What GAO Found
Debt buybacks can help advance Treasury’s goals under a variety of budget and market conditions. For example, Treasury currently faces rollover peaks—large increases in the amounts of maturing debt that must be refinanced at a given time—which expose Treasury to the risk of refinancing large amounts of debt when interest rates are less favorable. All four of our case study countries use debt buybacks to mitigate rollover risk. Buybacks can also be used to enhance liquidity, which can be adversely affected when the growth in borrowing slows rapidly and issue sizes decline significantly. GAO’s illustrative analysis of Treasury’s past buyback program showed that, had Treasury refinanced the debt by simultaneously issuing new debt, it could have captured a liquidity premium—the additional price investors are willing to pay for securities that can be easily traded—which would reduce interest costs.
Implementing a well-designed buyback program could help Treasury minimize borrowing costs over time. Other countries have used both reverse auctions—a process in which participants submit competitive offers to sell particular securities—and bilateral trades—transactions between the government and specific holders of a security. Of these, reverse auctions are most consistent with Treasury’s principles. However, if certain features of bilateral trades were modified, they could be useful for responding to unforeseen market disruptions. Participation in a buyback program would be encouraged by a regularly scheduled program, with a clear purpose and timely announcement of operations. Also, because greater participation fosters competition, broadening the eligibility to participate beyond primary dealers should be explored.
Switches and debt exchanges—tools similar to buybacks that involve early redemption of securities in exchange for liquid benchmark securities—could also be used to manage rollover peaks and help maintain liquidity. They could also have the added advantage of broadening Treasury’s investor base by appealing to investors that want to maintain the average maturity of their portfolios in ways that minimize market risk.
Why GAO Did This Study
The U.S. Treasury market is the deepest and most liquid debt market in the world. Liquidity is important to a well-functioning Treasury market and for lowest cost borrowing over time. Exploring various debt management tools can assist Treasury in maintaining liquidity as budget and market conditions change.
To help maintain an efficient Treasury market, Treasury needs the ability and flexibility to actively manage the mix of outstanding securities and respond to market disruptions. Debt buybacks—the redemption of marketable securities prior to their maturity dates—were used to manage declining debt during a time of budget surpluses. However, other countries use buybacks and similar tools even during times of deficit. GAO assessed: (1) the budget and market conditions under which debt buybacks could help Treasury achieve its debt management goals, (2) the operational features of buyback programs that would support these goals, and (3) other debt management tools used by case study countries to achieve similar objectives. GAO examined both the U.S. program and those of Canada, France, Germany, and the United Kingdom and analyzed the costs and benefits.
Reissued on March 21, 2012
To have flexibility to respond to potential changes in market conditions, GAO recommends that Treasury build the capacity for buyback and switch auction programs as well as bilateral trades or debt exchanges.
Treasury concurred with the findings and said the report would be very useful in analyzing tools that increase their flexibility.
Recommendations for Executive Action
|Department of the Treasury||1. Treasury should build the capacity for a buyback program that could be used to respond to potential changes in market conditions during times of deficit. Such a program should allow for broader direct participation beyond the primary dealers. In conducting any buyback operations Treasury should (1) clearly articulate the purpose of the buyback program, (2) conduct the buyback reverse auctions on a regular and predictable schedule consistent with the purpose of the buyback program, and (3) target a few securities in narrow maturity bands at each reverse auction.|
|Department of the Treasury||2. To further increase Treasury's flexibility to respond to potential changes in market conditions and improve its ability to continuously maintain liquidity among outstanding securities, Treasury should build the capacity for a switch auction program. In building this capacity, Treasury should allow for direct participation beyond the primary dealers. If Treasury chooses to implement a switch auction program, it should (1) clearly articulate the purpose of the switch auction program and (2) conduct the switch auctions on a regular and predictable schedule consistent with the purpose of the program.|
|Department of the Treasury||3. To ensure that Treasury has the flexibility to respond to sudden and wide-scale market disruptions, Treasury should develop the capacity to use bilateral trades or debt exchanges. It would be especially important to carefully consider the design of such a program to ensure that the features of the program are consistent with our recommendations related to buybacks and switch auctions and consistent with Treasury's long-standing debt management principles. For example, the price-setting principle should be transparent and results of any activities should be reported to the market.|