FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, Ranking Member Rangel, and distinguished members of the committee, it is an honor to be here today to discuss Treasury debt management and our proposal to create a mechanism to repurchase outstanding Treasury securities prior to maturity.

Mr. Chairman, I want to thank you personally and other members for the leadership this committee has shown on debt management issues. Your role in this area has been extremely helpful to the Department in exercising its debt management responsibilities in a fiscally prudent and non-partisan manner.

The fiscal discipline of recent years has helped to foster a strong U.S. economy and has led to our first back-to-back budget surpluses since 1956 and 1957. We expect this quarter to pay down $16 billion in privately held marketable debt, bringing the total reduction to an estimated $100 billion by the end of FY 1999.

In 1993, federal debt held by the public was projected to rise to $5.4 trillion by 1999 if additional fiscal discipline was not imposed. In fact, the stock of publicly held debt outstanding now stands at $3.6 trillion, more than $1.7 trillion lower than it otherwise would have been. As a result, Treasury debt is taking up an ever smaller share of the capital markets. In 1992, Treasury marketable securities represented 32 percent, or just under a third, of the U.S. debt markets. They now represent only 23 percent of the U.S. debt markets. Moreover, Treasury's share of the gross new issuance of long term debt has been reduced by more than half. While we still have to issue debt to refund maturing securities, last year that Treasury debt issuance represented only 18 percent of new long-term debt issued in the United States, down from 40 percent in 1990.

Reducing the supply of Treasury debt held by the public has enormous benefits for our economy.

It means that less of the savings of Americans will flow into government bonds and more will flow into investment in American businesses.

It means less reliance on borrowings from abroad to finance American investment.

It means less pressure on interest rates and thus lower relative borrowing costs for businesses and American families.

While reducing the debt held by the public greatly benefits the economy, it brings with it significant challenges. As a result of the reductions in publicly held debt, the ongoing task of debt management for the Federal government will be very different in the years ahead than it has been in the past when debt was rapidly increasing.

Before discussing our debt buy-back proposal in detail, I'd like to briefly review the goals and principles of Treasury's debt management program, which provide the background and context for the debt buyback proposal. These goals and principles were outlined in greater detail for this panel last year when my predecessor, now Under Secretary Gensler spoke to you about debt management more broadly.

Treasury debt management has three main goals: (1) to provide sound cash management in order to ensure that adequate cash balances are available at all times; (2) to achieve the lowest cost financing for the taxpayers; and (3) to promote efficient capital markets.

In achieving these goals, we are guided by five interrelated principles:

First, maintenance of the "risk-free" status of Treasury securities to assure ready market access and lowest cost financing.

Second, consistency and predictability in our financing program. Keeping to a regular

schedule of issuance with set auction procedures reduces uncertainty in the market and helps minimize our overall cost of borrowing.

Third, maintenance of market liquidity, both to promote efficient capital markets and lower Treasury borrowing costs.

Fourth, financing across the yield curve. A balanced maturity structure enables us to appeal to the broadest range of investors and mitigates refunding risks. Providing a pricing mechanism for interest rates across the yield curve also further promotes efficient capital markets.

Fifth, unitary financing. We aggregate the financing needs for all programs of the Federal Government and borrow as one nation. This ensures that all programs of the Federal government benefit from Treasury's low borrowing rate.

The financing tools that Treasury has had at its disposal in the past to achieve the goals and promote the principles described have included primarily the ability to determine the issue sizes, offering schedules and types of securities offered. Using these tools, Treasury has paid down debt by refunding our regularly maturing debt with smaller amounts of new debt. To do this, we have reduced the size of our regular Treasury bill auctions, reduced the frequency of issuance of 5-year notes, and discontinued issuance of 3-year notes. At our last quarterly refunding announcement, we announced a reduction in the frequency of issuance of our thirty-year bonds. Aside from allowing us to maintain the size of our benchmark issues, this reduction also will help to keep the average maturity of our debt from lengthening further.

Repurchase of outstanding debt prior to maturity would represent another tool that could provide us with greater flexibility in meeting our debt management goals and would be consistent with the principles we have followed in meeting those goals. While we have made no decisions as to whether we will, in fact, conduct debt buy-backs, publication of the proposed rule for public comment is the first step to making debt buy-backs an actual debt management tool for Treasury. We hope to have final regulations in place during the first quarter of 2000.

The process proposed for the debt buy-back program is fairly straightforward. Treasury would issue a press release, which would include the eligible securities and the total amount of the buy-back. Treasury would have the right to buy back less than the amount announced. Offers would be submitted through primary dealers. This limitation will enable us to make use of the Federal Reserve Bank of New York's open market facility. Other holders of eligible securities could participate through offers submitted to a primary dealer. The proposed rules call for a "reverse auction" - a multiple price process in which successful offerors receive the price at which they offered securities. Following the completion of the auction, Treasury would issue a press release providing for each security the amounts offered and accepted, the highest price accepted, and the remaining privately held amounts outstanding. FRB New York will transmit results messages to primary dealers informing them of the acceptance of the offers they submitted.

We believe that buybacks would have a number of potential benefits as a debt management tool:

• First, buy-backs could enhance market liquidity by allowing us to maintain regular issuance of new "benchmark" securities across the maturity spectrum, in greater volume than would otherwise be possible. This enhanced liquidity should reduce the government's interest expense and promote more efficient capital markets.
• Second, by paying off debt that has substantial remaining maturity, we would be able to prevent what could otherwise be a potentially costly and unjustified increase in the average maturity of our debt: from just over five years to more than seven years on the current trajectory.
• Third, buy-backs could be used as a cash management tool, absorbing excess cash in periods such as late April when tax revenues greatly exceed immediate spending needs.

In addition, although it is not a primary reason for conducting buy-backs, we may occasionally be able to reduce the government's interest expense by purchasing older, "off-the-run" debt and replacing it with lower-yield "on-the-run" debt. A Treasury security is referred to as being "on-the-run" when it is the newest security issue of its maturity. An on-the-run security normally is the most liquid issue for that maturity and therefore generally trades at lower yields than off-the-run debt. Because an off-the-run security generally does not have the same liquidity as an on-the-run issue, it may trade at higher yields, and thus lower prices, than on-the-run securities. Treasury may be able to capture part of the yield differential and thus reduce the government's interest costs by purchasing and retiring older debt and replacing it with lower yielding on-the-run debt.

Before I came to the Treasury Department, I spent thirteen years at a major investment bank. I frequently advised major corporations on their debt management policies. Debt buybacks and exchanges are common debt management tools used by some of the most sophisticated corporations in the private sector. Similarly, other countries experiencing budget surpluses have explored and/or implemented buyback programs to attempt to maximize the budgetary benefits of such surpluses. Even in the United States, the repurchase of outstanding securities that have not matured is not without precedent. Treasury conducted several debt exchanges or advance refundings between 1960 and 1966, and again in 1972 under which new issues were exchanged for outstanding, unmatured debt. In addition, the Treasury's Borrowing Advisory Committee has unanimously recommended the use of debt buy-backs as a debt management tool in the future.

Let me now turn to the budgetary treatment of proposed buybacks. As most older Treasury securities were issued in a higher interest rate environment, repurchasing such debt in the near term would most likely require payment of a premium, which means that we would have to pay more than the face value of the bonds. Current budget treatment would require that any premium paid by the Treasury to buy back debt would be treated as interest expense at the time of the buyback. It would account for future savings in interest expense in future fiscal years. The future savings, in reality, would offset the up-front expense paid in the form of the premium. In other words, the up-front budget impact would merely reflect a difference in the timing of immediate outlays and future savings. We also must recognize that not all securities trade at a premium. There are also securities, albeit a minority in today's environment, that trade at a discount to their face value. If buybacks were to involve such securities, the discount would lower interest outlays in the period during which the buyback occurred. Again, this would reflect a difference in the timing of cash flows.

Although we cannot ignore this issue, we must do our utmost to ensure that budgetary treatment issues do not affect the efficient management of our nation's debt. It is important to maintain both the integrity of our budget practices and the integrity of our debt management. We must ensure that everyone understands that both our budget treatment and debt management principles will be upheld, and their integrity maintained. Efficient debt management is consistent with the best long-run budget outcomes.

Having a mechanism in place through which Treasury can conduct debt buybacks is simply good policy. Debt buybacks can help fulfill our core debt management goals - by improving our cash management capabilities, offering potential taxpayer savings, and promoting efficiency in capital markets through enhanced liquidity.

Mr. Chairman, as you stated in your announcement of these hearings, "our goal should be to reduce significantly the national debt at the least cost to the taxpayer." This proposal is an effort to ensure that this Treasury Department and future Treasury Departments have another important tool in place with which to achieve that goal. We look forward to continuing to work with this committee and others to continue to advance these goals. I will be happy to answer any questions you may have.