service fund obligations:
required for exchange: $16.2 billion;
Book value of Treasury loans to FFB: $15.7 billion;
Gain or loss to FFB: $500 million loss;
Gain or loss to Treasury: $500 million gain.
Interest rate associated with Civil Service fund's par value specials:
5.25 percent;
Principal and accrued interest of Civil Service fund obligations:
required for exchange: $15.2 billion;
Book value of Treasury loans to FFB: $15.7 billion;
Gain or loss to FFB: $500 million gain;
Gain or loss to Treasury: $500 million loss.
Source: GAO.
[End of table]
FFB Issued Additional 9(b) Obligations on June 30, 2003, to Redeem FFB
9(a) Obligation:
As discussed earlier, when FFB decided on June 30, 2003, to redeem
prior to maturity the 9(a) obligation it had issued to the Civil
Service fund, another present value analysis was performed. As a result
of this analysis, FFB had to borrow about $16.6 billion from Treasury
using 9(b) obligations to redeem the $15 billion FFB 9(a) obligation it
had issued to the Civil Service fund. FFB needed these additional funds
because the FFB 9(a) obligation was based on an interest rate yield of
5.25 percent and the interest rate used in the present value analysis
was 3.5 percent (the June 2003 Civil Service fund investment rate).
According to FFB officials, the following approach was used to
structure this $16.6 billion loan from Treasury:
* FFB borrowed $15.4 billion using principal repayments that mirrored
principal payments used in the original FFB 9(a) obligation to the
Civil Service fund, which, in turn, mirrored the underlying FFB loans
made to its borrowers. For example, if FFB held a loan that called for
a $10 million principal payment on December 31, 2005, then FFB would
have borrowed $10 million from Treasury with a December 31, 2005,
repayment date. In effect, after these transactions, FFB's loan
repayments for its 9(b) obligations to Treasury mirrored the underlying
loan principal repayments that FFB expected to receive from its loan
portfolio.
* FFB borrowed about $1.1 billion using a short-term obligation.
The $1.1 billion corresponds to FFB's net loss of $633 million and the
Treasury general fund's loss of $520 million, which were realized on
the March 5, 2003, and June 30, 2003, transactions. According to FFB's
2003 financial statements, FFB expects to recover its loss in future
years.[Footnote 58]
FFB repaid the short-term $1.1 billion 9(b) obligation on April 1,
2004, since FFB had adequate cash flows from its loans to make these
payments. According to FFB officials, these increased cash flows
resulted from (1) the reduced interest costs associated with the
October 18, 2002, early redemption of FFB 9(a) obligations issued to
the Civil Service fund noted earlier in this report and (2) the reduced
interest costs associated with the June 30, 2003, FFB 9(b) obligations
that were used to redeem the FFB 9(a) obligation issued to the Civil
Service fund on March 5, 2003. Therefore, once the short-term 9(b)
obligation is redeemed, the future principal payments associated with
FFB's loan portfolio will, for all practical purposes, mirror the
principal payments that will be made to Treasury. However, the interest
earnings on FFB's loan portfolio will be far greater than the interest
payments that will be due to Treasury on FFB 9(b) obligations issued to
Treasury. This interest rate differential will then translate into
increased earnings for FFB that can be expected to offset the losses
associated with the 2003 exchange transactions with the Civil Service
fund.
[End of section]
Appendix IV: Transactions between FFB and the Civil Service Fund:
During the 1985 debt ceiling crisis, Treasury for the first time
invested excess Civil Service fund receipts of the Civil Service fund
in FFB 9(a) obligations. Treasury has also exchanged Treasury
obligations held by the Civil Service fund for obligations held or
issued by FFB when Treasury experienced debt ceiling difficulties
during the 1995/1996 debt ceiling crisis and the 2003 debt issuance
suspension period. These exchanges and their effects on the Civil
Service fund are discussed below.
1985 Debt Ceiling Crisis:
During the 1985 debt ceiling crisis, Treasury for the first time
exchanged about $15 billion of Treasury obligations held by the Civil
Service fund for obligations issued by FFB. The purpose of this
transaction was to make $15 billion of additional borrowing authority
available under the statutory debt ceiling. At the time the transaction
was made, these FFB obligations were mirror images of the Treasury par
value specials held by the Civil Service fund. As long as the FFB
obligations were held to maturity or redeemed in accordance with the
normal redemption policies of the Civil Service fund, this transaction
would result in no adverse financial consequences for the Civil Service
fund. As noted earlier in this report, it was not until October 2002
that the Civil Service fund portfolio was affected by this transaction.
1995/1996 Debt Ceiling Crisis:
During the 1995/1996 debt ceiling crisis, Treasury exchanged about $8.6
billion of Treasury obligations held by the Civil Service fund for
federal agency obligations held by FFB. The purpose of this transaction
was to make an additional $8.6 billion of borrowing authority available
under the statutory debt ceiling. Since the federal agency obligations
held by FFB differed from the terms and conditions of the obligations
held by the Civil Service fund, the task of determining a fair exchange
price was more complicated than in 1985. Because the effects of these
differences in terms and conditions can be significant, a generally
accepted methodology was used that considered such factors as (1) the
current market rates for outstanding Treasury obligations at the time
of the exchange, (2) the probability of changing interest rates, (3)
the probability of the federal agency paying off the debt early, and
(4) the premium the market would provide to an obligation that could be
redeemed at par regardless of market interest rates. Treasury then
obtained the opinion of an independent third party to determine whether
its valuations were accurate.
In 1997, portions of the obligations received in this transaction were
repaid early. Since the original analysis included a factor for the
risk associated with the federal agency redeeming its obligations
early, the Civil Service fund did not suffer any adverse consequences.
2003 Debt Issuance Suspension Period:
During the 2003 debt issuance suspension period, Treasury once again
exchanged Treasury obligations held by the Civil Service fund for a $15
billion FFB 9(a) obligation. However, unlike the 1985 exchange, the
terms and conditions associated with the FFB 9(a) obligation was not
identical to the terms and conditions of the Treasury obligations held
by the Civil Service fund. Therefore, to ensure that the transaction
was fair to both parties, Treasury performed a present value analysis
of the cash flows associated with the FFB obligation and the cash flows
associated with the Treasury obligations held by the Civil Service
fund. Furthermore, it was agreed that if FFB redeemed this obligation
before maturity, the price paid would be based on current market rates.
An agreement between FFB, Treasury, and Treasury on behalf of the Civil
Service fund allowed the Secretary of the Treasury on behalf of the
Civil Service fund to redeem the FFB 9(a) obligation at par. As noted
earlier, in June 2003 FFB redeemed this obligation and the Civil
Service fund had a $139.5 million gain.
[End of section]
Appendix V: Comments from the Department of the Treasury:
DEPARTMENT OF THE TREASURY
WASHINGTON, D.C.
April 30, 2004:
UNDER SECRETARY:
Mr. Gary T. Engel
Director:
Financial Management and Assurance
General Accounting Office
Washington, D.C. 20548:
Dear Mr. Engel,
Thank you for the opportunity to comment on the draft report entitled
Debt Ceiling: Analysis of Actions Taken During The 2003 Debt Issuance
Suspension Period (GAO-04-526). We appreciate the high level of
professionalism exhibited by GAO staff in conducting this exhaustive
analysis of a very complex matter.
As your draft report indicates, when Treasury borrowing in 2003 reached
the federal debt ceiling and legislation to increase the debt ceiling
had not been enacted, the Secretary of the Treasury took a series of
actions involving the Civil Service Retirement and Disability Fund
("Civil Service fund"), the Government Securities Investment Fund ("G
Fund") of the Federal Employees' Retirement System, the Exchange
Stabilization Fund, and the Federal Financing Bank ("FFB"). We are
pleased that you concluded that all of Treasury's actions were
"consistent with legal authorities provided to the Secretary," and that
the investment losses of the Civil Service fund and the G Fund
resulting from the Secretary's determination that a "debt issuance
suspension period" existed were fully restored as required by law.
Responses to Recommendations:
Following are our responses to the recommendations for executive action
made in the draft report.
"GAO recommends that the Secretary of the Treasury...
"(1) seek the statutory authority, to restore the losses associated
with the October 2002 early redemption of Federal Financing Bank (FFB)
obligations, computed in a manner to maintain equity between the Civil
Service fund and Treasury,":
Treasury will seek statutory authority to restore losses incurred by
federal government accounts with investment authority and by FFB as a
result of actions taken for the purpose of fiscal management during a
debt limit impasse. We look forward to working with Congress to enact
legislation providing the Secretary with such authority.
As you know, it was a difficult decision for Treasury to execute the
2002 early redemption of FFB obligations held by the Civil Service
fund. In 2002, FFB was facing imminent cash flow stress attributable to
the long-term consequences of the exchange transactions that Treasury,
FFB, and the Civil Service fund entered into during a debt limit
impasse in 1985. As a result of the structure of those transactions, 18
years later, FFB had a limited set of choices: (a) do nothing, and risk
a liquidity crisis for FFB; or (b) exercise the par call option which
was included as a term of the original transactions.
Exercising the call option presented, in our view, fully calculable
costs (i.e., reinvestment risk) to the Civil Service fund compared to
the alternative. As a result, the Treasury executed a course of action
that was considered the least harmful of a short list of less than
palatable options.
"GAO recommends that the Secretary of the Treasury...
°(2) direct the Under Secretary of Domestic Finance to document the
necessary policies and procedures that should be used for exchange
transactions between FFB and a federal government account with
investment authority and seek any statutory authority necessary to
implement the policies and procedures. ":
Treasury agrees that it will document appropriate policies and
procedures to be used for exchange transactions between FFB and a
federal government account with investment authority to ensure the
long-term fairness to all parties to such complex market based
transactions. However, we are gratified that you recognized in your
report that "Treasury needs a great deal of flexibility to structure
transactions that ft specific events." On its own initiative, Treasury
has already taken notable steps in the direction of documenting
policies and procedures for exchange transactions. For example, during
the debt issuance suspension period of 2003, the Treasury Under
Secretary for Domestic Finance, who is, ex officio, also the President
of FEB, approved core guidelines for future exchange transactions.
As you noted in your analysis, the 2003 exchange transaction was
executed within the time frame of the 2003 debt issuance suspension
period and reversed shortly thereafter. We appreciate GAO's
acknowledging, "The transactions between the Civil Service fund and FFB
fairly compensated the Civil Service fund, based on a present value
analysis, on the date of the exchanges. " As noted in your analysis,
the Civil Service fund received a substantial increase in the amount of
Treasury securities that the fund holds as investments, and FFB's
financing base was restructured, allowing it to recover losses over
time.
FFB has taken additional steps to ensure the long-term fairness to all
parties of exchange transactions. Not the least of these is the
requirement that all exchange transactions be reviewed by FFB's
independent auditor to ensure the terms and structure clearly achieve
the intended accounting result and long-term financial fairness to all
parties, prior to transaction approval and execution. The Inspector
General for Treasury, who oversees
the audits of FFB, has been asked to include such reviews in the scope
of its audit contracts.
Conclusion:
Congress granted the Secretary of the Treasury statutory authority to
manage the government's financial operations in order to avoid
exceeding the debt ceiling during a debt issuance suspension period.
During the most recent episode, lasting from February 20 through May
27, 2003, Treasury took - as in previous administrations - a number of
actions to stay under the debt ceiling. All of the actions taken then,
as in previous occurrences, were authorized by law. However, not all of
the authorized actions that the Secretary takes to protect the full
faith and credit of the United States are without cost. As long as
there continues to be the possibility for a debt limit impasse in the
future, Treasury will need to retain maximum flexibility in order to
safeguard the credit standing of the U.S. in the world markets and
execute its duty to the nation.
Sincerely,
Signed by:
Brian C. Roseboro:
Under Secretary for Domestic Finance:
Related GAO Products:
[End of section]
We have previously reported on aspects of Treasury's actions during the
2002 debt issuance suspension period and earlier debt ceiling crises in
the following reports:
Debt Ceiling: Analysis of Actions During the 2002 Debt Issuance
Suspension Periods.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO-03-134]
Washington, D.C.: December 13, 2002.
Debt Ceiling: Analysis of Actions during the 1995/1996 Crisis.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO/AIMD-96-130]
Washington, D.C.: August 30, 1996.
Information on Debt Ceiling Limitations and Increases.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO/AIMD-96-49R]
Washington, D.C.: February 23, 1996.
Debt Ceiling Limitations and Treasury Actions.
[Hyperlink, http:// www.gao.gov/cgi-bin/getrpt?GAO/AIMD-96-38R]
Washington, D.C.: January 26, 1996.
Social Security Trust Funds.
[Hyperlink, http://www.gao.gov/cgi-bin/ getrpt?GAO/AIMD-96-30R]
Washington, D.C.: December 12, 1995.
Debt Ceiling Options.
[Hyperlink, http://www.gao.gov/cgi-bin/ getrpt?GAO/AIMD-96-20R]
Washington, D.C.: December 7, 1995.
Civil Service Fund: Improved Controls Needed Over Investments.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO/AFMD-87-17]
Washington, D.C.: May 7, 1987.
Treasury's Management of Social Security Trust Funds during the Debt
Ceiling Crises.
[Hyperlink, http://www.gao.gov/cgi-bin/getrpt?GAO/HRD-86-45]
Washington, D.C.: December 5, 1985.
A New Approach to the Public Debt Legislation Should Be Considered.
FGMSD-79-58. Washington, D.C.: September 7, 1979.
(198243):
FOOTNOTES
[1] The public debt limit is established by 31 U.S.C. § 3101 (2000) as
amended by Pub. L. No. 107-199, § 1, 116 Stat. 734 (2002) and Pub. L.
No. 108-24, 117 Stat. 710 (2003).
[2] 5 U.S.C. §§ 8348(j)(5)(B), 8438(g)(6)(B) (2000).
[3] See the Report of the Conference Committee, H.R. Rep. No. 108-401,
at 915 (2003), that accompanied the Consolidated Appropriations Act,
2004, Pub. L. No. 108-199, January 23, 2004, which incorporated the
request for our review appearing in H.R. Rep. No. 108-243, at 145
(2003).
[4] Most of these accounts are commonly referred to as trust funds.
[5] The public debt limit established by 31 U.S.C. § 3101 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.
[6] Not all of the obligations issued by federal government agencies
are subject to the debt ceiling because either they are not issued
under chapter 31 of title 31, United States Code, or their principal
and interest are not guaranteed by the U.S. government. See, for
example, obligations that may be issued by the Tennessee Valley
Authority (TVA) under authority of section 15d(a) of the TVA Act of
1933, 16 U.S.C. 831n-4(a) (2000), and obligations that may be issued by
the United States Postal Service (USPS) under the authority of 39
U.S.C. 2005(a) (2000). See Transaction between the Federal Financing
Bank and the Department of the Treasury, 20 Op. Off. Legal Counsel 64
at 75 (1996).
[7] The Social Security trust funds consist of the Federal Old-Age and
Survivors Insurance Trust Fund and the Federal Disability Insurance
Trust Fund.
[8] The majority of obligations held by federal government accounts
with investment authority are Government Account Series (GAS)
securities (commonly referred to as Treasury securities). GAS
securities consist of par value securities and market-based securities,
with terms ranging from on demand to 30 years. Par value securities are
issued and redeemed at par (100 percent of the face value), regardless
of current market conditions. Market-based securities, however, can be
issued at a premium or discount and are redeemed at par value on the
maturity date or at market value if redeemed before the maturity date.
[9] For example, see U.S. General Accounting Office, Debt Ceiling:
Analysis of Actions During the 2002 Debt Issuance Suspension Periods,
GAO-03-134 (Washington, D.C.: Dec. 13, 2002); Debt Ceiling: Analysis of
Actions during the 1995/1996 Crisis, GAO/AIMD-96-130 (Washington, D.C.:
Aug. 30, 1996); Civil Service Fund: Improved Controls Needed Over
Investments, GAO/AFMD-87-17 (Washington, D.C.: May 7, 1987); and
Treasury's Management of Social Security Trust Funds During the Debt
Ceiling Crises, GAO/HRD-86-45 (Washington, D.C.: Dec. 5, 1985).
[10] The G-Fund consists of nonmarketable Treasury obligations held in
trust by the federal government as custodian on behalf of individual
federal employee participants.
[11] The amount of outstanding obligations that can be redeemed using
this authority is limited to the "amount of funds not exceeding the
amount equal to the total amount of the payments authorized to be made
from the fund" during the debt issuance suspension period. 5 U.S.C. §
8348(k)(2) (2000).
[12] The authority to suspend investments is an exception to the
requirement in 5 U.S.C. § 8348(c) (2000) that the Secretary immediately
invest the portion of the fund that is not immediately required for
payments in interest-bearing obligations of the United States.
[13] Section 15d(d) of the TVA Act of 1933, 16 U.S.C. § 831n-4(d)
(2000).
[14] 39 U.S.C. § 2005(d)(3) (2000).
[15] Section 9(d) of the Federal Financing Bank Act of 1973, 12 U.S.C.
§ 2288(d) (2000).The act's purposes include assuring coordination of
federal and federally assisted borrowing programs with the overall
economic, fiscal, and debt management policies of the government and
reducing the cost of federal and federally assisted borrowing from the
public. 12 U.S.C. § 2281.
[16] See Transaction between the Federal Financing Bank and the
Department of the Treasury, 20 Op. Off. Legal Counsel 64 at 67-70
(1996), concluding that USPS and TVA obligations are suitable
investments of the Civil Service fund.
[17] Such obligations include TVA and USPS obligations.
[18] See, for example, Pub. L. No. 104-103, 110 Stat. 55 (1996)
(authorizing the Secretary of the Treasury to issue obligations equal
to the amount of March 1996 Social Security payments and exempting the
obligations from counting against the ceiling) and Pub. L. No. 104-115,
110 Stat. 825 (1996) (exempting certain trust fund obligations issued
during a limited period and in a limited amount from being subject to
the debt ceiling).
[19] GAO/AIMD-96-130.
[20] Treasury and the Congress have a long-standing position of
obtaining the necessary authority to restore interest that was not
credited to an account with investment authority because of unusual
events. GAO, the Congress, Treasury, and the agency commonly refer to
this forgone interest as a "loss" to the fund.
[21] The SLGS obligations program was established in 1972, following
federal legislation enacted in 1969 restricting state and local
governments from earning arbitrage profits by investing bond proceeds
in higher-yielding investments.
[22] In its analysis relating to the early redemption of FFB 9(a)
obligations, FFB noted that the beneficiaries of the Civil Service fund
are subject to a defined benefit plan and that under current law, their
benefits will be honored and paid regardless of the return on the Civil
Service fund's investments. See "Federal Financing Bank Borrowings from
the Civil Service Retirement and Disability Fund," Memorandum for Peter
Fisher, President, FFB, from Paula Farrell, Secretary, FFB (Aug. 16,
2002).
[23] GAO-03-134.
[24] Because of the large amount of documentation related to the
transactions, we reviewed only those transactions that exceeded $250
million, which we determined would be more susceptible to manipulation
affecting the debt ceiling than transactions below that amount.
[25] The 3 funds for which Treasury did not follow its normal
investment and redemption policies and procedures were also reviewed
and had obligation balances totaling $640 billion on January 31, 2003.
Therefore, the 28 funds reviewed totaled about $2.776 trillion, or
about 99 percent of the $2.815 trillion obligations held by the funds
on January 31, 2003.
[26] We used the full-month periods of February 1, 2003, through May
31, 2003, which include the activity during the 2003 debt issuance
suspension period (February 20, 2003, to May 27, 2003), because
accounting records and reports are generally maintained on a monthly
basis.
[27] 5 U.S.C. § 8348(d) (2000).
[28] 5 U.S.C. § 8438(e) (2000).
[29] Section 201(d) of the Social Security Act, 42 U.S.C. § 401(d)
(2000).
[30] 5 U.S.C. § 8909(c) (2000).
[31] Subsection 9503(f)(2) of title 26, United States Code, provides
that after September 30, 1998, Highway Trust Fund assets would be
invested in non-interest-bearing U.S. obligations. Thus, the Highway
Trust Fund does not earn interest on its investments. As such, failure
to invest excess fund receipts did not have an economic effect on the
fund.
[32] Treasury policies and procedures call for the correcting entry to
reflect the actual date that the transaction should have been recorded.
For example, in this case, if the Treasury policies and procedures had
been followed, the over-redemption detected and validated in March 2003
would have been invested on the appropriate date.
[33] According to Treasury officials, they use the amount of expected
benefit payments that will be issued on the first business day of a
month in this calculation. For any other benefit payments and expenses
incurred by the Civil Service fund during the month, obligations are
redeemed on that payment date.
[34] Comptroller General Opinion to the Honorable John LaFalce,
Chairman, Subcommittee on Economic Stabilization, House Committee on
Banking, Finance and Urban Affairs, B-138524 (Oct. 30, 1985), and The
Federal Financing Bank and Debt Ceiling: Hearing before the
Subcommittee on Economic Stabilization of the House Committee on
Banking, Finance and Urban Affairs, 99th Cong. 28-34 (1986) (Statement
of Harry Havens, Assistant Comptroller General, U.S. General Accounting
Office).
[35] In its analysis relating to the early redemption of FFB 9(a)
obligations, FFB noted that the beneficiaries of the Civil Service fund
are subject to a defined benefit plan and that under current law, their
benefits will be honored and paid regardless of the return on the Civil
Service fund's investments. See "Federal Financing Bank Borrowings from
the Civil Service Retirement and Disability Fund," Memorandum for Peter
Fisher, President, FFB, from Paula Farrell, Secretary, FFB (Aug. 16,
2002).
[36] Section 9(b) of the Federal Financing Bank Act of 1973, 12 U.S.C.
§ 2288(b) (2000), authorizes FFB to issue obligations to the Secretary
of the Treasury, and the Secretary is authorized at his discretion to
purchase such obligations.
[37] For a detailed discussion of the legal support for these
transactions, see Memorandum for Secretary Snow from David D.
Aufhauser, "Authority of the Secretary of the Treasury and the Federal
Financing Bank to Enter into a Series of Transactions That Are Intended
to Reduce the Amount of Outstanding Debt That Is Subject to the Debit
Limit Statute" (Mar. 4, 2003).
[38] Present value is the discounted value of a payment or stream of
payments to be received in the future, taking into consideration a
specific interest or discount rate. Present value represents a series
of future cash flows expressed in today's dollars.
[39] The Civil Service fund and FFB have exchanged obligations on
several occasions, including during the 2003 debt issuance suspension
period.
[40] GAO-03-134.
[41] U.S. General Accounting Office, Government Auditing Standards:
2003 Revision, GAO-03-673G (Washington, D.C.: June 2003).
[42] For example, if the price of a 2-year note maturing on July 1,
2005, is 101, the account would either pay or receive a $1 premium for
each $100 of face value, depending on whether the account was
purchasing or selling the security. On the other hand, if the price is
99, the account would either pay or receive a $1 discount from the $100
face value. The purpose of premiums and discounts is to adjust the
market price of securities with various terms and conditions (e.g.,
interest rates, maturity dates, and interest payment dates) to ensure
that comparable securities will provide similar yields or returns to an
investor.
[43] For example, on June 3, 2003, Treasury, using its normal
investment and redemption policies and procedures, redeemed about $6
billion that had been invested on June 2, 2003, for a Social Security
account.
[44] The difference between the market-based rate for obligations that
mature the next business day and the G-Fund's par value rate can be
significant. For example, on March 31, 2004, the market-based rate for
investments that matured the next business day was 1 percent, while the
rate used for G-Fund investments was 4 percent.
[45] GAO/AFMD-87-17.
[46] Pub. L. No. 99-509, 100 Stat. 1874, 1931 (1986).
[47] H.R. Conf. Rep. No. 99-1012, at 256 (1986).
[48] Present value is the discounted value of a payment or stream of
payments to be received in the future, taking into consideration a
specific interest or discount rate. Present value represents a series
of future cash flows expressed in today's dollars.
[49] Reinvestment risk is the risk that proceeds received in the future
will have to be reinvested at a lower potential interest rate in the
case of a government account with the authority to invest or that the
proceeds will be reinvested at a higher rate in the case of the
Treasury general fund.
[50] The cash that Treasury lends to FFB under a 9(b) obligation is
derived from Treasury borrowing under chapter 31 of title 31, United
States Code. Thus, the agency obligation financed by FFB is counted
against the public debt ceiling in this manner.
[51] U.S. General Accounting Office, Civil Service Fund: Improved
Controls Needed over Investments, GAO/AFMD-87-17 (Washington, D.C.: May
7, 1987).
[52] According to FFB, this early redemption was necessary because its
maturing loans would not provide sufficient funds to enable FFB to
repay the entire principal amounts due to the Civil Service fund when
these obligations matured. FFB also noted that its loan portfolio had
been shrinking, making it more difficult for FFB to pay interest on its
9(a) obligations to the Civil Service fund. See "Federal Financing Bank
Borrowings from the Civil Service Retirement and Disability Fund,"
Memorandum for Peter Fisher, President, FFB, from Paula Farrell,
Secretary, FFB (Aug. 16, 2002).
[53] According to an FFB official, FFB did not calculate the comparable
benefit to it by making this repayment.
[54] GAO/AFMD-87-17.
[55] This gain was computed by taking the present value on June 30,
2003, of the Treasury obligations that were exchanged with FFB on March
5, 2003, and comparing this hypothetical value to the present value of
the FFB 9(a) obligation that was redeemed on June 30, 2003. A gain
occurred because the interest rate had changed since the March 5, 2003,
exchange. Specifically, as noted earlier, the March 5, 2003, interest
rate used to determine the exchange value was 3.875 percent, but on
June 30, 2003, the interest was 3.5 percent. Since the FFB obligation
had a longer term than the Treasury obligations, the reduction in
interest rates had a greater effect on the FFB 9(a) obligation, that
is, the FFB 9(a) obligation became more valuable. See app. II for a
discussion on how changing interest rates and terms affect a present
value analysis.
[56] Reinvestment risk is the risk that proceeds received in the future
will have to be reinvested at a lower potential interest rate in the
case of a government account with the authority to invest or that the
proceeds will be reinvested at a higher rate in the case of the
Treasury general fund.
[57] The amount of the June 30, 2003, short-term loan from Treasury
used to finance this loss that is discussed in the next section was
about $1.1 billion.
[58] U.S. Department of the Treasury, Office of Inspector General,
Audit of the Federal Financing Bank's Fiscal Years 2003 and 2002
Financial Statements, OIG-04-013 (Washington, D.C.: Dec. 9, 2003).
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