Borrowing Through the U.S. Treasury's "Fast Money Tree": The Need to Balance Austerity and Growth in the 21St Century

Borrowing Through the U.S.  

 Treasury’s Fast Money Tree:

The Need to Balance Austerity and Growth in the 21st Century

By

Michael William Sunner, Ph.D.

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© 2012 Dr. Michael William Sunner. All rights reserved.

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Published by AuthorHouse 7/25/2012

ISBN: 978-1-4772-1726-9 (sc)

ISBN: 978-1-4772-1724-5 (hc)

ISBN: 978-1-4772-1725-2 (e)

Library of Congress Control Number: 2012910657

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Contents

Acknowledgements

Section I

Chapter 1    INTRODUCTION

Chapter 2    THE 2011 DEBT CEILING REDUX

Chapter 3    A CONSTITUTIONAL DEBATE

Chapter 4   THE GOLD STANDARD AND THE PUBLIC DEBT

Section II

Chapter 5   THE FAST MONEY TREE’S EARLY GROWTH

Chapter 6   DYNAMICS OF THE FAST MONEY TREE

Chapter 7   BROADENING TREASURY AUCTION PARTICIPATION

Chapter 8   TREASURY AND ALTERNATIVE PRODUCTS

Section III

Chapter 9   FRAUD IN TREASURY AUCTIONS

Chapter 10

COMPLYING WITH TREASURY AUCTION RULES

Chapter 11

ANNUAL REPORTS TO CONGRESS

Chapter 12

THE ABUSE OF THE AUCTION GUARANTEE PROVISION

SECTION IV

Chapter 13

9/11 TRAGEDY FORCES TREASURY TO PLAN FOR THE UNTHINKABLE

Chapter 14   BEST PRACTICES HELP REDUCE  

 OPERATIONAL AND MARKET RISK

Chapter 15   THE CRITICAL ROLE OF THE FEDWIRE SERVICE

Chapter 16   THOUGHTS AND MUSINGS

SECTION V

Appendices

Appendix A   HOW THE TREASURY MANAGES DEBT WHEN IT NEARS THE STATUTORY DEBT LIMIT

Appendix B   DIRECT BIDDING AT U.S. TREASURY AUCTIONS:  

 A PRIMER²⁰⁹

Appendix C   THE DEBT BUYBACK PROGRAM

Appendix D   THE MECHANICS OF PAYMENT FOR AWARDED TREASURY SECURITIES

Appendix E    STRIPS, RECONSTITUTION AND MISCELLANEOUS UOC PROVISIONS

Appendix F   SYNOPSIS OF AUCTION PROCEDURAL CHANGES:  

1929 - 2011

Appendix G   SYNOPSIS OF AUCTION AUTOMATION

CHANGES 1992 - 2011

Appendix H   DELIVERING TWO-MINUTE AUCTIONS:

WHY, WHEN, AND HOW

Appendix I   POST– SALOMON REFORMS

Appendix J   NON-COMPETITIVE AUCTION VIOLATION COMPARISION CHART: 2000-2010

Appendix K   COMPETITIVE AUCTION VIOLATION COMPARISION CHART: 2000-2010

Appendix L   U.S. CAUGHT CHINA BUYING MORE DEBT THAN DISCLOSED, BY EMILY FLITTER, REUTERS

Appendix M   FEDERAL RESEVE BANK OF NEW YORK PRIMARY DEALERS LIST* JUNE, 2012

Appendix N   U.S. TREASURY AUCTION EMERGENCY BIDDING GUIDELINES

Appendix O   AREAS OF FOCUS FOR INTERNAL AUDITORS  

 RE: TREASURY AUCTIONS

End Notes

Acknowledgements

I began my Treasury career as the Deputy Assistant Commissioner, Office of Financing. U.S. Treasury in 1988, and was immediately immersed in the Treasury auction business. I became interested in the historical significance of debt management from the colonial days to the 21st Century. Hence, I originated a historical synopsis to help the Treasury Financing staff to quickly find answers to questions about various events in the history of Treasury auctions and debt management policy. Such questions emanated from a curious public (academic, press, and Wall Street) that was interested in precise dates for certain events such as when did Treasury switch from multiple-price auctions to single-price auctions, etc…? The original synopsis entailed the documentation of Treasury’s modifications to the auction automation process, and policies and procedures over many years. At one point, because the synopsis grew in size, my colleagues decided to split the single synopsis into two parts: Synopsis of Auction Procedural Changes: 1929 – 2011, and the Synopsis of Auction Automation Changes: 1992 – 2011. This made reading and researching the historical data much easier and allowed updates to be added based on their fit into two well-defined categories.

My goal was to chronicle the recent history of the Treasury auction process and its systems (e.g., I refer to the Treasury Automated Auction Processing System or TAAPS® as the Fast Money Tree). Furthermore, my industrious and supportive former Treasury colleagues, Mr. Harry Vavra and Ms. Lori Caplinger have faithfully maintained the Treasury synopses of procedural and automation changes over the years. (Please see the historical synopses in Appendices F and G).

Since my retirement in October 2011, I believe that the Financing staff has continued to update both synopses whenever events have occurred that required factual changes to these documents. I assume that the Financing staff has performed those updates regularly, accurately, and without fail. Hence, the Office of Financing’s tradition of documenting and maintaining Treasury’s auction operational, procedural, automation, and policy changes as well as any other significant event impacting the auction business line continues without fail. This is analogous to the actual operation of Treasury auctions, whereby they operate in a continuous, regular, timely, and flawless fashion. I’m certain that the current Financing staff and future staffers will continue with keeping up with this tradition, and knowing Harry and Lori well, they will ensure that the legacy will be passed on to the new wave of Treasury auctioneers for from knowledge there is truth (ex scientia vera).

Also, many of my former colleagues at Public Debt have given me the encouragement to move forward with this publication so that those who want to know more about Treasury auctions (the Fast Money Tree) can better understand the many system components, functions, and the resilience that was built into the TAAPS® infrastructure. I commend all of my former colleagues at Treasury and the Federal Reserve for their excellent work in developing and maintaining the Fast Money Tree.

The United States borrowing capability and its philosophical underpinnings have slowly, but profoundly evolved since the founding of our Country, and this story captures many of the important events and elements of that evolutionary history. It is my fervent hope that the reader finds this treatise both interesting and educational. Many thanks are in order for a number of individuals who have provided me with salient and vitally important debt management information, which appear in this body of work.

My watch at Treasury began in 1988, and since then, I have gathered, aggregated, updated, and maintained debt management operational and policy information in my work papers. Also, my work papers are replete with information that was shared by various colleagues’ work papers at Main Treasury, the Bureau of the Public Debt (BPD), and the Federal Reserve Bank of New York (FRBNY), e.g., the 2011 debt ceiling impasse. Much of that information was faithfully incorporated in this manuscript.

Also, I have included informed auction commentary about the history of direct bidding in Treasury auctions, which was taken in whole or in part from my own research papers, the Treasury Auction Staff (TAS) of the FRBNY and BPD. My career at Treasury spanned approximately 24 years, and I had the good fortune of being privy to many important and well-publicized debt management events that are memorialized herein, and are faithfully recorded from memory, personal notes, observations, and papers that I authored and/or published, or were prepared by others at BPD or at the debt management offices at Main Treasury, or the FRBNY.

It would be a rather large undertaking to name all of the individuals I’ve worked with in my Treasury career who have contributed to the continuous improvement of Treasury’s auction program, but suffice it to say that, unfortunately, their intellectual contributions are referenced in this essay without attribution. I apologize for that oversight. However, any credit or kudos that may be due for this manuscript are willingly shared with all of my former colleagues at Treasury, the FRBNY, and the Primary Dealer community as this book is an intellectual amalgamation of analyses as well as formal and informal observations freely offered by all of those groups. Any omissions or factual misrepresentations are mine alone, and I assume full responsibility for any such errors.

I also want to thank my many friends and contacts at the Primary Dealers and the Securities Industry and Financial Markets Association (SIFMA) who taught me the auction business from the dealers’ side (or the sell side). The dealers’ traders, senior managers, compliance, operations, and audit experts willingly provided me with inside knowledge regarding the primary and secondary market trading of Treasury securities over these many years. (For example, Stephanie Wolf at Merrill Lynch explained how the auction guarantees were being abused by the foreign central banks, and that such abuses were harmful to Treasury and should cease as the practice of purchasing Treasuries through the guarantees could possibly lead to short squeezes.)

I truly enjoyed my relationship with the SIFMA audit and legal and compliance communities who helped strengthen Primary Dealer compliance by developing strong industry wide auction compliance and operational procedures that conformed to Treasury rules. Finally, the SIFMA Operations and Contingency committees played an important role in assisting my work in ensuring that Treasury auctions could sustain a major contingency. I was extremely fortunate to work with some of the finest professionals in the financial industry, and I will always be grateful for that opportunity.

This manuscript has not been reviewed or sanctioned by the Department of Treasury or the FRBNY, and therefore, it is not an official work product of the U.S. Government. It is a work product based on my personal observations, memories of events, conversations, and represents research that I have performed or projects that I was involved in during my long career with the U.S. Treasury while working closely with the Federal Reserve and the Primary Dealer community from September 1988 through October 2011. I am now happily retired from the Federal service.

Michael W. Sunner, Ph.D.

June, 2012

Section I

Chapter 1

INTRODUCTION

A Eurozone Debt Conundrum – The Choice of Scylla or Charybdis

Thus far, the year 2012 has been a horrible year (annus horribilis) for the Eurozone with continued accounts and rumors about the European debt crisis, an impending Greek default, and the possibility of contagion affecting the governments of Portugal, Ireland, Italy, and Spain whose borrowing costs were becoming exorbitant. Today, many of the Eurozone countries remain borrowed to the hilt, and their financing costs are slowly but continuously rising, which raises palpable global fears that some of these countries will be unable to pay their debts in full and eventually default on their loans. There’s no doubt that such defaults would cascade around the globe causing a Lehman-like crisis or worse. While the United States appears to be recovering from its recession, the world’s leaders are nervously watching (and mostly talking without concrete actions) as the Eurozone’s economic problems deepen, and many EU countries remain mired in recession.

In a sea change election held on May 6, 2012, French President Nicolas Sarkozy was defeated by Francois Hollande, while other European countries also saw recent changes in leadership, e.g., Britain, Italy, Spain, Greece, and the Netherlands.¹ The Eurozone’s fiscal crisis with its attendant high unemployment and cost-cutting has moved the leadership of many of these countries to the left of center. At the time of this writing, the Germanic austerity proposals appear to be on the rocks with radical left and right elements gaining traction throughout Europe. Increasingly, there was a backlash in sentiment throughout the Eurozone towards the austerity measures proposed by the Germans and the EU institutions to reduce the widespread and deep indebtedness of so many of these countries. However, as evidenced by the events in Greece, a wave of hopelessness has swept over the country as austerity measures caused widespread pain to millions of its citizens.

Hence, these strict austerity measures that focus on cutting government spending and higher taxes that have the support from the European Central Bank (ECB), the European Commission (EC), and the International Monetary Fund (IM) have been soundly rejected by voters in many of these countries. The message is clear, unless the focus changes from total austerity to some reasonable combination of austerity and stimulus to spur economic growth and jobs, the Eurozone may dissolve into economic chaos. Ultimately, the disintegration of the Eurozone seems more likely now (June 2012) than ever with the possibility that several countries could ultimately exit the Eurozone sometime between 2012-2014, and ultimately revert to their own currencies. This crisis seemingly will go on and on until the countries that are unable to control their debt (and grow out of their fiscal problems) will simply default on their outstanding obligations and leave the Eurozone where an uncertain fiscal future awaits them.

One Hellenic commentator recently noted that when and if the new leaders of the Greek government decide to leave the Eurozone and revert to the country’s former currency, the drachma, Greece will be committing political and fiscal "suicide.² Subsequent to those statements, European leaders as well as the global financial markets were in a frenzy preparing for the worst case scenario with the world’s financial markets plunging given the possibility of Greece leaving the Eurozone.

Based on comments coming out of the newly elected political leadership in Greece, it would appear that some of the newly elected members of the government are not interested in remaining in the Eurozone, and more importantly, are quite hostile to the barbarity of German and the ECB’s demands for deep austerity measures. The new leadership could ultimately reject the notion of paying its debts. So the question arises, if the Greeks openly defy those EU authorities on "their austerity pledge, where will they get money to pay their bills if its government can no longer borrow at reasonable rates or at all? Who will invest in such a government or a people so willing to negate contractual and fiscal pacts? Greece has been holding the world hostage to its financial problems and threats to pull out of the Euro. Many are now saying it’s time to allow Greece to go it alone as they will certainly suffer the unthinkable and that economic life could possibly get worse than it is today.

Hence, leaving the Euro might not be the best solution for Greece’s socio-economic and fiscal problems. Some commentators have postulated that the newly elected Greek leadership’s hard line approach is mere posturing and the goal is to remain in the Eurozone, but with a better deal and lower targets for debt vs. GDP ratios. This may seem like a tenuous argument, but it does make sense for the Germans and the EU institutions to offer some kind of compromise to the Greeks that could maintain the stability of the Eurozone while stimulating the Greek economy with a Marshall-like investment plan along with a reasonable dose of austerity. Such an approach might serve to reduce the tensions and voter anger inside Greece and elsewhere.

Former Greek Prime Minister Costas Simitis who led Greece when it joined the euro in 2001, remarked at a May 15th forum in Beijing that Greece must be part of the euro area and it would be a catastrophe for it to revert to its own currency, a move that threatens a run on bank. He opined further that The idea of coming back to the drachma is an idea that cannot function.³ An exit would require banks to close for at least three months while preparations, including printing a new currency, are made, Simitis said, citing the views of experts. Closing the banks for three months is a nonstarter. Essentially if they close for more than three days there will be a bank run. Simitis believes that Greece will never leave the euro and that its political parties are in a certain sense trying to renegotiate the austerity conditions with the European Union." He concluded that while Europe is saying the agreements will not be renegotiated, but after a time they will agree to new conditions.⁴

Paul Krugman, a liberal economist, recently offered a clever counter argument for breaking up the Euro that would send Greece back to the drachma. Obviously Europe wouldn’t be in this fix if Greece still had its drachma, Spain its peseta, Ireland its punt, and so on, because Greece and Spain would have what they now lack: a quick way to restore cost-competitiveness and boost exports, namely devaluation.⁵ Yet breaking up the euro would be highly disruptive, and would also represent a huge defeat for the European project, the long-run effort to promote peace and democracy through closer integration. He further postulates that the key to the Eurozone’s recovery is further economic expansion across Europe.⁶ (Krugman seems to favor maintaining the stability of the Eurozone with Greece still in the mix).

Krugman hypothesizes that Germany’s economy was in the dumper in the early years of the last decade, but managed to recover. Moreover, the German’s economic recovery was driven by the emergence of a huge German trade surplus vis-à-vis other European countries or those now in crisis. The EU was experiencing economic boom times, and above-normal inflation, thanks to low interest rates. Europe’s crisis countries might be able to emulate Germany’s success if they faced a comparably favorable environment if, this time, it was the rest of Europe, especially the Germans, that were experiencing a bit of an inflationary boom. ⁷

Hence, Krugman offers that the German economic experience is counterintuitive to their position and argument for unilateral austerity in Southern Europe, and that to end this crisis much more expansionary policies are needed in the Eurozone and elsewhere.⁸ He concludes that the European Central Bank must drop its obsession with inflation and focus on stimulus and growth.⁹

The U.S.’s Growing Debt – Raising Cash Through the Fast Money Tree

Meanwhile, U.S. debt is the largest in its history, and represents a massive shortfall between government expenditures and revenues. Our public debt is now approximately 100% of our Nation’s Gross Domestic Product (GDP). Hence, the United States is not far behind some of those European countries with respect to the serious problem of growing and unchecked indebtedness.

However, despite the growing debt of the United States, it remains one of the few safe financial havens in the world, and we are still blessed (and cursed) with the ability to raise the necessary cash to fund our governmental needs by selling U.S. Treasuries quickly and efficiently with few worries about meeting our borrowing needs.

The U.S. Government has developed a fast and efficient borrowing capability, and the means to quickly raise low interest cash from investors around the globe in minutes if not seconds. In essence, this is our Fast Money Tree which is executed through the Treasury Automated Auction Processing System (TAAPS®). This Fast Money Tree is the mechanism that borrows trillions each year quickly, efficiently, and without a flaw. As a former Treasury employee, I helped raise trillions over my career working alongside my colleagues at Treasury and the FRBNY in developing and maintaining TAAPS®.

Prior to developing the automated means to raise cash through the sale of U.S. Treasuries, I was a participant in the conduct of manual auctions using hand-held and desk calculators. Even back in the late 1980’s, the auctions were conducted manually, and it was a process that was open to risk of error when calculating and reporting Treasury’s auction results.

When Treasury did manual auctions from the 1930’s to the early 1990’s, it literally took days, and then later in the 1980’s hours to conduct Treasury auctions and issue results. After the Salomon scandal in the early 1990’s, led by Treasury and FRBNY staffs (the Office of Financing in particular), auction automation became a priority of the federal government. In 1993, the initial version of TAAPS® went live. After several revisions were enacted in the late 1990’s and early 2000’s, the auction results were issued within two minutes of the competitive close. All of these automation advances culminated in the latest version of TAAPS® that went live in 2008. The U.S. Government now has at its disposal a fast, efficient, robust, and flawless automated auction process that connects to a few hundred direct bidders. Because the Fast Money Tree has an incredibly complex automation infrastructure, the U.S. Government can borrow billions in minutes, and release the results to the financial press, and investors around the globe in seconds.

This paper is the first comprehensive review of the Treasury auction program, and was written to give the reader a different and more accurate perspective on Treasury’s somewhat complicated, but extremely efficient borrowing process and its historical antecedents.

Because the debt ceiling took center stage during the Spring and Summer of 2011, it seemed appropriate to take a closer look at how the country came so close to a default, and the slippery slope Congress and the President followed to avert a default prior to the August 2, 2011 drop dead date for raising the debt ceiling.¹⁰

An update that covers the recent debt ceiling crisis is provided (Chapter 2), which offers informed opinion and insight regarding the competing philosophies – austerity versus growth - being put forth by political parties in the U.S. and those in Europe.

Chapter 3 presents a plausible and provocative argument that would allow the President of the United States the power under the Constitution to singularly authorize the Secretary of the Treasury to borrow in excess of the statutory limit. Next, Chapter 4 revisits the argument for a return to the gold standard as well as featuring a discussion of the historical significance of the gold clause cases and their relationship to government debt.

Treasury debt managers have long held that the U.S. Government will achieve its desired outcome of borrowing at the lowest possible cost over time by continuous improvement in the auction process, and ensuring that auction results are issued to the public quickly, accurately, and consistently. Chapter 5 and 6 discuss the nuts and bolts of Treasury auctions, and a detailed examination of how the Treasury fulfills its responsibility to routinely raise the necessary funds through the Fast Money Tree in order to carry out the multifaceted and complex operations of the U.S. Government. Also, the process through which critical auction information is disseminated directly, quickly and accurately to the public to achieve substantial cost savings to the taxpayer is thoroughly reviewed. Furthermore, the historical antecedents and significance of speeding up the delivery of auction results is closely examined, along with Treasury’s dealer visits, compliance and contingency programs.

Any study of Treasury auctions must, perforce, include an assessment of the political impact of the 1991 Salomon scandal on today’s auction processes (see Chapter 9). Furthermore, in Chapter 10, a detailed description of the salient features of the Treasury auction process is provided including Treasury’s heralded Primary Dealer visits to monitor dealer auction operations, compliance with auction rules.

Later the Treasury’s auction contingency plans are outlined along with efforts to guard against the threat of global terrorism that reared its ugly head on 9/11, which caused the Treasury to cancel a scheduled auction (see Chapter 13).

Finally, a number of informative appendices have been added, which offer details regarding Treasury’s efforts to remain under the debt ceiling during the 2011 debt ceiling crisis; how Treasury caught China hiding its participation in auctions using the guarantee provision in the auction rules; the workings of the STRIPS program; the emergence of direct bidders in Treasury auctions; the journey to implement two-minute auctions; and a description of the debt buyback program before it was discontinued. Also included are two separate appendices that provide historical information that document auction automation changes from 1992 – 2011, and changes in Treasury auction policies and procedures from 1929 – 2011.

Chapter 2

THE 2011 DEBT CEILING REDUX

What is a Debt Ceiling?

The leading juridical view of the Nation’s borrowing authority can be summed up as follows: Article I Section 8 of the United States Constitution confers the sole power to borrow