FROM THE OFFICE OF PUBLIC AFFAIRS

I would like to begin by thanking you for the opportunity to address such a distinguished gathering.

As Assistant Secretary for Financial Markets at the Treasury, I am responsible for advising Secretary O’Neill on the federal government’s debt management policies. I am also one of Treasury’s bond salesmen. I am therefore particularly pleased to appear in front of our biggest customers. Central banks including the Federal Reserve and other sovereign institutions around the world now own more than half of all marketable US Treasury securities.

Today my goal is to encourage you to continue heavily investing in securities backed by the full faith and credit of the United States. I’ll spend the time you’ve graciously afforded me by first outlining the core of Treasury’s debt management policies – that is, to meet the U.S. government’s financing needs at the lowest cost over time. As part of that, I’ll touch upon the dynamics of the Treasury primary and secondary markets. I will close by reviewing our improvement program: specifically, to quicken our primary market auctions, and to deepen the market for a product that central bankers may want to look at more closely, the 10-year Treasury Inflation-Indexed Security.

Treasury’s debt management policy: one objective with constraints

It’s important to understand that Treasury has less influence over how much debt we issue than do many other finance ministries. How much money we need to raise is instead a function of decisions the Congress and President make about spending and taxes, and most important, the level of U.S. economic activity.

What we do control is how we will raise that sum of money. And here we have set a single overarching objective for managing Treasury’s marketable debt: to achieve the lowest borrowing cost, over time, for the federal government’s financing needs.

While our financing needs rise and fall, that objective remains our lodestar. From the 1970’s to the mid-1990’s, the U.S. faced seemingly ever-expanding deficits. Then, since 1998, gross new issuance of Treasury coupon securities has lagged not one but three other domestic bond markets – corporate, agency, and mortgage-backed securities. Yet even as our borrowing needs have waxed and waned, Treasury does not "time the market." We never have.

Traders and corporate chief financial officers sometimes have trouble understanding Treasury’s mindset, but you as sovereigns will better understand. We don’t hold snap unscheduled auctions for a given maturity when yields appear low. We don’t even take the yield curve into account when we allocate how much to raise by different maturities. Instead, to achieve our objective of lowest cost over time, Treasury commits to "regular and predictable" issuance across a wide range of securities.

This regularity and predictability provides certainty for investors as to the availability of our securities. We’re always there. Market participants thus have grown habituated to using Treasury securities for pricing, hedging, and cash management, and to relying on our stable issuance patterns. Over time, this regularity and predictability cuts our financing costs more than any market-timing could.

Consequently, we accept the cost of occasionally borrowing when it is temporarily inconvenient or expensive in return for the savings, over time, from providing greater certainty to the Treasury market. Only at the margin must we deviate from regular and predictable issuance to manage the swings in our cash balances through seasonal changes in bill issuance and the use of cash management bills. If our financing approach requires more fundamental adjustment, we use our regular quarterly refunding announcements to explain any changes. Market participants gain substantial lead-time for any specific changes to our offerings, and an awareness of problems or choices we face.

Ideally, we would like to lock down our issuance calendar through eternity. Realistically, we can’t. Our biggest constraint is uncertainty about our future financing needs: how much will we need to borrow and when? Our financing needs, and thus auction sizes, are constantly shifting in response to (1) seasonal changes in our cash flows, (2) structural changes in tax policy, (3) ebbs and flows in government spending, and (4) U.S. economic activity. We do what we can to minimize that uncertainty. We work to forecast our likely borrowing needs. We try to anticipate how we would alter our borrowing pattern when – not if – the future does not fit our forecast. We try to anticipate what will prove to be the lowest cost means of financing in the future.

This leads us to an additional constraint on our overarching objective: the need to sustain the liquidity of secondary market trading, principally by ensuring an adequate supply at each maturity. A deep, liquid, and resilient secondary market serves our goal of lowest-cost financing for the taxpayer by encouraging more aggressive bidding in the primary market.

Treasury over the past few decades has been quite successful at managing this constraint and at fostering the deepest, most liquid securities market in the world. In 2001, even with reduced issuance over the prior years, the daily average volume of transactions in the Treasury market averaged almost $300 billion, or over three times the daily average volumes for each of corporate debt, agency debt, mortgage-related securities, and even the New York Stock Exchange. Only the volume of interest rate swaps compare with Treasury securities.

Some over-simplify by presuming that secondary market liquidity is a linear function of how much debt we issue, as if we controlled secondary liquidity with a joystick. That’s not accurate: secondary liquidity is even more dependent on what market participants do with what we issue. We do, however, look to matching our financing needs with market needs. For instance, at the May 2002 quarterly refunding, we announced the end of the regular re-opening policy for the 5-year note and a return to issuing four CUSIPs a year. We expect this change will smooth the maturity distribution of our issuance, allow for slightly larger issuance sizes, and enhance secondary market liquidity.

Actions to improve product offering

Secretary O’Neill insists we make excellence a habit. This insistence builds upon Treasury’s long tradition of continually adapting to changing markets and financing needs to achieve the lowest borrowing cost over time. Over the last three decades, Treasury has introduced and withdrawn numerous securities including the 52 week bill, 3 year note, 4 year note, 5 year inflation index note, seven year note, twenty year bond, thirty year bond, thirty year callable bond, thirty year inflation indexed bond, and foreign-denominated securities. This same imperative to adapt has led to the utilization of the single price auction, promotion of the ten-year inflation index note, debt buybacks, Internet-based auction bidding, and the 4-week bill.

More recently, we have worked to improve the efficiency of the primary market. Our top priority has been to reduce the time it takes us to release auction results. We believe that the faster and more predictable the release time, the less uncertainty bidders will bear – and the lower the premium they will charge taxpayers. In the 1970s it took as much as a day to release auction results. In 1995, the average release time was 45 minutes; by 2000, 27 minutes. Our ultimate objective is a two-minute release with a variance of +/- 30 seconds. On the way, we are setting interim targets and reporting on our progress. In February 2002, we started at 6 minutes +/- 60 seconds; now we’re at 5 minutes.

We will also continue to improve our technology, both hardware and software. We especially want to make submitting tenders more user-friendly. To take one example, we have made available technology to allow direct primary auction participation over the Internet on TAAPSLink (Treasury Automated Auction Processing System). TAAPSLink is a safe and reliable application that uses 128-bit encryption for security and requires no additional cost or fees. A diverse group of approximately 900 entities currently uses it. We expect this initiative will aid us in expanding the number of competitive bidders in our auctions.

As I mentioned, we are promoting the 10-year U.S. Treasury inflation-indexed note. These notes are particularly interesting to investors because their market values move differently from conventional securities. Their market value at any given moment is a function of the real price and measured inflation since original issuance. Thus, their real (inflation unadjusted) price varies inversely with real U.S. interest rates, not nominal interest rates. For example, if nominal yields increase because of inflationary expectations for the U.S. rise, the market value of outstanding nominal securities will fall – but the market value of inflation-indexed securities may even increase.

Nothing can be as important to risk management as diversification. For us as issuers, indexed notes diversify our portfolio of liabilities. And because Treasury Inflation-Indexed Securities (TIIS) are a unique asset class – dollar-denominated, inflation- protected, backed by U.S. full faith and credit – we think every diversified investor should own some. We think central banks in particular should take a close look at Treasury Inflation-Indexed Securities. First, adding these securities to a portfolio increases diversification but does not increase credit risk, thus potentially improving the risk/reward tradeoff. Second, these securities can be used to mitigate exchange rate risk, since they are linked to a measure of purchasing power. Third, they can at times provide a superior return to investments in short-term Treasury bills, which might be viewed as an alternative investment for decreasing market risk. While the investment goals of any particular central bank are unique, central banks should carefully consider how Treasury Inflation-Indexed Securities could benefit their portfolios.

Over the 5 years we have been issuing inflation-indexed securities, some analysts have said they are a more expensive form of borrowing than the comparable nominal securities. (That’s because most inflation forecasts are higher than the prospective inflation-rate at which we would break-even). We’ve concluded that we need to take a broader and longer view of their performance. It’s too early to pass judgment on the cost effectiveness of these instruments. It takes time and effort to build a critical mass of liquidity. The right time to assess their cost-effectiveness is after they have worked their way through at least an entire interest rate cycle – 10 years of experience, perhaps more.

We are looking for suggestions on how to deepen the market for the 10-year inflation indexed security. One step we are already taking in reaction to market feedback is to reduce the when-issued period for Treasury Inflation-Indexed Security auctions beginning in July. As we stated at our May 2002 quarterly refunding, the 10-year Treasury Inflation-Indexed Security will be announced on July 8, be auctioned on July 10, and settle July 15^th. It will be re-opened twice, in October 2002 and January 2003.

We invite your suggestions on how we can make this product more attractive to you as reserve managers – and more broadly on how we can make all our products more attractive to you. The best way to get in touch with us is at email address debt.management@do.treas.gov. We’d welcome the chance to hear from you.

U.S. Treasury securities are the most liquid and highest quality investment available to reserve managers. We understand the importance of effective, direct communication channels with the holders of our securities. We are striving to be as transparent as possible on how changes in our financing needs will affect security issuance. As we work to manage our financing needs, we will also be working to deliver our securities more efficiently and in a product mix of maturities and classes that you will find appealing.

I again thank you for inviting me to speak at the conference. I would be more than happy to answer any questions you may have about Treasury debt management policy.