Submitted by Tyler Durden
With Tim Geithner having proven repeatedly and beyond a reasonable doubt he has insurmountable intellectual challenges, many have wondered just who it is that makes the real decisions at the US Treasury? The answer is, The Treasury Borrowing Advisory Committee, or the TBAC in short, chaired by JP Morgan and Goldman Sachs, which meets every quarter, and in which the richest people in America (here is its composition) set the fate of the US for the next 3 months in the form of a very much irrelevant report to TurboTax (link). What is of huge importance, however, are the minutes, which unlike the FOMC, are released immediately following the meeting. Below are the full minutes from the latest TBAC meeting held yesterday, just released by the US Treasury (and yes, the issuance of FRN Treasurys, corporate cash hoarding as well as the resumption of the SFP program are both discussed – like we said: these guys run the world) as well as the critical associated powerpoint.
Minutes of the Meeting of the Treasury Borrowing Advisory Committee the Securities Industry and Financial Markets Association November 1, 2011
The Committee convened in closed session at the Hay Adams Hotel at 9:30 a.m. All Committee members were present with the exception of Paul Tudor Jones. Assistant Secretary for Financial Markets Mary Miller, Deputy Assistant Secretary (DAS) for Federal Finance Matthew Rutherford and Director of the Office of Debt Management Colin Kim welcomed the Committee and its newest member, Stuart Spodek [fixed income PM at BlackRock]. Other members of Treasury staff present were Fred Pietrangeli, Jennifer Imler, Amar Reganti, Allen Zhang, David Chung, Alfred Johnson, Dara Seaman and Brian Zakutansky. Federal Reserve Bank of New York members Dina Marchioni and Mark Cabana were also present.
DAS Rutherford began the meeting with an update on tax receipts, which were $140 billion higher in 2011 versus the prior fiscal year (FY). He noted that withheld receipts were up only slightly on a year-over-year basis due in part to the payroll tax cut. Corporate tax growth slowed in Q4 FY 2011.
DAS Rutherford then discussed outlays, which totaled approximately $3.6 trillion in FY 2011 or roughly 24 percent of GDP. Health and Human Services was the largest outlay in FY 2011 at $891 billion, with Medicare and Medicaid being the largest sub-categories. Social Security spending totaled $784 billion, with Old-Age, Survivors and Disability Insurance increasing the most. The third largest outlay was Defense, within it, Operations and Maintenance was the largest expenditure. Rounding out the top four categories was Treasury. Roughly 85 percent of the $537 billion in Treasury outlays was made up of interest expense, with $235 billion from debt service on marketable debt and about $220 billion from non-marketable interest payments. With respect to nonmarketable borrowing, DAS Rutherford noted that SLGS redemptions continued into Q4 FY 2011, causing Treasury to borrow an extra $17.6 billion last quarter.
Next, DAS Rutherford reviewed the deficit for this past fiscal year versus the prior two years. For FY 2011, the deficit was recorded at 1.299 trillion, or 8.7 percent of GDP. Going forward, dealers expect the deficit in FY 2012 to total $1.132 trillion, consistent with expectations last quarter. Most estimates assume the deficit will fall to below $1 trillion by FY 2013.
DAS Rutherford briefly summarized the American Jobs Act (AJA) into three components: extension of current laws, spending measures and new/incremental tax cuts. He noted that the President’s plan was meant to stimulate to the economy in the short term, while putting in place a medium-to-long-term credible deficit reduction plan.
Director Kim then discussed Treasury’s debt portfolio. Given current OMB deficit projections, which include the AJA, and assuming no changes to issuance sizes or auction frequency, Treasury expects to be modestly under-financed in FY 2012. However, given the same assumptions, Treasury would be over-financed from FY 2013 through FY 2016.
Kim next reviewed a number of debt metrics. The average maturity of the portfolio, which currently stands slightly above 62 months, continues to extend. Kim proceeded to discuss hypothetical average maturity calculations. In the example used by Director Kim, Treasury adjusted future nominal coupon issuance on a pro-rata basis, while keeping the mix of securities and the auction schedule constant. Treasury also held the bill stock constant. In this example, the maturity was shown to naturally extend to approximately 70 months by 2015.
Kim emphasized that the average maturity projections and the associated underlying assumptions for future issuance were purely hypothetical. The projections were not meant to convey future debt management policy or an average maturity target. He reiterated that Treasury must remain flexible in the conduct of debt management policy.
Currently, Treasury bills make up about 15 percent of the debt portfolio, with nominal coupons and TIPS at slightly more than 77 and 7 percent, respectively. If Treasury were to adjust nominal coupons to meet OMB’s future financing estimates, bills would become approximately 10 percent of the debt portfolio around 2016. Additionally, on a percentage basis, the amount of Treasury debt maturing in the next 1, 2 and 3 years remains at historic lows. If Treasury were to continue its current issuance pattern, Kim noted that by FY 2020 almost 20 percent of the portfolio would have a maturity profile greater than or equal to 10 years.
Director Kim then discussed demand for Treasuries. He commented that auction coverage ratios remain very high for all of Treasury’s products. Treasury bill bid-to-cover ratios have averaged 4.61 for this FY and coupon bid-to-cover ratios averaged 2.98. Kim also noted that Treasury’s investor class data, which is released twice a month, continues to show healthy participation from a variety of accounts. Kim highlighted that investment funds are becoming a larger participant in TIPS. Observing the change in investor class auction purchases in FY 2011, as compared to past years, he noted that there was an auction rule change in June 2009. The new rule prevented primary dealers from guaranteeing an auction award at the clearing level to their customers. Once this new rule went into effect, primary dealer awards declined.
Kim mentioned that private and public foreign participation was slightly less in FY 2011 than in FY 2010, with the largest decline in the bill sector. Also, data shows an uptrend in longer-dated nominal coupon awards to foreign accounts. Lastly, Kim noted that primary dealer awards averaged 59 percent for bills, 49.4 percent for nominal coupons and 49.5 percent for TIPS.
Following DAS Rutherford and Director Kim’s presentation, the Committee turned to a brief discussion on potential changes to financing and the auction calendar. It was the consensus that Treasury should not make any changes to issuance sizes or existing auction calendar at this time.
The Committee noted that they have consistently advised Treasury over the last several years to extend the average maturity of the debt portfolio. Further, members of the committee observed that maturity extension expectations should already be priced into fixed income markets. It was the Committee’s view that Treasury should continue to extend average maturity in the most cost effective way. Members of the Committee stated that their purpose is to advise and assist Treasury in achieving its mandate of minimizing borrowing costs over time.
A member then broached the subject of Floating Rate Notes (FRNs), noting that it was recently discussed with primary dealers ahead of the November refunding. DAS Rutherford noted that while FRNs have many features that make them a potentially attractive instrument for Treasury, there is still a lot of work that needs to be done on the product related to cost, structure, and demand. DAS Rutherford emphasized that no decision has been made on whether to introduce this product. It was the view of the Committee that Treasury should continue to study the product idea with a focus on cost.
Another member raised a question about the possible resumption of Supplemental Financing Program (SFP). In light of debt ceiling constraints, it was the view of the Committee that Treasury should not resume the program at this time.
The Committee next turned to the charge on the TBAC agenda: “The Impact of a Prolonged Period of Low-Interest Rates on Financial Markets.”
The presenting member first turned to the state of borrowers within the U.S. economy. The member noted that overall loan growth continues to rise as lenders are making more commercial and industrial (“C&I”) loans. However, consumer and real estate loan growth remains weak.
The presenter noted that loan recovery was still well below prior economic recoveries. All forms of bank credit were significantly weaker than levels seen during those other periods. The member noted that, based on the presented data, the lack of lending was driven, in part, by a lack of credit demand rather than a lack of credit supply from traditional bank lending.
The discussion moved into the demand segment, the presenter noted that U.S. corporations have built up significant amounts of cash, lowering their marginal demand for borrowing. A spirited discussion followed on whether the increase in cash holdings was due to corporate concerns regarding future funding or whether corporations did not see a significant opportunity cost in holding cash.
The presenter briefly summarized the effects of the current rate environment on various fixed income investors. The member noted that low rates are particularly challenging to the money fund industry, resulting in a difficult low return environment. Pension funds and insurers have had difficulty sourcing enough long-duration paper at appropriate yields for their ongoing asset-liability management strategies. A variety of investors may have to either extend duration or reallocate into higher yielding products to meet certain performance targets. Banks, particularly small banks, are facing challenges due to the compression of their net interest margins. The impact on mortgage lenders is uncertain, with an ongoing debate on whether lower rates and a flatter curve will spark more origination or “refi burnout”. The presenter noted that REITS will likely suffer due to a lower carry and higher pre-payments. In addition, mortgage servicers will see their mortgage servicing rights impacted during periods of refinancing or prepays. The presenter also noted that foreign investor demand for Treasuries still remains healthy by historical standards.
Finally, the presenter concluded that Treasury should continue to investigate new product alternatives in order to diversify its investor base.
The meeting adjourned at 12:00 p.m.
The Committee reconvened at the Department of the Treasury at 5:40 p.m. All Committee members were present with the exception of Paul Tudor Jones. The Chairman presented the Committee report to Secretary Geithner.
A brief discussion followed the Chairman’s presentation but did not raise significant questions regarding the report’s content.
The Committee then reviewed the financing for the remainder of the July through September quarter (see attached).
The meeting adjourned at 6:15 p.m.
Treasury Borrowing Advisory Committee Members
Dana M. Emery
CEO, President & Director of Fixed Income
Dodge & Cox
555 California Street
San Francisco, CA 94104
Vice Chairman, CEO, Invest. Mgmt.
One Wall Street
New York, NY 10286
Global Head of Research
1776 I Street NW
Washington, DC 20006
Elizabeth M. Hammack
Global Head of Short Term Interest Rate Trading
Goldman, Sachs & Co.
200 West Street
New York, NY 10282
CIO, Fixed Income
Voya Investment Management
5780 Powers Ferry Road NW
Managing Director, Head of Global Rates
11 Madison Avenue
New York, NY10010
Managing Director, Head of Credit Markets
390 Greenwich Street
New York, NY10013
Chief Investment Officer
Prudential Fixed Income
655 Broad Street
Walter J. Muller III
Chief Investment Officer
Bank of America
600 Peachtree Street
Co-Head of Global FICC Research
Barclays Capital Inc
745 Seventh Avenue
650 Newport Center Drive
Newport Beach, CA92660
Brian P. Sack
Director of Global Economics
- E. Shaw & Co., L.P.
1166 Avenue of the Americas
New York, NY10036
55 East 52nd Street
New York, NY10055
Matthew E. Zames
Chief Operating Officer
JP Morgan Chase & Co.
270 Park Avenue
New York, NY 10017