We hinted at some Fed charts yesterday, but have yet to finish the heavy lifting, so we willfully admit to bait and switch and hope the following has some interest to our readers.

First, let’s revisit a statement from the Aug 4 2009 minutes of the Treasury Borrowing Advisory Committee, as it pondered the future of the Treasury, both in debt raising and governmental financial “innovation”.  From the Minutes, verbatim (emphasis ours throughout this post):

 The presenting member then discussed interest-rate volatility. Both realized and implied volatility remained at elevated levels relative to historical norms, with long-term rate volatility significantly higher than front-end rate volatility. The negative convexity profile of the mortgage market has increased with the QE purchases but it is difficult to hedge the convexity in the current market. This is because there are no natural sellers of volatility left in the market, following the collapse of hedge-fund capital, despite overwhelming demand for volatility from mortgage servicers and originators; this has created a chronic structural net short position in the market place. The presenting member suggested that Treasury, if it wanted to be opportunistic, could potentially benefit from this demand for volatility by offering putable issues.

It bothered us at the time that the Treasury would be so cavalier at throwing out the possibility of assuming the traditional risk taking functions of the private market, and we pondered aloud that it might be a bit jealous of the Federal Reserve, which has become the word’s largest de facto hedge fund. 

So, what is the Treasury’s role?  According to its Congressional mandate issued Sep 2 1789:

Section 2. And be it further enacted, That it shall be the duty of the Secretary of the Treasury to digest and prepare plans for the improvement and management of the revenue, and for the support of public credit; to prepare and report estimates of the public revenue, and the public expenditures; to superintend the collection of revenue; to decide on the forms of keeping and stating accounts and making returns, and to grant under the limitations herein established, or to be hereafter provided, all warrants for monies to be issued from the Treasury, in pursuance of appropriations by law; to execute such services relative to the sale of the lands belonging to the United States, as may be by law required of him; (b) to make report, and give information to either bra[n]ch of the legislature, in person or in writing (as he may be required), respecting all matters referred to him by the Senate or House of Representatives, or which shall appertain to his office; and generally to perform all such services relative to the finances, as he shall be directed to perform.

This is a bit broad and the assumption of hedge fund roles are not mentioned, per se.  However, we’ll give the Founding Fathers the benefit of the doubt and believe that they did not intend such.  The next question is, what is the Treasury’s own view of being “opportunistic”?

From the Mar 6 1998 address of Assistant Secretary for Financial Markets Gary Gensler:

Second is maintaining the consistency and predictability in our financing program. Treasury issues securities on a regular schedule with set auction procedures. This reduces uncertainty and helps minimize our overall cost of borrowing. Related to this principle, Treasury does not seek to time markets. Our sheer size does not practically permit an opportunistic approach. Over the long run, moreover, it is unlikely that we could consistently and successfully time markets.

Gensler (former Goldman partner and now Chairman of the CFTC) admits that Treasury opportunism (at least from the perspective of attempting to time Treasury auctions) is impractical.

From the Oct 30 2002 TBAC minutes:

The question on performance measures generated some debate among Committee members about both the feasibility and desirability of quantifying debt management performance.  Some members felt that this issue required more preparation than the current meeting format permitted. Treasury’s efforts to reduce auction release times was cited as one area where quantification is beneficial, but some Committee members were skeptical that Treasury would be able to identify other quantifiable performance measures.  Part of this skepticism stems from Treasury’s issuance approach as a non-opportunistic issuer. 

The Committee identified some measures relating to debt management that may form part of a larger package of performance indicators: bid volumes, auction tails, bid-to-cover ratios, persistence of fails in the financing market, pricing relative to a curve (spline, LIBOR or RP-adjusted swaps, or G3 funding), and turnover or volume in secondary market.  Any performance measures will need to be adjusted for economic and market conditions.  Some Committee members argued that debt management is inherently subjective given the enormous range of uncertainty associated with fiscal forecasts and the dependence on current conditions.   The Committee also noted the unique difficulties faced by the U.S. Treasury which cannot use another issuer as a benchmark.

As to the first bolded statement, the Treasury again states its role as non-opportunistic.  As to the second,  we note only the ominous nature of the “difficulties” that can only be remedied by the US Dollar being replaced as the world’s reserve currency. 

From the Dec 5 2002 remarks of Treasury Deputy Assistant Secretary for Federal Finance, in a speech titled “Treasury is Committed to Inflation Indexed Securities [TIPS]“:

Good morning. It is a pleasure to have the opportunity to speak with you again. Yesterday, I tried to give you a feel for debt management at Treasury as well as our position in the marketplace. We talked about the regularity and predictability of Treasury debt management. I stressed that Treasury is not an opportunistic borrower. We believe a regular auction calendar will provide investors with certainty. That certainty will help translate into broader investor participation which will then help lower Treasury’s borrowing costs.

Ditto.

From the June 26, 2003 Presentation of Deputy Assistant Secretary for Federal Finance Timothy S. Bitsberger to the Bond Market Association’s Inflation-Linked Securities Conference New York, NY:

Why Treasury Issues TIPS

As the primary seller of TIPS, I am frustrated where I talk to private and public funds that view TIPS as the long-term panacea for their ills, but then trade them with a short-term, opportunistic bias. Growth depends on long-term commitment to this market; arbitraging break-evens and carry versus nominals increases one-way liquidity and does nothing to create long-term sponsorship.

Here, the Treasury (at least when being channeled through Mr. Bitsberger) views short term opportunism as a negative.  Interestingly, the very same TBAC minutes from August 2009 that we first quoted in this post, where opportunism is casually bandied about, discusses the negatives of the TIPS (inflation protected government debt) program:

…much of the criticism of TIPS has been based on ex-post cost measures which have shown a high cost.

i.e., inflation makes TIPS a clear loser to the US Treasury, even with gamed CPI–surprise.

From the Sep 15 2008 Treasury Office of Debt Management Director Karthik Ramanathan
Remarks at Real Return USA:

Given the extensive uncertainty Treasury faces, debt management requires considerable flexibility. The recent fiscal stimulus package, in which rebates were literally place into the hands of Americans just 20 weeks after enactment, shows such a need for adapting to rapidly changing conditions. At the same time, our large size makes behaving opportunistically impractical. Moreover, it would not necessarily lower borrowing costs. Financial market participants would likely model our interest rate objectives and anticipate our debt issuance behavior, limiting any potential gains we might hope to achieve.

In addition, opportunistic behavior would increase investor uncertainty and could limit demand for our securities. Therefore, in order to ensure ready market access, we issue debt regularly and in predictable amounts. Our set of instruments consists of 8 nominal issues and 3 inflation indexed issues – a very simple, liquid set of benchmarks which investors can tailor to their needs.

So, until as recently as Sep 15 2008, the Treasury viewed itself as non-opportunistic and did not want to issue exotic debt (e.g., putable issues?).  What a difference six weeks makes.   From the TBAC minutes of Nov 4 2008:

One member pointed out that the reopening was not executed well but that it did help to fix fails, and that Treasury should consider being more opportunistic to take advantage of rich issues. Being opportunistic in this manner may help Treasury fund at low costs while also addressing the fails situation. Other members stated that certainty of supply was a hallmark of Treasury policy. A few members stated that such reopenings however would create a premium on Treasuries due to uncertainty of supply.

Since then, the Treasury has indeed reopened longer dated issues (i.e., issued more of them).  However, the recent wording in the August 2009 TBAC minutes suggests that there may be more than simple “reopenings” in the pipeline. 

One wonders if the “one member” from above is the same as the “presenting member” from the Aug 4 2009 minutes.  Comparing the then members of TBAC to now, there are a few commonalities.  Notably, 

1. Keith T. Anderson (now Chief Investment Officer of Soros Fund Management; then Chief Investment Officer – Fixed Income, Vice Chairman, BlackRock)
2. Goldman, Sachs & Co.  (now represented by Ashok Varadhan, Managing Director; then represented by Gary Cohn, President & Co-Chief Operating Officer)
3. Richard A. Axilrod (now and then Managing Director, Moore Capital Management, Inc.)
4. Ian G. Banwell (now & then Chief Executive Officer, Roundtable IMC, located at Bank of America Corporate Center)

One also wonders if the “short-term, opportunistic bias”, once derided by the Treasury is on the verge of being self- institutionalized.   Part 2 will take a deeper look at the players involved and a Treasury-cum-wannabe-hedge-fund.