The Treasury Department has a problem: too much money.
In a sign of just how radically the dynamics of the federal budget have changed since the sudden advent of budget surpluses last year, Treasury's auctions of bonds, notes and bills threaten to raise more money than the federal government needs for its day-to-day expenses.
One Wall Street analysis estimates the mismatch is so great that unless Treasury significantly reduces its auctions, it could raise $50 billion more than the government needs to spend next year. Instead of increasing the nation's publicly held debt, Treasury is steadily paying it down--$87 billion this fiscal year, according to a White House announcement yesterday (that still leaves about $3.6 trillion in publicly held debt, however).
Treasury has tried several nips and tucks to cut back on its money raising over the past couple of years, chiefly canceling the sale of some shorter-term debt and reducing the auctions of others. Treasury shrank its issuance of new public debt to $2 trillion in 1998, down from $2.3 trillion in fiscal 1997, and there is more downsizing underway this year.
But cutting back on sales of new debt risks destabilizing a crucial market that sets benchmark rates for home mortgages, corporate bonds and many other financial instruments, Treasury officials and Wall Street experts fear. The fewer bonds, notes and bills Treasury offers, the more volatile the market, and the harder it is for traders to set a reliable price.
With the problem growing increasingly acute, sources said Treasury will propose regulations tomorrow to allow it to do something it hasn't done since the 1960s--buy back securities that haven't matured yet. This would stabilize the active market for new government debt and let Treasury move more aggressively to pay down the nation's publicly held debt.
In so-called reverse auctions, Treasury would offer to buy back older bonds and notes, some with such high interest rates that it would have to pay substantial premiums to get bondholders to part with them. That would allow officials to continue selling big chunks of newer, more easily traded debt, which Wall Street analysts say would lower Treasury's overall borrowing costs, along with keeping the market liquid.
Although the program is clearly aimed at inducing large debt holders to cash in older, high-interest-rate securities, even little guys might benefit. A year ago, Treasury lowered the minimum bond purchase from $10,000 to $1,000 in an attempt to give smaller investors a shot at the market. Those same investors might now be eligible to sell their bonds back at a premium.
Treasury hasn't yet released details of the buyback plan, but it is expected to be purely voluntary, since very little of Treasury's debt is "callable"--can be called in before it has matured.
Economists generally approve of the buyback idea. "They'll save the taxpayers some money and make the financial system a little more efficient," said Louis Crandall, chief economist for Wrightson Associates, a Wall Street economic research firm.
Analysts explained that the smooth functioning of the Treasury market is a crucial linchpin for other markets both here and abroad. While Treasury itself sells securities according to a schedule that has become increasingly sporadic, more than $200 billion in government securities are sold and resold every day in a market that investors look on as one of the safest in the world--since Treasury securities are backed by the strongest and richest government in the world.
It is important for that market to remain highly liquid--meaning that securities can be bought and sold quickly and easily. Market psychology dictates that the most liquid of all Treasuries are the newest--so-called on-the-run issues. Increasingly, Treasury will be able to issue new, on-the-run securities only if it begins buying up older, "off-the-run" securities, analysts explained.
Treasury officials refuse to say when or even whether they'll put the buyback plan into operation, or what amount of yet-to-mature securities they would buy back if they did go ahead. But Wall Street has expected such a move for a year or more, and estimates there are that Treasury could buy back anywhere from about $20 billion to $50 billion in securities a year if it starts up the program, which could happen as soon as next spring or summer.
Treasury could do all this without permission from Congress and without tripping any pay-as-you-go budget rules, which require offsets only for spending that results from congressional legislation signed by the president. But Treasury is stepping gingerly, because the program would cost money, potentially quite a lot.
Analysts say Treasury may have to offer substantial premiums to buy back some of the older, high-interest bonds it is likely to target. For example, a 30-year bond issued in November 1991, when interest rates were 8 percent, now trades at a 20 percent premium above its face value, which means Treasury would have to pay $12,000 to buy back a $10,000 bond.
On the other hand, though, a 30-year bond issued just three years ago in 1996, when interest rates were 6 percent, is trading at a 3 percent discount, which means Treasury could buy back a $10,000 bond for $9,700. Treasury would likely buy back a mix of issues.
Even though the buyback program would cost money in the short run, economists say the government stands to save substantial amounts in the long run by lowering its total interest costs. Administration officials worried that the short-run cost might create a political problem, because it would have the effect of reducing the size of the budget surpluses congressional Republicans have already targeted to pay for tax cuts.
But it may be hard to argue with a proposal that would cut the government's overall borrowing costs. And at least at first, the size of the program is likely to be manageable. G. William Hoagland, chief of staff of the Senate Budget Committee, estimated that the net costs in the first year or so would be only about $200 million to $300 million. "I don't think [Republicans] should have a problem" with the proposal, Hoagland said.
The buyback proposal is, in effect, simply a stopgap action to keep the Treasury market the important interest rate-setting forum it is--for now. If the government continues to pay down the national debt, Treasury borrowing will eventually shrink to the point of insignificance, and corporate bonds and other high-grade securities will have to take over the rate-setting function now performed by Treasuries.
"The capital markets are . . . adaptable," Deputy Treasury Secretary Stuart Eizenstat said in a written answer to a question during his Senate confirmation. "We believe that the capital markets will adjust, as they have done time and time again."