oversight

Debt Management: Buybacks Can Enhance Treasury's Capacity to Manage under Changing Market Conditions [Reissued on March 21, 2012]

Published by the Government Accountability Office on 2012-03-07.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States Government Accountability Office

GAO          Report to the Secretary of the Treasury




March 2012
             DEBT MANAGEMENT

             Buybacks Can
             Enhance Treasury’s
             Capacity to Manage
             under Changing
             Market Conditions




               Revised on March 21, 2012 to clarify information on page 17.
               The corrected section should read: Agence France Tresor
               officials told us that the flexibility of bilateral trades helps them to
               minimize borrowing costs.




GAO-12-314
                                               March 7, 2012

                                               DEBT MANAGEMENT
                                               Buybacks Can Enhance Treasury’s Capacity to
                                               Manage under Changing Market Conditions
Highlights of GAO-12-314, a report to the
Secretary of the Treasury




Why GAO Did This Study                         What GAO Found
The U.S. Treasury market is the                Debt buybacks can help advance Treasury’s goals under a variety of budget and
deepest and most liquid debt market in         market conditions. For example, Treasury currently faces rollover peaks—large
the world. Liquidity is important to a         increases in the amounts of maturing debt that must be refinanced at a given
well-functioning Treasury market and           time (see fig.)—which expose Treasury to the risk of refinancing large amounts of
for lowest cost borrowing over time.           debt when interest rates are less favorable. All four of our case study countries
Exploring various debt management              use debt buybacks to mitigate rollover risk. Buybacks can also be used to
tools can assist Treasury in                   enhance liquidity, which can be adversely affected when the growth in borrowing
maintaining liquidity as budget and            slows rapidly and issue sizes decline significantly. GAO’s illustrative analysis of
market conditions change.
                                               Treasury’s past buyback program showed that, had Treasury refinanced the debt
To help maintain an efficient Treasury         by simultaneously issuing new debt, it could have captured a liquidity premium—
market, Treasury needs the ability and         the additional price investors are willing to pay for securities that can be easily
flexibility to actively manage the mix of      traded—which would reduce interest costs.
outstanding securities and respond to
market disruptions. Debt buybacks—             Treasury Notes and Bonds Maturing
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             Note: Does not include future debt issuance to refinance maturing debt or finance new borrowing
and those of Canada, France,                   needs.
Germany, and the United Kingdom and            Implementing a well-designed buyback program could help Treasury minimize
analyzed the costs and benefits.               borrowing costs over time. Other countries have used both reverse auctions—a
                                               process in which participants submit competitive offers to sell particular
What GAO Recommends                            securities—and bilateral trades—transactions between the government and
To have flexibility to respond to              specific holders of a security. Of these, reverse auctions are most consistent with
potential changes in market conditions,        Treasury’s principles. However, if certain features of bilateral trades were
GAO recommends that Treasury build             modified, they could be useful for responding to unforeseen market disruptions.
the capacity for buyback and switch            Participation in a buyback program would be encouraged by a regularly
auction programs as well as bilateral          scheduled program, with a clear purpose and timely announcement of
trades or debt exchanges.                      operations. Also, because greater participation fosters competition, broadening
Treasury concurred with the findings           the eligibility to participate beyond primary dealers should be explored.
and said the report would be very              Switches and debt exchanges—tools similar to buybacks that involve early
useful in analyzing tools that increase        redemption of securities in exchange for liquid benchmark securities—could also
their flexibility.                             be used to manage rollover peaks and help maintain liquidity. They could also
View GAO-12-314. For more information,         have the added advantage of broadening Treasury’s investor base by appealing
contact Susan J. Irving at (202) 512-6806 or   to investors that want to maintain the average maturity of their portfolios in ways
irvings@gao.gov.                               that minimize market risk.
                                                                                               United States Government Accountability Office
Contents


Letter                                                                                   1
              Background                                                                 3
              Debt Buybacks Can Help Advance Treasury’s Goals under a Variety
                of Budget and Market Conditions                                          8
              A Well-Designed Buyback Program Can Promote Lowest-Cost
                Financing over Time                                                    16
              Switches and Debt Exchanges Could Also Be Used to Manage
                Rollover Peaks and Help Maintain Liquidity                             26
              Conclusions                                                              31
              Recommendations for Executive Action                                     33
              Agency Comments and Our Evaluation                                       33

Appendix I    Objectives, Scope, and Methodology                                        35



Appendix II   GAO Contact and Staff Acknowledgments                                     39



Tables
              Table 1: Illustrative Estimate of Long-Term Cost Savings from
                       Financing Treasury 2000-2002 Buybacks with New Debt             14
              Table 2: Buyback Methods Used by Case Study Countries                    17
              Table 3: Results of Canadian Switch Auction Held on
                       September 28, 2011 (amounts in CAD)                             27


Figures
              Figure 1: Treasury Notes and Bonds Maturing                                4
              Figure 2: Deficits Decline in Next Several Years under Different
                       Assumptions                                                       6
              Figure 3: Impact of Buybacks on Amounts of Maturing Canadian
                       Securities                                                       9
              Figure 4: November 2011 Auction Schedule                                 20




              Page i                                   GAO-12-314 Debt Management - Buyback
Abbreviations

CAD               Canadian dollars
CBO               Congressional Budget Office
CRSP              Center for Research in Security Prices
FRBNY             Federal Reserve Bank of New York
OECD              Organisation for Economic Co-operation and Development
TAAPS             Treasury Automated Auction Processing System
TRAPS             Trading Room Auction Processing System
Treasury          U.S. Department of the Treasury
U.K.              United Kingdom




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Page ii                                           GAO-12-314 Debt Management - Buyback
United States Government Accountability Office
Washington, DC 20548




                                   March 7, 2012

                                   The Honorable Timothy F. Geithner
                                   Secretary of the Treasury

                                   Dear Mr. Secretary:

                                   The U.S. Treasury market is the deepest and most liquid government
                                   debt market in the world. This assists the U.S. Department of the
                                   Treasury (Treasury) as it seeks to finance the federal government’s
                                   borrowing needs at the lowest cost over time. Today—in part due to the
                                   economic slowdown and global financial crisis that brought about a flight
                                   to quality—interest rates on U.S. Treasury securities are at historic lows.
                                   Nevertheless, exploring the benefits of various debt management tools
                                   can assist Treasury in the continued achievement of its debt management
                                   goal in future years as economic and market conditions change.

                                   As part of our ongoing work on debt management issues and under the
                                   Comptroller General’s authority, we examined debt buybacks—a debt
                                   management tool that enables debt managers to actively manage the mix
                                   of outstanding Treasury securities by redeeming particular marketable
                                   securities prior to their maturity dates using a voluntary process. The
                                   United States used debt buybacks from 2000 through 2002 as part of
                                   managing declining debt during a time of surplus; other countries use
                                   them to address debt management issues even during times of deficit or
                                   increasing debt. Specifically, we 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 objectives similar to those
                                   of a U.S. buyback program.

                                   To address these objectives, we examined Treasury’s 2000-2002
                                   buyback program as well as the buyback programs and similar debt
                                   management tools used in Canada, the United Kingdom (U.K.), France,
                                   and Germany. We selected countries that are members of the
                                   Organisation for Economic Co-operation and Development (OECD) and
                                   whose sovereign debt markets are most similar to the United States in
                                   terms of size and liquidity. We analyzed the cost of Treasury’s buybacks,
                                   including the extent to which Treasury could have reduced its interest
                                   costs had it “re-financed” its buybacks by simultaneously issuing new
                                   debt. We largely used data from Treasury and the Center for Research in


                                   Page 1                                   GAO-12-314 Debt Management - Buyback
Security Prices (CRSP) for this analysis. To assess the reliability of CRSP
data, we compared them to another published source of similar data and
discussed any differences with the data providers. We determined that
such differences were likely due to methodological differences between
the two sources and were consistent with industry practices. To assess
the reliability of the Treasury data, we also compared them to another
published source of similar data and found them consistent. Based on
these assessments, we determined that the Treasury and CRSP data
were sufficiently reliable for our purposes. We interviewed officials from
Treasury’s Office of Debt Management and the Bureau of the Public Debt
and from the Board of Governors of the Federal Reserve System and the
Federal Reserve Bank of New York (FRBNY)—one of the Federal
Reserve Banks serving as Treasury’s fiscal agent. We also interviewed
officials from the Canadian Department of Finance and the Bank of
Canada, the U.K. Debt Management Office, Agence France Tresor
(France’s debt agency), and the German Finance Agency. 1 The
experiences of our case study countries are not generalizable, but they
provide illustrative examples of the use of buybacks and other debt
management tools. We obtained perspectives from market participants,
including four primary dealers and two large investors, and two market
analysts. To assess the operational features that would support
Treasury’s borrowing goals, we analyzed the extent to which features of
Treasury’s past buyback program and the features of other countries’
buyback programs are consistent with Treasury’s debt management
goals and principles. See appendix I for more information on our scope
and methodology. On December 13, 2011, we briefed Treasury officials
on our findings and expected recommendations.

We conducted this performance audit from November 2010 to March
2012 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a reasonable basis for
our findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.




1
 We interviewed officials from Canada’s central bank because of the large role the central
bank plays in buybacks. We did not interview central bank officials from the United
Kingdom, France, or Germany because their buybacks role was limited.




Page 2                                            GAO-12-314 Debt Management - Buyback
             To achieve its primary debt management objective of financing the
Background   federal government’s borrowing needs at the lowest cost over time,
             Treasury issues debt through a regular and predictable schedule of
             auctions across a wide range of securities. Treasury marketable
             securities consist of bills that mature in a year or less, notes with original
             maturities of more than 1 to not over 10 years, and bonds with original
             maturities of more than 10 years. 2 Treasury seeks to appeal to a broad
             range of investors and to provide the market with a high degree of
             stability in the amount issued of each security, particularly for longer-term
             securities. 3 Financing across the yield curve (that is, issuing short-,
             medium-, and long-term debt) appeals to the broadest range of investors,
             mitigates refunding and market rate risks, and provides the market with a
             pricing mechanism for setting interest rates. These all contribute to overall
             market liquidity and promotion of efficient capital markets. In a liquid
             market, trading can be completed at will and the offer and purchase
             prices differ only slightly. Liquidity is important to Treasury because liquid
             securities can be auctioned at lower rates and thus minimizes Treasury
             borrowing costs.

             The mix of outstanding Treasury securities can significantly influence both
             rollover risk and the federal government’s borrowing cost. Longer-term
             nominal securities typically carry higher interest rates, primarily due to
             investor concerns about interest rate risk, part of which is inflation for
             nominal securities. In general, risk premiums and therefore interest rates
             are higher for longer-term debt than for shorter-term debt. In contrast,
             shorter-term securities generally carry lower interest rates but add
             uncertainty to the government’s interest costs and require Treasury to
             conduct more frequent auctions to refinance maturing debt, which
             increases rollover risk—the risk that Treasury will have to refinance its
             debt at less favorable interest rates.


             2
              Treasury issues both nominal and inflation-adjusted notes and bonds. In addition to
             marketable securities—which can be resold by whoever owns them—Treasury issues
             nonmarketable securities, such as savings securities and special securities for state and
             local governments that cannot be resold.
             3
              We have previously reported on the benefits of diversifying Treasury’s investor base and
             collecting information to gauge investor demand. See GAO, Debt Management: Treasury
             Inflation Protected Securities Should Play a Heightened Role in Addressing Debt
             Management Challenges, GAO-09-932 (Washington, D.C.: Sept. 29, 2009) and Debt
             Management: Treasury Was Able to Fund Economic Stabilization and Recovery
             Expenditures in a Short Period of Time, but Debt Management Challenges Remain,
             GAO-10-498 (Washington, D.C.: May 18, 2010).




             Page 3                                            GAO-12-314 Debt Management - Buyback
One of the debt management challenges that Treasury will continue to
face in the next several years will be rollover peaks—large increases in
the amounts of maturing debt that must be refinanced at a given time
(see fig. 1). Such peaks expose Treasury to the risk of refinancing an
especially large amount of maturing debt at a time when interest rates are
less favorable. Current interest rates on U.S. Treasury securities are at
historical lows, in part because of the global economic downturn and
investors’ demand for liquid, risk-free assets; interest rates are, however,
expected to increase as the economy recovers.

Figure 1: Treasury Notes and Bonds Maturing




Note: Does not include future debt issuance to refinance maturing debt or finance new borrowing
needs. Therefore, the amounts maturing in 2014 and 2015 do not reflect any 2- or 3-year notes that
will be issued in 2012 and 2013.


The rollover peaks Treasury faces are primarily the result of increased
short-term borrowing following the onset of the economic recession in




Page 4                                                 GAO-12-314 Debt Management - Buyback
December 2007. 4 In 2008 and 2009, in response to the recession and the
financial crisis, Treasury dramatically increased issuance of bills and 2-,
3-, and 5-year notes. These actions shortened the average maturity of the
Treasury’s debt portfolio and are now resulting in large amounts of debt
maturing in 2012 and 2013. For example, the amount of notes and bonds
maturing in 2011 was $866 billion and the amount in 2012 is $1,253
billion. Treasury has taken steps to extend the average maturity of the
portfolio and reduce rollover risk. For example, Treasury reduced bills as
a share of its debt outstanding since 2009. Although the average maturity
of the portfolio has lengthened from 55 months in December 2007 to
slightly more than 62 months in December 2011, it is still shorter than that
of other developed countries.

Liquidity is important to a well-functioning Treasury market. Liquidity is
also important to Treasury because investors are willing to pay more for
liquid securities that can be easily traded, resulting in lower borrowing
costs for Treasury. 5 Liquidity can be adversely affected when the growth
in borrowing slows and issue sizes decline significantly. Even at very high
(and growing) levels of outstanding debt, there would be a decline in net
borrowing needs when federal deficits decline. Federal deficits have been
at record highs in recent years, reaching $1,413 billion in fiscal year 2009.
Both a projection assuming continuation of current law and an alternative
fiscal scenario that assumes recent policies continue show deficits
declining below $1 trillion in the next several years; the rate of decline
differs depending on the assumptions used (see fig. 2). Federal tax
receipts would grow and spending on programs like unemployment
benefits would decrease with economic growth. In addition, the waning of
spending to support the economic recovery and the mechanisms imposed
by the Budget Control Act of 2011, 6 such as discretionary spending caps
and sequestration, will also likely reduce federal spending. Nevertheless,
we cannot “grow our way out of” the long-term fiscal challenge; the




4
 The economic downturn along with the federal government’s response to it and other
actions taken to stabilize financial markets contributed to a rapid buildup in federal debt
held by the public—increasing from roughly 36 percent of gross domestic product at the
end of 2007 to roughly 68 percent at the end of fiscal year 2011.
5
 For example, we reported in 2009 on the impact of illiquidity on the cost of borrowing
using Treasury Inflation Protected Securities. See GAO-09-932.
6
Pub. L. No. 112-25, 125 Stat.239 (Aug. 2, 2011).




Page 5                                              GAO-12-314 Debt Management - Buyback
                                         declines in the deficit are projected to be short-lived and borrowing needs
                                         projected to increase again. 7

Figure 2: Deficits Decline in Next Several Years under Different Assumptions




                                         Note: Data are from the Congressional Budget Office (CBO), The Budget and Economic Outlook:
                                         Fiscal Years 2012 to 2022 (January 2012). The current law projections reflect sharp increases in
                                         revenues that will occur if tax provisions expire as scheduled and sharp reductions in Medicare’s
                                         payment rates for physicians’ services scheduled under current law. However, those assumptions
                                         differ from historical policy actions. In CBO’s alternative fiscal scenario, certain tax provisions that
                                         have expired or are set to expire are extended, the alternative minimum tax exemption amount is
                                         indexed to inflation, and Medicare payment rates for physician services are held constant.


                                         Treasury can take several steps to respond to a decline in net borrowing
                                         needs, including reducing the size of new issues, reducing the frequency
                                         of auctions, and eliminating the offerings of certain securities. However,




                                         7
                                          See GAO, The Federal Government’s Long-Term Fiscal Outlook: Fall 2011 Update,
                                         GAO-12-28SP (Washington, D.C.: October 2011).




                                         Page 6                                                      GAO-12-314 Debt Management - Buyback
any rapid decline presents some debt management challenges. 8
Shrinking the size of some new issues could reduce Treasury’s flexibility
to sustain liquid markets across the wide variety of instruments desired by
potential investors. Further, changes in the frequency of auctions or in the
types of securities auctioned can reduce the regularity and predictability
of Treasury operations; this would be especially problematic if the trend in
borrowing needs turned out to be short-lived and the changes would have
to be reversed. Both Treasury and market participants place a high value
on the regular and predictable nature of Treasury’s approach to financing
the government.

Market disruptions—or illiquidity in particular maturities—can occur when
there are supply-demand imbalances in the Treasury market. For
example, demand may increase when investors flee other holdings in
search for safety or fall when they rebalance their portfolios through
purchases of riskier assets offering a higher return. While rollover peaks
and a decline in borrowing needs pose foreseeable risks to Treasury,
market disruptions are more difficult to anticipate. There were significant
supply and demand imbalances in the Treasury market during the
financial crisis in 2008. 9 To help maintain an efficient Treasury market
that promotes lowest cost borrowing over time, Treasury must have tools
that provide for sufficient flexibility to respond to any market disruptions.




8
 We previously reported on the challenges of managing declining debt. See GAO, Federal
Debt: Debt Management in a Period of Budget Surplus, GAO/AIMD-99-270 (Washington,
D.C.: Sept. 29, 1999) and Federal Debt: Debt Management Actions and Future
Challenges, GAO-01-137 (Washington, D.C.: Feb. 28, 2001).
9
 Demand for Treasury securities increased because lenders became reluctant to lend
against mortgage-related securities, demanding higher-quality collateral. At times during
the crisis, unusually high demand for certain Treasury securities resulted in negative
yields on those securities.




Page 7                                            GAO-12-314 Debt Management - Buyback
Debt Buybacks Can
Help Advance
Treasury’s Goals
under a Variety of
Budget and Market
Conditions

Debt Buybacks Help           Debt buybacks can be used to mitigate rollover risk while also promoting
Mitigate Rollover Risk and   liquidity. All four of the countries we studied—Canada, France, Germany,
Can Enhance Liquidity        and the United Kingdom—use buybacks to smooth peaks in their maturity
                             profile, even in times of budget deficits. The U.K. Debt Management
when Net Borrowing           Office buys back securities with 6 or fewer months remaining to maturity
Needs Decline and when       to smooth maturity peaks. France also uses buybacks to smooth maturity
There Are Market             peaks. According to officials from Agence France Tresor, this practice
Disruptions                  helps them avoid having to issue abnormally large amounts of debt on a
                             particular day to raise the funds to pay the maturing securities. Similarly,
                             the German Finance Agency buys back debt to smooth maturity peaks,
                             although it does not limit those trades to securities with a specific time
                             remaining until maturity. The Canadian government buys back securities
                             with 18 or fewer months remaining to maturity to smooth maturity peaks.
                             For example, in its 2010/2011 fiscal year, Canada bought back $21.9
                             billion in this cash management bond buyback program. According to
                             officials from the Canadian Department of Finance, buying back securities
                             from key maturity dates helps reduce the high levels of cash balances
                             needed for large maturity dates and helps smooth variations in their bill
                             auction sizes over the year. For example, in 2010, early redemptions
                             (including both buybacks and switches, discussed later in this report)
                             reduced the size of Canada’s June 1, September 1, and December 1
                             bond maturities by 44 percent (see fig. 3).




                             Page 8                                    GAO-12-314 Debt Management - Buyback
Figure 3: Impact of Buybacks on Amounts of Maturing Canadian Securities




                                       The challenges rollover peaks pose to U.S. Treasury debt managers
                                       differ from those faced by our case study countries. Because other
                                       countries have smaller sovereign debt markets than the United States,
                                       some rely more heavily on fewer key maturity dates to enhance liquidity.
                                       For example, until recently, Canada concentrated its securities around
                                       four large single-day bond maturities and coupon payment dates: March
                                       1, June 1, September 1, and December 1. According to Canadian
                                       officials, such concentration is helpful in maintaining benchmark liquidity,
                                       particularly in an environment of declining debt issuance, but also
                                       increases rollover risk. Market participants pointed out that Treasury’s
                                       regular and predictable schedule of auctions spread throughout the year,
                                       across maturities, and in different products (nominal coupons, Treasury
                                       Inflation Protected Securities, and bills) mitigates this risk and helps to
                                       keep monthly rollover peaks at a manageable size, though rollover peaks
                                       may still exist due to historical issuance patterns. Also, some market
                                       participants said that Treasury’s bill market can provide the necessary



                                       Page 9                                    GAO-12-314 Debt Management - Buyback
flexibility to adjust issuance for these peaks. As discussed earlier,
Treasury faces annual—rather than monthly or daily—rollover peaks in
the next several years. In fiscal year 2011, Treasury funded the budget
deficit of $1,296 billion with net marketable borrowing totaling $1,104
billion. Because the deficit is estimated to decline to $585 billion in fiscal
year 2013 under current law, if Treasury held net issuance constant, it
would have excess funds that it could use to buy back debt to reduce
maturity peaks in coming years.

Debt buybacks can help Treasury minimize changes to its regular auction
schedule and maintain or enhance liquidity in times of declining, albeit still
high, budget deficits. Prior to Treasury’s past buyback program, it initially
responded to declining deficits by reducing the number of coupon
auctions, eliminating the offerings of some securities, and reducing
auction sizes, particularly of bills. However, this raised concerns about
maintaining liquidity in the remaining issues and increasing the average
maturity of Treasury’s debt portfolio. Buybacks enable debt managers to
delay or avoid making further changes to the auction calendar and to
maintain issuance of its benchmark securities in greater volume than
would otherwise be possible. Over the long run, this enhanced flexibility
should help minimize borrowing costs by increasing the predictability of
Treasury’s debt issuance. According to Canadian debt management
officials, Canada used bond buybacks to minimize or smooth changes to
the auction schedule not only during years of surplus but also when net
borrowing needs were low. Also, because Treasury could continue to
increase new issue sizes and use the proceeds to buy back older off-the-
run securities that are generally less liquid, 10 overall market liquidity was
maintained or improved. 11 Enhanced liquidity promotes more efficient
capital markets and so reduces the government’s cost of borrowing.

Buybacks can also help increase liquidity during market disruptions. For
example, Treasury officials and others told us that buybacks could have
provided additional liquidity to the market during the 2007-2009 financial


10
  A security is “off-the-run” when it is not the most recently auctioned security of a given
maturity. Conversely, an “on-the-run” security is the newest issue of its maturity. On-the-
run securities are normally more liquid than their off-the-run counterparts because as
securities age they find their way into buy-and-hold investor portfolios and are less actively
traded.
11
  M.J. Fleming, “Are Larger Treasury Issues More Liquid? Evidence from Bill Reopenings”
Journal of Money, Credit, and Banking, Vol. 34, No. 3 (August 2002, Part 2), pp. 707-735.




Page 10                                             GAO-12-314 Debt Management - Buyback
crises. During that time large banks were looking to free up balance sheet
capacity to take on additional risk or increase lending. A buyback program
could have enabled Treasury to repurchase off-the-run Treasury
securities at significant discounts and simultaneously enhance secondary
market liquidity. Several primary dealers suggested that the presence of a
large buyer in the market can help address, or may actually help prevent,
such market disruptions. One primary dealer said that the market now
assumes that securities will become illiquid over time. If the market knows
that Treasury will more actively manage liquidity, it will increase overall
Treasury market efficiency and investors will pay more for Treasury
securities upfront, thereby reducing Treasury’s borrowing costs. They
noted, however, that when the Federal Reserve conducts large-scale
asset purchases, it plays the role of a large buyer so the Treasury would
want to avoid buying at that time.

Alternatively, buybacks can be used to build liquidity of certain benchmark
issues. In 2011 Canada reintroduced buybacks of 10- and 30-year bonds
to support the size of new issue auctions for those specific securities,
which were generally less liquid than Canada’s 2-, 3-, and 5-year
securities. An official from the Bank of Canada noted that there is high
demand in the 10- and 30- year sectors from pension funds and
insurance companies that want to match the time frames of their assets
with their liabilities.

Two of our case study countries used buybacks more extensively during
periods of budget surplus. Canada and the United Kingdom used
buybacks to enhance liquidity during times of surplus in the early 2000s.
By concentrating debt into fewer, larger benchmark issues, governments
are able to capture a liquidity premium in the market that reduces their
cost of financing. 12 In the early 2000s the United Kingdom had a buyback
program. At that time, the United Kingdom was in budget surplus and
revenues were higher than the debt management office had anticipated.
The Canadian government began its buyback program in 1999 and used
buybacks to promote liquidity more heavily in years when net borrowing
needs were lower. For example, in fiscal year 2009/2010, when net
issuance was over $100 billion, the government did not buy back any
debt for the purpose of enhancing liquidity by building benchmark



12
  A liquidity premium is the incremental price market participants are willing to pay for
securities that are part of large issues that can be easily traded.




Page 11                                             GAO-12-314 Debt Management - Buyback
securities, but in fiscal year 2002/2003, when net issuance was about $32
billion, the Canadian government bought back over $7 billion for liquidity
enhancement. 13

In the early 2000s, a period of budget surpluses in the United States,
Treasury used debt buybacks to manage the maturity structure of the
debt portfolio. From 2000-2002, Treasury held 45 reverse auctions to
redeem securities with 10 or more years remaining to maturity. 14 Treasury
was able to finance these buybacks by maintaining issue sizes of its
benchmark securities. By redeeming longer-dated securities and
maintaining issuance of its shorter-term debt securities, debt buybacks
helped Treasury limit the lengthening of the average maturity of the debt
portfolio. For example, Treasury reported in November 2000 that
buybacks limited the lengthening of the average maturity of the debt
portfolio by 2 months. Treasury manages the average maturity of the debt
portfolio to balance risk and borrowing cost.

Treasury and FRBNY staff also examined several measures of the
performance of Treasury’s past program. For example, coverage ratios—
the ratio of offers made to those accepted—for the reverse auctions
ranged from a low of 2.14 to a high of 8.98; one indicator of strong market
demand for buybacks. 15 According to Treasury officials, the coverage
ratios for buybacks in calendar year 2000 were generally larger than the
ratio for auctions of Treasury securities. Also, Treasury’s and other’s
studies indicated that Treasury bought the securities back at competitive
market prices. 16




13
  In fiscal year 2002/2003 Canada also bought back $12.9 billion of near maturity bonds
for its cash management bond buyback program and redeemed $5.0 billion in bonds early
in switch auctions. In fiscal year 2009/2010, Canada redeemed $2.1 billion in bonds early
in switch auctions.
14
 A reverse auction is a process in which participants submit competitive offers to sell
particular Treasury securities to the Treasury.
15
 K.D. Garbade and M. Rutherford, Buybacks in Treasury Cash and Debt Management,
Federal Reserve Bank of New York Staff Reports, No. 304 (October 2007).
16
  B. Han, F.A. Longstaff, and C. Merrill, “The U.S. Treasury Buyback Auctions: The Cost
of Retiring Illiquid Bonds” The Journal of Finance, Vol. 62, No. 6 (December 2007), pp.
2673-2693.




Page 12                                            GAO-12-314 Debt Management - Buyback
Buybacks Can Reduce        The indirect cost reduction from the impact of buybacks on overall market
Long-Term Borrowing        liquidity is not the only way in which buybacks may reduce the
Costs Even if Market       government’s borrowing cost over time. Buybacks also provide direct
                           savings because investors are willing to sell their older, off-the-run
Conditions Make Them       securities at prices lower than the market price for otherwise comparable,
Costly in the Short Term   on-the-run securities that are generally more liquid. All of the case study
                           countries cited reducing overall borrowing costs as a benefit of their
                           buyback programs. Although these direct savings were not a primary goal
                           of Treasury’s prior buyback program, they were a secondary benefit. We
                           analyzed the results of Treasury’s buybacks from 2000-2002 and
                           estimate for illustrative purposes that if Treasury had financed the prior
                           buyback operations by issuing additional securities of the same average
                           duration as the securities bought back and at the prevailing market
                           interest rates of the time, 17 it would have paid $3 billion, or about 3.3
                           percent, less than the value of the repurchased debt (see table 1). 18




                           17
                             Duration is a measurement of how long, in years, it takes for the price of a security to be
                           repaid by its internal cash flows. Duration is affected by the time remaining to maturity, the
                           schedule of coupon payments, and the coupon (i.e., interest) rate of the security.
                           18
                             Although refinancing is a useful way to estimate the potential cost savings of buybacks,
                           Treasury’s practice of regular and predictable debt issuance creates operational and
                           timing issues that preclude Treasury’s ability to simultaneously fund buybacks with new
                           issues equal to the average duration of securities repurchased.




                           Page 13                                             GAO-12-314 Debt Management - Buyback
Table 1: Illustrative Estimate of Long-Term Cost Savings from Financing Treasury
2000-2002 Buybacks with New Debt

          Price paid & refinancing                                                   Long-term savings
          a
    Price paid
    for repurchased
    debt (equal to the
    dollar amount of                         Estimated                 Value of reduced     Value of reduced
                                                     c
    hypothetical newly               present value of                  borrowing costs      borrowing costs
    issued debtb)                   repurchased debt                          (dollars in   (as % of value of
    (dollars in billions)          (dollars in billions)                        billions) repurchased debt)
    88                                                       91                              3           3.3%
Source: GAO analysis of data from Treasury and the Center for Research in Security Prices.
a
    Includes accrued interest.
b
 For simplicity, we assume Treasury issued new debt in the same amounts as prices paid for the
repurchased debt, with the same average duration—18.6 years on average—as repurchased debt,
and at par values. We also assumed that Treasury’s additional issuance would not have altered
market rates, which in all likelihood they would have done.
c
 Discounted to present values using estimated market rates for newly issued debt on the date of each
buyback operation.


Even when buybacks provide interest savings over the long term, under
some market conditions they are costly in the short term. Specifically, if
interest rates at the time of the buyback are lower than the coupon rates
on the securities being bought back, Treasury will have to pay a premium
over the par value of the securities. In the 2000-2002 buyback program,
Treasury paid $87.3 billion to buy back $67.5 billion in outstanding
securities. The $19.8 billion premium Treasury paid was a cost to
Treasury during the buyback period. However, this premium was more
than offset by reduced borrowing costs over the long term because
Treasury avoided paying higher coupon rates for the remaining term of
the bond. In contrast, if interest rates at the time of a buyback are higher
than the coupon rates on the securities subject to buyback, Treasury
would be able to buy back the securities at a discount from their par
value. Such buybacks would show cost savings in the short term, but
these savings would be offset by the payment of higher coupon rates on
the newly issued bond over the long term. Regardless of the premium or
discount paid during the buyback period because of relative interest rates,
the key savings of a buyback program arise from being able to purchase
older, off-the-run securities at a lower price because of their illiquidity
relative to new issues.

The premium paid to buy back securities is recorded as a cost in the
financial statements, but it does not affect the budget deficit or surplus.
Budgetary treatment is neutral in that any premium or discount would be


Page 14                                                                  GAO-12-314 Debt Management - Buyback
recorded as a “means of financing” in the year of the buyback and does
not affect the budget deficit or surplus. Financial accounting, however,
records the immediate loss or gain in the year of the buyback since
financial statements provide information on the operating cost of
government for a single year. 19 Over time both the financial statement
and the budget would reflect lower borrowing costs, but the reduction
would not be shown as attributable to any buyback program. Some of the
case study countries take a different approach to accounting for buyback
premiums and losses. For example, for its cash basis bond buybacks,
Canada amortizes the buyback premium or discount over the remaining
term-to-maturity of the security bought back or the related issuance,
whichever is shorter. Such an approach would not be consistent with U.S.
financial accounting standards.

Overall, market participants we spoke with thought a U.S. buyback
program could help Treasury maintain a more liquid and efficient market
and address market disruptions. One explained that the announcement of
Treasury’s ability and willingness to use a buyback program to address
illiquidity or potential market disruptions might actually help prevent such
disruptions. Market participants would be assured that there is a large
and consistent buyer of illiquid securities, which increases confidence in
the Treasury market. We heard from primary dealers that having a large
buyer in the market helps to maintain liquidity of outstanding securities.
For example, three primary dealers noted that the Federal Reserve’s
large-scale purchases of Treasury securities from 2009 through 2011
helped to enhance the liquidity of Treasury securities. 20




19
 U.S. generally accepted accounting principles state that gains and losses shall not be
amortized into future periods (see Federal Accounting Standard Board codification 470-
50-40-2).
20
  The Federal Reserve’s large-scale asset purchase program involves purchasing
hundreds of billions of dollars of long-term Treasury securities and other financial
instruments (e.g., mortgage-backed securities) to help bolster the economy. These
purchases result in a reduction in interest rates, which reduces businesses’ cost of
borrowing to finance new investments. For an analysis of the liquidity effects of the
Federal Reserve’s earlier asset purchases, see J. Gagnon, M. Raskin, J. Remache, and
B. Sack, “Large Scale Asset Purchases by the Federal Reserve: Did They Work” Federal
Reserve Bank of New York Staff Reports, No. 441 (March 2010).




Page 15                                           GAO-12-314 Debt Management - Buyback
                            If and when Treasury decides to reinstitute a buyback program, it would
A Well-Designed             again need to make decisions about operational features, which may vary
Buyback Program             depending on the purpose of the program. The key questions include the
                            method for determining the price of repurchased securities paid by the
Can Promote Lowest-         government, schedule of buyback operations, communication about
Cost Financing over         purpose and timing, eligible participants, and the securities targeted for
Time                        early redemption.


Reverse Auction Method      The price paid by the government is determined in part by the method in
for Determining Security    which buyback operations are conducted. Our case study countries use
Prices Is Most Consistent   two different methods to buy back outstanding debt—reverse auctions
                            and bilateral trades. Reverse auctions are transactions where securities
with Treasury’s Debt        are bought back in a competitive bidding process that provides equal
Management Principles,      access to eligible participants. In contrast, bilateral trades are
but Carefully Designed      transactions between a government’s debt management office and
Bilateral Trades May Also   specific holders of a security. In most of our case study countries, the
Be Feasible under Certain   price in a bilateral trade is either set up front by the debt management
Conditions                  office or determined by offers in the secondary market. As conducted in
                            our case study countries, bilateral trades are less transparent than
                            reverse auctions. In reverse auctions, the targeted amount and eligible
                            securities are announced in advance of the auction and the results are
                            announced shortly after the auction. The amount purchased through
                            bilateral trades in other countries is typically subjected to the debt
                            management office’s discretion and the results are not typically reported.

                            Of these two methods, reverse auctions are more consistent with
                            Treasury’s principles, which emphasize transparency and equal access in
                            its transactions. Treasury used reverse auctions from 2000-2002. If,
                            however, there are debt management challenges for which bilateral
                            trades might be more useful than reverse auctions, certain features of
                            bilateral trades could be modified to make such an approach more
                            consistent with Treasury’s debt management principles. For example,
                            because market disruptions are unforeseen, it could be difficult to set up a
                            reverse auction in such a circumstance. Bilateral trades could be useful to
                            address certain unforeseen market disruptions because they could be
                            conducted on short notice. Other countries have said that bilateral trades
                            are more flexible and can be used to achieve this purpose. In addition,
                            Treasury could use bilateral trades to buy back the most illiquid securities.

                            All our case study countries except Germany use or have used reverse
                            auctions to manage their outstanding debt; Germany, France, and the
                            United Kingdom currently use bilateral trades (see table 2).


                            Page 16                                   GAO-12-314 Debt Management - Buyback
Table 2: Buyback Methods Used by Case Study Countries

 Country                 Reverse auction                Bilateral trades
 Canada                  X (currently)
 France                  X (2000-2006)                  X (currently)
 Germany                                                X (currently)
 United Kingdom          X (2000-2001)                  X (currently)
Source: GAO analysis.



The French government used reverse auctions from 2000-2006 to
manage its outstanding debt but now uses bilateral trades because it
sees them as more flexible and easier to conduct than reverse auctions.
These are not announced in advance. Rather, the primary dealers are
generally aware of the debt management office’s interest in buybacks and
the debt management office purchases bonds over the counter when they
receive offers. The current financing rate is the limit on what it would pay
to buy back a security. Agence France Tresor officials told us that the
flexibility of bilateral trades helps them to minimize borrowing costs.

Bilateral trades are also used by both the British and German
governments. To smooth cash flow, the British government currently
repurchases securities with only 6 months left to maturity. The U.K. Debt
Management Office makes an offer in response to a request from a
primary dealer; neither the price nor the results of individual trades is
publicly reported. The Debt Management Office’s offer takes into account
money market conditions and its prevailing cash position. The British
government used reverse auctions from 2000-2001 to maintain the
liquidity of benchmark issues during a time of budget surplus. Officials
from the U.K. Debt Management Office told us they reserve the right to
reintroduce reverse auctions if deficits decline. The German Finance
Agency is an active participant in the secondary market for German
government securities and regularly uses bilateral trades to help smooth
maturity peaks, enhance liquidity of specific bonds, and reduce
government borrowing costs. The German Finance Agency does not
announce the purpose or specifics of its buybacks in advance and does
not report results of the bilateral trades. It determines which bonds to buy
back based on market prices and the liquidity and maturity dates of the
bonds.

Treasury has not conducted bilateral trades for its debt management
operations in recent history, but this year it used them for the more limited
purpose of selling certain assets. In March 2011 Treasury began selling



Page 17                                    GAO-12-314 Debt Management - Buyback
                      its portfolio of mortgage-backed securities worth $142 billion, at a rate of
                      up to $10 billion per month, as market conditions permit. These
                      transactions are conducted on Treasury’s behalf by a third party vendor.
                      Eligible buyers can make offers for specific securities and the third party
                      that manages the program has the option of accepting or declining their
                      bids with a goal of maximizing value for the taxpayer. Treasury sees this
                      method as appropriate for obtaining the best return for the taxpayer in
                      selling the mortgage-backed securities.

                      It may not be feasible to provide the same amount of transparency,
                      regularity, and predictability for bilateral trades as is done for reverse
                      auctions in part because of the different nature of the debt management
                      challenges for which bilateral trades are most likely to be useful in the
                      United States. However, certain features of bilateral trades used by other
                      countries could be modified to make bilateral trades more consistent with
                      Treasury’s debt management principles. First, the creation of a bilateral
                      trade capability or facility could be announced in advance; the advance
                      announcement could include the purposes of such a program and
                      information on the circumstances in which it might be used. The
                      announcement would need to be clear on how prices would be set in the
                      absence of a competitive bidding process. For example, prices could be
                      tied to the secondary market. Second, the results of the bilateral trades—
                      including the amount bought back and the average price paid—could be
                      publicly reported, similar to what is reported for regular and reverse
                      auctions.


Regularly Scheduled   Just as regular and predictable auctions provide investors with greater
Buybacks Promote      certainty and better information with which to plan their investments,
Predictability        participation in any buyback program would be encouraged by a regular
                      schedule and advance communication. During 2000-2002, Treasury used
                      buybacks in part to limit the accumulation of large cash balances.
                      Treasury generally held two reverse auctions in the second half of the
                      month when cash balances were generally higher, with a few
                      exceptions. 21




                      21
                       Of the 45 reverse auctions, 7 auctions were held in the first half of the month. In 7 of the
                      26 months that the buyback program was active, Treasury held more or fewer than 2
                      auctions per month.




                      Page 18                                             GAO-12-314 Debt Management - Buyback
Adding regularly scheduled buyback auctions to Treasury’s auction
schedule might seem to present a challenge. The frequency of Treasury
auctions has increased in recent years along with borrowing needs.
Treasury conducted 269 public auctions in 2011, up from 220 auctions in
2007. In November 2011, for example, an auction was held most
business days of the month (see fig. 4). Both Treasury and primary
dealers noted that it is best to avoid days when the Treasury market could
be volatile, such as days when key economic data are released.
Additionally, Treasury should consider when the FRBNY conducts open
market operations to sell or purchase Treasury securities from primary
dealers. Treasury also prefers not to conduct auctions on Fridays or
around holidays because of low trading volume. 22




22
 FRBNY has the responsibility of conducting open market operations on behalf of the
Federal Reserve.




Page 19                                         GAO-12-314 Debt Management - Buyback
Figure 4: November 2011 Auction Schedule




                                      Page 20   GAO-12-314 Debt Management - Buyback
                            Most of the primary dealers with whom we spoke emphasized the need
                            for predictability of reverse auctions. This is especially important because,
                            as some market participants noted, if they were sufficiently convinced that
                            a buyback program marked a change in Treasury’s regular and
                            predictable framework, it could actually result in higher borrowing costs.
                            Some market participants suggested that Treasury hold reverse auctions
                            on the same day as regular auctions. This is similar to a practice used in
                            Canada. The Canadian government conducts its cash basis bond
                            buyback auction, which is used to maintain auction sizes and thereby
                            enhance liquidity of securities, on the same day as its standard auctions.
                            The bidding deadline for the buyback program is 20 minutes after the
                            deadline of its standard auction. The Canadian debt management officials
                            said the close timing reduces market risk for the participants. 23 Treasury
                            officials said that while this would be possible it would require
                            coordination with the market and the FRBNY so that auctions are
                            conducted at a time when they would get complete dealer participation as
                            well as not interfere with scheduled open market operations.

                            While bilateral trades conducted in other countries were not done on a
                            regular schedule, they could be implemented in a manner that is
                            consistent with Treasury regular and predictable principles. For example,
                            Treasury could communicate with the market the rules for bilateral trades,
                            including explicit criteria for the purpose of the program, how securities
                            would be selected, and how prices would be determined. Such a format
                            would allow participants to anticipate when such an operation might be
                            used and plan accordingly.


Participation Is Promoted   Most of the market participants we spoke with said that transparency
by Clarity of Program       about the purpose would be important for any buyback program. They
Purpose and Timely          suggested that Treasury officials clearly announce the purpose of the
                            buyback program well in advance to promote broad participation and
Announcements of            more competitive bidding. By understanding the purpose of the program,
Buybacks                    especially in times of budget deficit, market participants could better
                            predict when the buyback program would be used and the type of
                            securities that might be targeted.




                            23
                             Market risk arises, in part, from changes in the level of interest rates.




                            Page 21                                             GAO-12-314 Debt Management - Buyback
                             As with regular auctions, market participants said the specific details of an
                             auction such as the securities eligible for buyback should be announced
                             in advance, similar to Treasury’s past practice and the FRBNY’s large-
                             scale asset purchase program from 2009 through 2011. Treasury used a
                             phased announcement for its previous buyback program. In January
                             2000, Treasury announced that it would conduct a buyback program to
                             maintain benchmark issue sizes and limit the lengthening of its portfolio. It
                             said it would purchase as much as $30 billion of securities with
                             substantial remaining maturity through reverse auctions in calendar year
                             2000. As part of each quarterly refunding statement Treasury then
                             announced both its expected funding requirement and the amount it
                             would buy back for that quarter or year. For example, on November 1,
                             2000, Treasury announced that it would buy back $9 billion in securities
                             during the January to March, 2001 quarter. Treasury then announced
                             more specific details—on the maximum amount and the specific
                             securities eligible for repurchase—1 or 2 days before each auction.

                             Literature suggests that the length of time between the announcement
                             and the actual auction can affect the prices that Treasury pays to
                             repurchase the security. 24 Some market analysts suggest that the market
                             prices of the securities increase between the time of the announcement
                             and the morning of the buyback operation—the so called “announcement
                             effect” which would suggest that a shorter announcement period would be
                             beneficial. However, market participants said that a longer period
                             between the announcement and the buyback operation is beneficial to the
                             market because it gives the market time to find holders of the securities
                             and determine prices and is consistent with Treasury’s standard auction
                             practices. One primary dealer said that the longer announcement period
                             might reduce a run-up in the prices of the securities because it would
                             allow more time for price discovery.


Broadening the Eligibility   Treasury officials have said that greater participation in its debt auctions
for Bidding in Reverse       fosters competition, thereby helping achieve its goal of lowest cost
Auctions Is Consistent       borrowing over time. Regular Treasury auctions are open to all market
                             participants consistent with Treasury’s principle of providing equal access
with Treasury’s Principle    for transactions. However, participation in reverse auctions could be
of Equal Access

                             24
                              See K.D. Garbade and M. Rutherford, Buybacks in Treasury Cash and Debt
                             Management, Federal Reserve Bank of New York Staff Reports, No. 304 (October 2007).




                             Page 22                                       GAO-12-314 Debt Management - Buyback
limited because of current operational constraints. Direct participation in
the 2000-2002 reverse auctions was limited to primary dealers largely
due to system limitations. Because the buyback program was
implemented quickly, Treasury used an existing Federal Reserve system,
Trading Room Auction Processing System (TRAPS), which was capable
of doing reverse auctions; it, however, could only accept bids submitted
by primary dealers. Other investors could make offers to sell their
Treasury securities in the reverse auctions through the primary dealers.
Treasury officials said that the period of time between the announcement
and the auction was sufficient for these other investors to participate
through the primary dealers.

The more recently developed Treasury Automated Auction Processing
System (TAAPS) used for standard auctions can accept bids from both
primary dealers and direct bidders, 25 but it cannot currently conduct
reverse auctions. Treasury officials told us it would take a year and a half
to add this new functionality to TAAPS. Since the time of the prior
buybacks, the Federal Reserve has replaced TRAPS with FedTrade,
which has the capacity to conduct transactions, including reverse
auctions, with a limited number of direct bidders; its capacity is greater
than the number of primary dealers but not large enough to open up to all
market participants. A decision by Treasury to expand eligibility for
bidding in reverse auctions would require either TAAPS or FedTrade to
be modified or Treasury to develop a process for determining which
institutions beyond the 21 primary dealers would be allowed to participate
in buyback auctions.

Expanding eligibility and allowing for broader participation in any future
buyback auctions could reduce prices Treasury would have to pay.
Furthermore, large investors with whom we spoke said it would be
important for them to have the option of bidding directly. However, there
are countervailing issues. The first is operational; auction resources and
staffing would likely increase when Treasury sends people offsite to
monitor auction operations, which was necessary during the previous
buyback auctions. Also, because Treasury would have less control over



25
  Direct bidders are financial institutions that, like primary dealers, can bid for and buy
Treasury securities competitively at auction directly from Treasury instead of in the
secondary market. Unlike primary dealers, direct bidders are not required to participate in
all Treasury auctions. Most Treasury securities are bought at auction by primary dealers.
A much smaller, but growing volume of securities is purchased by direct bidders.




Page 23                                            GAO-12-314 Debt Management - Buyback
                             the delivery of securities than in a regular auction, Treasury would have to
                             determine its likely response if successful bidders delay delivery or fail to
                             deliver the agreed upon security on the agreed upon date. Another
                             consideration has to do with market behavior. The majority of the primary
                             dealers with whom we spoke said that expanding the auction to all
                             participants could increase uncertainty about market demand and lead
                             them to bid less aggressively, which could result in lower prices for the
                             securities auctioned. In previous work, we have noted primary dealers’
                             concerns about the volume of direct bidding in auctions. 26 In contrast,
                             investors we spoke with supported broader participation, noting the
                             benefits to Treasury of competition among holders. These disparate
                             views suggest that the effects of broader participation need further
                             exploration.


Targeting Fewer Securities   The number of securities eligible for buybacks can affect the
and a Narrower Maturity      competitiveness of dealers’ bidding and consequently the cost of the
Band Is Important            buyback operation. For example, the Canadian government found it
                             beneficial to limit buybacks to a predetermined size because when the
                             announced size is too large relative to demand, dealers bid less
                             aggressively. For the cash management bond buyback auctions the
                             Canadian government made illiquid bonds ineligible in an effort to control
                             the size of the auction and found that having 10-12 bonds eligible in each
                             operation is a good number. Treasury made 51 bonds eligible for
                             buybacks over the course of the previous program. However, Treasury
                             officials found it more cost effective to limit the size of an operation to not
                             more than $2 billion and the set of eligible bonds to about 10-12 issues.
                             When determining the size of the buyback operations, Treasury also
                             considered the tradable supply of the eligible securities to encourage
                             participation. One primary dealer said that having too many eligible
                             securities available complicates the bidding process and creates more
                             manual work. An analysis of previous Treasury buyback auctions shows
                             that Treasury’s buyback costs could increase with a large number of
                             bonds included in the auction. 27 Treasury’s analysis of the buybacks in
                             2000 found that Treasury generally paid market prices for the securities it



                             26
                              GAO-10-498.
                             27
                               B. Han, F.A. Longstaff, and C. Merrill, “The U.S. Treasury Buyback Auctions: The Cost
                             of Retiring Illiquid Bonds” The Journal of Finance, Vol. 62, No. 6 (December 2007), pp.
                             2673-2693.




                             Page 24                                          GAO-12-314 Debt Management - Buyback
bought back except for the auction in which 26 securities were eligible for
repurchase. This auction was relatively expensive, but Treasury said it
provided valuable information on the ability of market participants to make
many simultaneous bids.

The competitiveness of dealers’ bidding and consequently the cost of the
buyback operation can also be affected by the type of securities eligible
for buybacks. The primary dealers with whom we talked suggested that
Treasury narrow the eligible securities to a specific sector or specific
maturity at each auction. One suggested the bands of eligible securities
be narrower for longer-term securities. Another primary dealer said that a
wide range of maturities at the long end of the curve complicates the
bidding process and could reduce the competitiveness of bids. Because
the prices of longer-term securities are more sensitive to changes in the
yield, changes in market yields during the bidding period require larger
and wider ranging changes to the prices they would offer for a security. In
the 2000-2002 buyback program, Treasury generally narrowed the range
of eligible securities for each auction to securities maturing within 6 years
or less of one another.

The securities selected for any buyback in the United States and other
countries were based on the goal of the program. For example, the goals
of the 2000-2002 buyback program were to limit the increase of the
average maturity of the portfolio, which could result in unnecessarily high
interest costs, and to enhance the liquidity of Treasury’s benchmark
securities, which market participants value. Treasury generally targeted
off-the-run 30-year bonds with over 10 years remaining to maturity so that
it could maintain issuance of its benchmark securities while maintaining
the average maturity of its portfolio. The Canadian government also
selects the securities eligible for repurchase based on the purpose of its
buyback program. For example, the purpose of Canada’s cash
management bond buyback program is to smooth maturity peaks;
therefore, Canada targets bonds with 18 or fewer months remaining to
maturity. Canada reintroduced cash basis bond buybacks to support
auction sizes and enhance liquidity for the 10- and 30-year bond as they
were generally less liquid than the 2-, 3- and 5-year sectors. For this
program, Canada targets illiquid high-coupon bonds and specifically
excludes current issues being built as benchmarks.

The market participants we spoke with said that the securities targeted for
any buyback should be clearly aligned with Treasury’s goals for the
program. While they understood that Treasury needed to adjust issuance



Page 25                                    GAO-12-314 Debt Management - Buyback
                           in order to manage its long-term debt, they said that sporadic purchases
                           of securities could confuse the market and would not be well received.



Switches and Debt
Exchanges Could
Also Be Used to
Manage Rollover
Peaks and Help
Maintain Liquidity

Switches Can Help Manage   Our case study countries have used a debt management tool called a
Maturity Peaks and         switch for purposes similar to those of buybacks, including managing the
Address Future Liquidity   maturity profile and helping to enhance liquidity of benchmark issues. 28 In
                           a switch, the government buys back an outstanding security prior to
Issues                     maturity and delivers a reopened 29 liquid benchmark security via a
                           competitive switch auction. 30 Bidders submit offers based on how much of
                           the outstanding security they are willing to sell for the reopened
                           benchmark security. 31 The government uses the bids to determine the




                           28
                             The U.S. Treasury used similar tools called exchange offerings and advance refundings
                           in the 1950s and 60s. For more information, see K.G. Garbade, The Emergence of
                           “Regular and Predictable” As a Treasury Debt Management Strategy, FRBNY Economic
                           Policy Review (March 2007).
                           29
                             In a security reopening, the government issues additional amounts of a previously
                           issued security. The reopened security has the same maturity date and coupon interest
                           rate as the original security, but with a different issue date and usually a different purchase
                           price.
                           30
                            In Canada, a small cash transaction adjusts for the premium or discount. The cash may
                           be paid by the Canadian government or the successful bidder, depending on whether the
                           outstanding or reopened security was more valuable.
                           31
                             Bids for switches in the United Kingdom were for the amount of the outstanding security
                           offered and the price for the reopened security. In France, bids were submitted as an
                           exchange ratio. For example, the mean exchange ratio for its auction in 2008 was 82.57
                           securities bought back for 100 securities issued. In Canada, bids included the amount of
                           outstanding securities offered and the difference in yields between the outstanding and
                           reopened securities.




                           Page 26                                             GAO-12-314 Debt Management - Buyback
exchange ratio and thus the amount of the benchmark security each
successful bidder receives.

The Canadian government has conducted switches as part of its regular
auction schedule since 2002. Canada first used switches to maintain new
issuance sizes during a budget surplus but has since focused more on
enhancing liquidity and managing the maturity profile. For example, when
cash-based buybacks were scaled back due to higher financing
requirements in 2008-2010, the government continued to use switches to
maintain liquidity in longer-term maturities. Canadian switches provide
market participants with more frequent access to benchmark bonds.
France and the United Kingdom have used switches on a more limited
basis. France used a switch in 2008 to promote liquidity of 30-year bonds
in response to a strong demand from investors. The United Kingdom
conducted switch auctions of securities with similar terms to maturity from
1999 to 2001, during a period of budget surplus to maintain the supply of
current benchmark securities in a low issuance environment and to
manage maturity peaks. U.K. officials told us that switches remain
available as a debt management tool, though there are no current plans
to use them.

Table 3 shows the results of a switch in Canada (in Canadian dollars or
CAD). In September 2011, the government repurchased and retired
portions of two securities with less than 2 years remaining to maturity and
delivered a reopened 2-year note.

Table 3: Results of Canadian Switch Auction Held on September 28, 2011 (amounts
in CAD)

 Securities repurchased
 Coupon rate                                      Maturity date              Amount repurchased
 3.5%                                             June 1, 2013               $1.17 billion
 5.25%                                            June 1, 2013               $0.05 billion
 Security reopened
 Coupon rate                                      Maturity date              Amount issued
 1.5%                                             November 1, 2013           $1.0 billion
Source: Bank of Canada announcement of switch operation results.

Note: The amount of new bonds issued through switches does not necessarily equal the amount of
old bonds bought back through those operations because the exchange is not based on par value,
but rather is on a duration-neutral basis.




Page 27                                                            GAO-12-314 Debt Management - Buyback
In Canada, switch issuances are a small amount of total gross issuance.
For example, in 2009-2010, the Canadian government used switches to
issue $2.3 billion CAD of its total gross issuance of $102.2 billion CAD.
The Canadian government tends to buy back a smaller amount through
switches than it does through its regular buyback programs. For example,
in 2009-2010, the Canadian government bought back $2.1 billion CAD
using switches and $10.3 billion CAD using buybacks.

Switches can help maintain a liquid Treasury market. Some market
participants we spoke with said that the current Treasury market was
liquid and did not need an additional tool such as a switch to address
liquidity. Nevertheless, both Treasury officials and most market
participants we spoke with said that switches could help address future
liquidity problems in individual securities or types of securities. For
example, switches could help avoid disruptions in the Treasury market,
which occur when any security is difficult to trade (i.e., illiquid), by
targeting those securities for early redemption. One primary dealer we
spoke with said switches that target specific securities could also increase
liquidity across the entire Treasury securities market—a benefit to
Treasury and investors—because participants would know that Treasury
would be willing to make an exchange for their securities if they became
highly illiquid. However, most market participants we spoke with said
Treasury should limit the amount of the outstanding supply bought back
to help ensure the security remains liquid enough to trade. The United
Kingdom limits the repurchase quantity such that the amount repurchased
does not reduce the amount outstanding to less than £4.5 billion.

Switches have been successful at enhancing liquidity in Canada.
Participants in the Canadian debt market who were consulted by the debt
management office reported that, as of 2009-2010, the liquidity of long
off-the-run bonds had improved significantly due to switches of longer-
term maturities. 32 Switches aimed at enhancing liquidity may achieve a
secondary benefit of maintaining or reducing debt financing costs over
time because bidders tend to pay higher prices for more liquid securities.




32
 The Canadian government securities market is smaller and has had more of a challenge
maintaining liquidity than the U.S. market.




Page 28                                        GAO-12-314 Debt Management - Buyback
Switches that are duration-neutral could have the added advantage of
broadening Treasury’s investor base. 33 Duration-neutral switches
minimize market risk because interest rate changes affect both securities
similarly. They are also attractive to investors because duration-neutral
switches allow them to maintain portfolio duration. Canadian switches are
duration-neutral and therefore reduce participants’ market risk at
repurchase operations. There is broad interest in maintaining portfolio
duration among investors in the Canadian government securities market,
according to a Canadian government official. There are also such
investors in the U.S. Treasury securities market. For example, one
primary dealer we spoke with said that some investors have essentially
asked them to broker duration-neutral exchanges involving the securities
they offered to the Federal Reserve during its large-scale asset purchase
program from 2009 through 2011.

Most market participants we spoke with said that any new Treasury
program should be designed consistent with Treasury’s principles of
regularity and predictability. Treasury has been successful with and the
market is accustomed to this approach. Implementing a switch program
would also require consideration of the operational features below:

•    Operating system: Neither Treasury’s nor the Federal Reserve’s
     auction systems support switch auctions. According to a Treasury
     official, Treasury could develop its own system to include switch
     auction capability or use the FedTrade system operated by the
     Federal Reserve, if the Federal Reserve modified that system.
     FRBNY officials told us that they would need to modify FedTrade to
     support switch auctions or develop or procure a new system that
     supports switch auctions.
•    Scope of eligible bidders: As in their conventional auctions, the
     Canadian and U.K. governments limit direct participation in switch
     auctions to certain government-registered traders. The U.S. primary
     dealers with whom we spoke generally preferred limiting auction
     participation to primary dealers. However, the U.S. Treasury has a
     broader scope of direct bidders in its conventional auctions, consistent
     with its principle of equal access and objective to appeal to a broad




33
  Because duration indicates how long, in years, it takes for the price of a security to be
repaid by its internal cash flows, it measures the price sensitivity of a security to interest
rate changes.




Page 29                                               GAO-12-314 Debt Management - Buyback
                                 investor base. (The earlier discussion about participation in buybacks
                                 is also applicable here.)
                             •   Auction schedule: A switch auction would need to fit into Treasury’s
                                 regular auction schedule. Market participants we spoke with
                                 suggested following Treasury’s practice of regular auctions. The
                                 Canadian government holds switches of 30-year bonds during
                                 quarters in which there are no conventional 30-year bond auctions.
                                 (The earlier discussion about buybacks via reverse auction is also
                                 applicable here.)
                             •   Announcements: Most market participants stated that Treasury could
                                 maintain its transparency by clearly communicating the purpose of a
                                 switch program. Consistent with Treasury’s practice of announcing its
                                 auction schedule on a quarterly basis and announcing the specific
                                 securities it will auction several days in advance of the auction, the
                                 Canadian and U.K. governments publicly announce the details of their
                                 switch auctions. For example, the U.K. Debt Management Office
                                 announces the date of and securities involved in a switch auction in its
                                 quarterly auction announcement and, approximately 1 week prior to
                                 the auction date, announces the maximum amount of the outstanding
                                 security it is willing to buy.
                             •   Targeted securities: Program goals and expected participation both
                                 influence the selection of securities for a switch. For example, Canada
                                 currently reopens 30-year bonds in exchange for buying back more
                                 illiquid longer-end bonds in line with its goal to promote liquidity in the
                                 long end of the maturity profile. One primary dealer we spoke with
                                 said that investors must be interested in purchasing the security being
                                 reopened, as well as hold the eligible outstanding security. Another
                                 primary dealer noted that participation may be limited if buy-and-hold
                                 investors hold a large portion of the eligible outstanding security, since
                                 they would be less likely to trade their securities.
                             •   Rules for switch operations: Treasury’s rule for buyback operations
                                 covers exchanging a security for cash but does not cover exchanging
                                 two securities. According to a Treasury official, Treasury would need
                                 to modify the existing buybacks rule or issue a new rule.

A Variation on Debt          A debt exchange is an exchange of securities whereby the government
Exchanges Could Help         buys a certain amount of outstanding securities in exchange for the
Address Sudden Illiquidity   delivery of a certain amount of reopened benchmark securities at an
                             exchange ratio set by the government. The U.K. government used debt
Issues                       exchanges from 1998 to 2002 to retire illiquid securities and build the size




                             Page 30                                     GAO-12-314 Debt Management - Buyback
              of new benchmarks. 34 The debt exchanges began upon initial
              announcement and continued for 3 weeks. Results were announced on
              the following business day, including the total amount of the outstanding
              security repurchased by the government, the total amount outstanding in
              the market, and the coupon rate and total amount of the reopened
              security issued.

              Debt exchanges as conducted in the United Kingdom carry market risk to
              the government. Because the exchange ratio was fixed at the start of the
              exchange, the government was exposed to changes in the market value
              of the eligible securities that occurred during the length of time the
              securities were eligible for exchange. Market participants we interviewed
              agreed that debt exchanges would increase the government’s risk
              exposure. A variable—rather than fixed—exchange ratio tied to
              movement in secondary market prices would reduce the risk associated
              with changing market prices and maintain transparency by having a
              government-announced exchange ratio.

              In the United States, debt exchanges could be used to maintain or
              enhance liquidity on an ongoing or as-needed basis to address sudden
              illiquidity issues that a preannounced auction could not. We have
              previously reported that a wide-scale financial market disruption may
              require Treasury to take actions outside of its regular and predictable
              schedule. 35 However, they would need to be modified to fit Treasury’s
              regular and predictable principles, including informing the market in
              advance of its plans to buy or sell debt. For example, the government
              could operate a regular or ongoing debt exchange via an open window
              with the market provided the Treasury publicly announces the purpose of
              the program and the securities it will exchange.


              The U.S. Treasury market is the deepest and most liquid sovereign debt
Conclusions   market in the world. Nevertheless, Treasury faces a number of debt
              management challenges, including some that may not be foreseeable at



              34
               The securities the U.K. government selected for buyback had an amount outstanding
              below a set threshold.
              35
                See GAO, Debt Management: Backup Funding Options Would Enhance Treasury’s
              Resilience to a Financial Market Disruption, GAO-06-1007 (Washington, D.C.: Sept. 26,
              2006).




              Page 31                                         GAO-12-314 Debt Management - Buyback
this time. Given the market uncertainties and the federal government’s
fiscal challenges, increasing Treasury’s capabilities to respond to
changing market conditions or potential disruptions in ways that minimize
costs would be prudent. Buybacks are one such capability. Other
countries have ongoing buyback programs—even in times of deficit—to
address challenges, including rollover peaks, which the U.S. Treasury
faces in the next several years. A buyback program would allow Treasury
to maintain current issuance levels even as net borrowing needs decline.
This would permit more gradual changes to the auction schedule and
reduce rollover peaks. A buyback program could also help enhance
liquidity, address market disruptions, and, as Treasury’s previous
experience shows, reduce borrowing costs over the long term. Building
the capability to use switches and debt exchanges would provide
Treasury additional flexibility to respond to changing market conditions,
as well as the potential to broaden its investor base by appealing to
investors that want to maintain the average maturity of their portfolios in
ways that minimize market risk.

The design and implementation of any of these debt management tools
has implications both for Treasury’s ability to minimize borrowing costs
over time and for the Treasury market in general. Several features of
Treasury’s previous buyback program were driven by the sudden need for
a buyback program and Treasury’s lack of experience at the time with
such a program. Building the capacity to conduct a buyback program now
can help ensure that Treasury is prepared to respond with a well-
designed program using features similar to its regular auctions and
consistent with its debt management principles. While the competitive
bidding process of reverse and switch auctions is beneficial when the
Treasury has sufficient advance notice to plan an auction and notify the
market, bilateral trades or debt exchanges may provide Treasury with
greater ability to respond to sudden illiquidity issues that would benefit
from Treasury acting quickly. Treasury could examine ways to modify
certain features of bilateral trades and debt exchanges to better align with
Treasury’s long-standing principle of transparency. A regular schedule of
buyback or switch operations would help Treasury maintain its reputation
of predictability, which the market values. Also important to predictability
would be a clear communication about the purpose of the program, so
that the market could anticipate the timing and securities targeted for
early redemption. While the benefits of expanding eligibility for direct
bidding in reverse and switch auctions to all auction participants need
further exploration, it would be prudent to build in the capacity up front
because allowing all market participants to directly participate would be
consistent with Treasury’s principle of equal access. Finally, while the


Page 32                                   GAO-12-314 Debt Management - Buyback
                      securities selected for any buyback program would be tied to the purpose
                      of the program, both past experience and market participants suggest
                      that Treasury would benefit from targeting a limited number of securities
                      at each auction and targeting a narrower band of maturities, particularly
                      for longer-term maturities.


                      Treasury should build the capacity for a buyback program that could be
Recommendations for   used to respond to potential changes in market conditions during times of
Executive Action      deficit. Such a program should allow for broader direct participation
                      beyond the primary dealers. In conducting any buyback operations
                      Treasury should

                      •   clearly articulate the purpose of the buyback program,
                      •   conduct the buyback reverse auctions on a regular and predictable
                          schedule consistent with the purpose of the buyback program, and
                      •   target a few securities in narrow maturity bands at each reverse
                          auction.
                      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

                      •   clearly articulate the purpose of the switch auction program and
                      •   conduct the switch auctions on a regular and predictable schedule
                          consistent with the purpose of the program.
                      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.


                      We provided a draft of this report to the Secretary of the Treasury and
Agency Comments       Federal Reserve officials for comment. In oral comments from the
and Our Evaluation    Treasury Deputy Assistant Secretary for Federal Finance, Treasury



                      Page 33                                   GAO-12-314 Debt Management - Buyback
concurred with our analysis and findings and said the report would be
very helpful in analyzing tools that increase their flexibility for responding
to changes in market conditions. Treasury and Federal Reserve officials
also provided technical comments that were incorporated, as appropriate.


We are sending copies of this report to interested congressional
committees, the Secretary of the Treasury, and other interested parties.
In addition, the report is available at no charge on the GAO website at
http://www.gao.gov.

If you or your staff have any questions concerning this report, please
contact Susan J. Irving at (202) 512-6806 or irvings@gao.gov. Contact
points for our Offices of Congressional Relations and Public Affairs may
be found on the last page of this report. GAO staff making key
contributions to this report are listed in appendix II.

Sincerely yours,




Susan J. Irving
Director for Federal Budget Analysis
Strategic Issues




Page 34                                    GAO-12-314 Debt Management - Buyback
Appendix I: Objectives, Scope, and
              Appendix I: Objectives, Scope, and
              Methodology



Methodology

              As part of our ongoing work on debt management issues and under the
              Comptroller General’s authority, we examined debt buybacks—a debt
              management tool that enables debt managers to actively manage the mix
              of outstanding Treasury securities by redeeming particular marketable
              securities prior to their maturity dates using a voluntary process. They are
              used in other countries to address debt management challenges but are
              not currently used in the United States. Specifically, we 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 objectives
              similar to those of a U.S. buyback program.

              To address these objectives, we examined Treasury’s 2000-2002
              buyback program as well as the buyback programs and similar debt
              management tools used in Canada, the United Kingdom (U.K.), France,
              and Germany. We selected case study countries whose practices and
              experiences with debt buybacks and other debt management tools used
              for similar purposes could provide useful insights about the potential
              benefits and risks of a debt buyback program for the United States. We
              selected countries that are members of the Organisation for Economic
              Co-operation and Development (OECD) and whose sovereign debt
              markets are most similar to the United States in terms of size and
              liquidity. We determined that, for our purposes and considering resource
              constraints, four is a sufficient number of case study countries.

              We determined that a nongeneralizable sample is sufficient for our
              purposes because we will use the case study information to describe
              aspects and understand the context of the use of buybacks and other
              debt management tools, as well as to provide illustrative examples of our
              findings. The experiences of any one country are not necessarily
              generalizable to other countries. In analyzing other countries’ experiences
              and identifying useful insights for the United States, it is important to
              consider the differences between the countries. For example, the public
              sector debt within the purview of the national debt management office
              varies among countries depending on the nature of their political and
              institutional frameworks. Furthermore, the United States has the world’s
              largest economy, flexible markets, and stable economic and political
              systems. Some officials and market participants we interviewed noted
              that the Canadian sovereign debt market is much smaller than the
              Treasury market and has had more of a challenge maintaining liquidity.
              We previously reported that some debt management tools used abroad
              may be difficult to implement in a way consistent with U.S. values of


              Page 35                                   GAO-12-314 Debt Management - Buyback
Appendix I: Objectives, Scope, and
Methodology




transparency, predictability, and equal access or may require the
government to assume credit risk. 1

To examine Treasury’s past buyback program, we reviewed literature
evaluating the program and related aspects of the Treasury market,
analyzed the cost of the buybacks, and interviewed agency officials and
others. We analyzed the cost of Treasury’s past buybacks, including the
extent to which Treasury could have reduced its interest costs over the
long term had it financed its buybacks by simultaneously issuing new
debt. To illustrate how much Treasury could theoretically have reduced its
interest costs through such actions, we compared published auction
results of the buyback operations Treasury conducted from March 2000
through April 2002 against Treasury note and bond secondary market
price data from the Center for Research in Security Prices (CRSP) U.S.
Treasury Database for the same periods. 2 Specifically, we calculated the
invoice prices paid by Treasury for each auction. 3 We then simulated
market rates that Treasury could theoretically have attained on the dates
of the buybacks by extracting yield curves from forward rates based on
the secondary market prices of on-the-run 2-year notes, 5-year notes, 10-
year notes, and 30-year bonds, as well as market rates for 4-week bills. 4
We assumed that on the date of each buyback auction Treasury could
have issued new debt with various terms to maturities subject to these
simulated rates (1) in total face value amounts equal to the total invoice
prices paid per buyback auction, and (2) in combinations such that the
average duration (weighted by amount issued) matched that of the




1
GAO-02-14.
2
  We obtained the secondary market price data from the CRSP U.S. Treasury Database
through Wharton Research Data Services in April 2011.
3
 The invoice price is the actual price paid for a security and consists of the published price
(known as the clean price) plus any interest accrued from the last coupon payment. We
use the invoice price because this reflects the actual amount Treasury paid and would
need to be covered with new debt issues in order for the transactions to be cash-neutral
on net.
4
 A forward rate is the expected interest rate for some future period implied by current
interest rates. We formed yield curves extending from 4 weeks to 30 years. Because on-
the-run 30-year bonds in our analysis periods generally had terms to maturity several days
short of a full 30-year term, we assumed that the yield curves would be flat after the knot
points based on the on-the-run 30-year-bonds in our data.




Page 36                                             GAO-12-314 Debt Management - Buyback
Appendix I: Objectives, Scope, and
Methodology




repurchased securities. 5 Using yields to maturity based on the prices of
the on-the-run securities, we calculated for each auction the present
value of the cash flows of the off-the-run bonds repurchased. 6 We then
calculated the value of the reduced interest costs for each auction by
taking the difference between the present value of the cash flows
associated with the off-the-run bonds repurchased and the present value
of the cash flows of the hypothetical new issues (represented by the
invoice prices Treasury paid for the repurchased securities). 7 Our
illustrative estimate of the value of reduced interest costs for the buyback
auctions as a whole is the sum of these per-auction differences. To
assess the reliability of CRSP data, we compared them to another
published source of similar data and discussed any differences with the
data providers. We determined that such differences were likely due to
methodological differences between the two sources and were consistent
with industry practices. To assess the reliability of the Treasury data, we
also compared them to another published source of similar data and
found them consistent. Based on these assessments, we determined that
the Treasury data and the CRSP data were sufficiently reliable for our
purposes.

We interviewed officials from Treasury’s Office of Debt Management and
the Bureau of the Public Debt and the Board of Governors of the Federal
Reserve System and the Federal Reserve Bank of New York (FRBNY)—
one of the Federal Reserve Banks serving as Treasury’s fiscal agent. We
also interviewed officials from the Canadian Department of Finance and
the Bank of Canada, the U.K. Debt Management Office, Agence France




5
 We selected the coupons of the hypothetical newly issued securities such that, based
upon the yield curve implied by the prices of the on-the-run securities, the valuations of
the newly issued securities would be equal to par values.
6
 Consistent with market convention, we used the first callable date as the effective
maturity date for callable bonds and yield-to-call in lieu of yield-to-maturity for those
callable bonds bought back by Treasury where the bonds’ coupon rates were higher than
market yields. All the callable off-the-run bonds that Treasury purchased in its buyback
operations met this criterion.
7
 The value of the hypothetical new issuances is equal to the invoice price of the debt
repurchases paid by Treasury because of the assumptions described earlier about how
Treasury would have constructed the portfolios of new issues and because the yield curve
we use to discount the cash flows of the hypothetical newly issued securities is the same
as the market rates we expect the new issues to attain.




Page 37                                             GAO-12-314 Debt Management - Buyback
Appendix I: Objectives, Scope, and
Methodology




Tresor (France’s debt agency), and the German Finance Agency. 8 We
obtained perspectives from market participants, including primary dealers
and large investors, and market analysts. To assess the operational
features that would support Treasury’s borrowing goals, we analyzed the
extent to which features of Treasury’s past buyback program and the
features of other countries’ buyback programs are consistent with
Treasury’s debt management goals and principles. On December 13,
2011, we briefed Treasury officials on our findings and expected
recommendations.

We conducted this performance audit from November 2010 to March
2012 in accordance with generally accepted government auditing
standards. Those standards require that we plan and perform the audit to
obtain sufficient, appropriate evidence to provide a reasonable basis for
our findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our findings
and conclusions based on our audit objectives.




8
 We interviewed officials from Canada’s central bank because of the large role the central
bank plays in buybacks. We did not interview central bank officials from the United
Kingdom, France, or Germany because their buybacks role was limited.




Page 38                                           GAO-12-314 Debt Management - Buyback
Appendix II: GAO Contact and Staff
                  Appendix II: GAO Contact and Staff
                  Acknowledgments



Acknowledgments

                  Susan J. Irving, (202) 512-6806, or irvings@gao.gov
GAO Contact
                  In addition to the contact named above, Melissa Wolf (Assistant Director),
Staff             Susan Etzel (AIC), Serena Agoro-Menyang, Richard Krashevski, Nicole
Acknowledgments   McGuire, Lindsay Read, Cynthia Saunders, Albert Sim, Dawn Simpson,
                  and Stacy Ann Spence all made contributions to this report.




(450863)
                  Page 39                                  GAO-12-314 Debt Management - Buyback
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