Summary
The September 11, 2001, attacks significantly affected the financial markets that the U.S. Treasury (Treasury) relies on. To understand how Treasury could obtain funds during a future potential wide-scale financial market disruption GAO examined (1) steps Treasury and others took during the September 11 attacks and after to assure required debt obligations and payments were made on time and ensure liquidity in the markets, (2) major actions Treasury and others have taken since the attacks to increase the resiliency of the auction process, and (3) the opinions of relevant parties on the main design features of any backup funding options. We conducted interviews with Treasury officials and others and reviewed appropriate documents.
In response to the effects of the September 11 attacks on the financial markets, Treasury canceled a scheduled 4-week bill auction after communicating with the Federal Reserve Bank of New York (FRBNY). Treasury then used compensating balances from banks across the country to help meet its obligations on time. Compensating balances were replaced by direct payments in 2004. Also, in response to the attacks' financial effects, the Federal Reserve lent billions of dollars to both domestic and foreign financial institutions through a combination of methods to help markets recover. Federal Reserve actions and market behavior in the aftermath of the September 11 attacks are informative when considering potential alternative funding sources for Treasury during a future wide-scale financial market disruption. Treasury, the Federal Reserve, and primary dealers have added contingency sites and systems intended to increase the resilience of the auction process. Regardless of resiliency efforts, the nature and impact of a potential future wide-scale disruption are unknown. In addition, Treasury has at least one less source of cash since the compensating balances Treasury relied upon during the September 11 attacks are no longer used. Finally, Treasury's cash management policy of minimal cash balances to lower borrowing costs further limits Treasury's access to cash during a wide-scale disruption. All these factors make it prudent for Treasury to explore other funding alternatives to use during a wide-scale disruption. Relevant parties with whom we spoke, including primary dealers, agreed. They also generally agreed on a list of main design features including source of funds, situations for use, approvals, and costs, among others, that should be considered when weighing alternative funding options. Discussions with Treasury, the Federal Reserve, and other relevant parties have led GAO to conclude that a two-tiered approach is promising. The first tier consists of two funding options involving a range of appropriate financial institutions, namely a credit line and a private placement of a flexible security known as a cash management (CM) bill. The second tier involves a direct draw from the Federal Reserve that would provide Treasury a last resort source of funds when other options are not viable. A credit line with several financial institutions would involve a prior transparent commitment or understanding by certain financial institutions to provide funds to Treasury. A private placement of a CM bill would involve a prior arrangement to issue a CM bill after communicating with certain senior executives at financial institutions who would have the ability and authority to meet Treasury's immediate funding needs. Finally, a direct draw from the Federal Reserve would require a change in the law to allow the Federal Reserve to directly lend to Treasury. Appropriate limitations, adequate flexibility, and accountability would have to be included in the design.
Recommendations
Our recommendations from this work are listed below with a Contact for more information. Status will change
from "In process" to "Implemented" or "Not implemented" based on our follow up work.
Director:
Team:
Phone:
Susan J. Irving
Government Accountability Office: Strategic Issues
(202) 512-9142
Matters for Congressional Consideration
Recommendation: Congress may wish to consider providing the Federal Reserve the explicit authority to lend directly to Treasury as a last resort when other options are not viable during a wide-scale disruption. Developing a direct draw authority would require careful consideration and determination of design features and any other requirements to support Treasury's need for an effective funding source, the Federal Reserve's independence, and congressional oversight and accountability concerns. An approach that appears promising would be to require that both the Secretary of the Treasury and Chairman of the Federal Reserve approve any draw and agree on specific amounts and duration at the time of any draw. This might balance independence and accountability concerns with the need for sufficiently prompt action and flexibility.
Status: In process
Comments: As of December 5, 2007, the workgroup in Domestic Finance completed its analysis and review of the recommendations in the 2006 report on backup funding. It wrote an internal paper that was finalized in September. It needs to be reviewed by the Under Secretary. They will share the paper with GAO once the Under Secretary's review is complete.
Recommendations for Executive Action
Recommendation: The Secretary of the Treasury should examine in detail the implementation requirements for establishing a line of credit and a private placement of a CM bill with a range of appropriate private sector financial institutions, select the most appropriate option(s), and take steps to put required frameworks into place for use during a wide-scale disruption. Implementation details to be considered for both options include determining the design features discussed earlier, including situations or criteria for use, how to determine the appropriate financial institutions to rely upon, and the amount needed. For the private placement of a CM bill, the cost or price determination method would have to be analyzed since price discovery may not be possible in a significantly degraded financial market. For a credit line, ways to reduce the cost of an understanding or a guarantee of credit would have to be explored, such as a prearranged proposal process that determines the fees (if any) and terms of the transaction. As Treasury explores these options, it should consider how other countries have implemented alternative funding options to obtain any useful insights on its design, recognizing that the U.S. Treasury market has a unique role as the largest and most active debt market in the world.
Agency Affected: Department of the Treasury
Status: In process
Comments: Treasury started a study group to explore these recommendations and other issues in late 2006.
