Quarterly Refunding Discussion ChartsAugust 2, 2005

30-Year Bond Issuance

2

Three Fundamental Issues

• Financing Needs• Flexibility • Cost Considerations

3

Financing Needs

• Existing securities can finance projected needs

• Bond issuance is not projected to crowd out other securities

Debt Portfolio Flexibility• Average maturity has declined in recent years;

modest 30-year issuance would not adversely impact flexibility

• Roll-over is within the historical range; 30-year issuance would reduce short-term funding needs while maintaining short bias in financing

• Reintroduction of the 30-year diversifies funding

• The reintroduction of 30’s increases the investor base4

5

Costs• Term premium partially offset by reduced

event and operation risk, improved cash management, and broader customer base

• Market consultation indicates potential structural demand from real money accounts, pension funds, and asset-liability managers

• Previous presence in market eases market acceptance

6

DEBT MATURITY MEASURES

20

30

40

50

60

70

80

90

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

months

20

30

40

50

60

70

80

90

months

Average Maturity of Issuance

Average Maturity

54.7

As of June 30, 2005

36.8

(Projected)

Assumptions: Current CBO budget estimates through FY2015 (except internal Treasury estimate used for FY2005). Future residual financing needs are spread equally across auctioned securities to maintain constant maturity of issuance.

Dashed lines represent measures with semi-annual 30-year issuance.

7

Distribution of Marketable Debt Outstanding by Security

0%

5%

10%

15%

20%

25%

30%

35%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 20140%

5%

10%

15%

20%

25%

30%

35%

BILLS 2-3 YR NOTES 4-7 YR NOTES 8-10 YR NOTES BONDS TIPS

Projected

Projections are based on current CBO budget estimates through FY2015 (except internal Treasury estimate for FY2005). Future residual financing needs are spread equally across auctioned securities to maintain constant maturity of issuance. Approximately $25-$30B of bonds are included starting FY2006.

Dotted line: with Bonds

8

Percentage of Debt Maturing in Next 12 to 36 Months

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 201425%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%

Maturing in 12 Months

Maturing in 24 Months

Maturing in 36 Months

Projected

Projections are based on current CBO budget estimates through FY2015 (except internal Treasury estimate for FY2005). Future residual financing needs are spread equally across auctioned securities to maintain constant maturity of issuance. Approximately $25-$30B of bonds are included starting FY2006.

Dotted line: with Bonds

9

Security Characteristics of Treasury Debt Portfolio

Security

Average Spread to 3-

month

SD of spread to 3-

month

Correlation to 3-month

nominal yield

Correlation to 3-month

real cost

Average modified

duration for change in

nominal rates

Average convexity for 100

bps change in nominal rates

6-month 0.19 0.20 0.997 0.71 0.47 0.002-year 0.75 0.56 0.977 0.70 1.85 0.043-year 0.90 0.72 0.963 0.71 2.69 0.095-year 1.10 0.91 0.940 0.65 4.20 0.23

10-year 1.36 1.21 0.904 0.69 7.18 0.6530-year 1.42 1.39 0.858 * 12.90 2.71

5-year TIP 2.01 2.71 0.425 -0.18 4.67 0.2510-year TIP 1.43 2.93 0.242 -0.26 8.71 0.8720-year TIP 1.57 3.42 -0.081 -0.35 15.10 2.80

Attributes of Different Treasury Security Offerings, Jan 1959-May 2005

Notes: Historical data for TIPS are simulated assuming real yields are equivalent to the difference between the yield of a nominal security of comparable maturity and inflation expectations. Inflation expectations are derived using a simple adaptive expectations model that weights last month CPI-U NSA,current month CPI-U NSA and next month CPI-U NSA at 25%, 50% and 25%, respectively. OMB's inflation forecast of 2.4% is assumed for realized CPI-U NSA post-May 2005. Simulated TIPS' historical real yield is used to calculate TIPS' duration and convexity. * Insufficient data.

10

The Impact of Various Securities on Portfolio Costs and Flexibility

Security

Annual Auction

Frequency

Contribution of debt stock maturity to steady-state portfolio's average maturity (in months) /1

Historical average

spreads to 3-month bill

rate

Steady-state Debt Stock incl SOMA ($ billions)

Additional Debt That Can Be Raised For $1 Billion

Increase in Auction Size In a Fiscal Year ($ billions) /1

Contribution of $1 billion to steady-state

portfolio's average maturity

(in months) 1-month 52 0.0 0 53 4 0.0003-month 52 0.1 0 283 13 0.0006-month 52 0.3 0.19 551 26 0.0002-year 12 1.3 0.75 646 12 0.0023-year 4 0.8 0.90 264 4 0.0035-year 12 6.0 1.10 1236 12 0.00510-year 8 13.3 1.36 1368 8 0.01030-year * 2 23.6 1.42 810 2 0.029

5-year TIP 2 1 2.01 115 2 0.00510-year TIP 4 4 1.43 420 4 0.01020-year TIP 2 8 1.57 420 2 0.019

Totals 202 58 6166 89 0.084

* Hypothetical# A steady state portfolio illustrates the implications for Treasury's debt stock if Treasury's current issuance pattern and offering sizes were maintained in perpetuity. Assumes no growth in SOMA.

Different Securities' Impact on Flexibility and Cost of a Steady-State Portfolio#

Notes: /1 Average nominal historical rates are based on data from 1959 to present. A synthetic series to estimate historical nominal rates for TIPS is used -- per the prior table.

11

Impact of a new 30 year on Debt Portfolio2005 2010 2015

Maturity (years) Current issuance schedule 1/ 4.50 3.92 3.50 With 30-year bonds 2/ 4.50 4.58 4.58

Duration (years) Current issuance schedule 3.93 3.58 3.33 With 30-year bonds 3.93 3.91 3.84

Nominal Interest Cost ($B) Current issuance schedule 152.6 248.9 338.7 With 30-year bonds 152.6 249.4 339.8

Nominal Interest Cost Sensitivity ($B) 3/ Current issuance schedule -- 389.0 389.4 With 30-year bonds -- 400.9 401.7

Financing Flexibility ($B) /4 Current issuance schedule -- 5.37% 4.54% With 30-year bonds -- 4.39% 4.04%

Notes: Projections are based on current CBO budget estimates through FY2015 (except internal Treasury estimate for FY2005), and on current OMB estimates for interest rates and inflation. 1/ Under current issuance schedule, auction sizes as percents of total marketable borrowing needs are held constant. 2/ Approximately $25B to $30B of 30-year bonds are included starting in 2006; subsequent auction sizes as percents of total marketable borrowing needs are held constant. 3/ Nominal interest cost sensitivity is the change in the debt portfolio's interest expense given a positive shock of 100bps to real and inflation rates. 4/ Average percentage change in auction size over 2006-2010 or 2006-2015.

Treasury Backstop Securities Lending Facility

13

Trading volumes are growing compared to supply

•Cash Market•Futures Market•RP Market

14

Turnover RatiosAverage Daily Trading Volume/Marketable Debt Outstanding

Annual Data

0

2

4

6

8

10

12

14

1980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004

Percent

0

2

4

6

8

10

12

14Percent

Sources: FRBNY, MSPD, BMA

Average Annual Growth Rates 1981-2004

Outstandings 8%Average Daily Trading Volume 16%

1990-2004Outstandings 5%

Average Daily Trading Volume 11%2000-2004

Outstandings 4%Average DailyTrading Volume 22%

Annual growth rates in Primary Dealer trading volume based on BMA data.

Turnover Ratios have doubled since 1999.

15

Peak Open Interest in Front 10-yr Futures Contract vs. Issuance of Cheapest Deliverable Security ($bn)

0

40

80

120

160

200

M J S D M J S D M J S D M J S D M J S D M J S D M J S D M J S

1998 1999 2000 2001 2002 2003 2004 2005

peak open interest for front contractoriginal issuance of cheapest-to-deliver security

CBOT data through 7/15/2005

16

Imbalances Cropping Up More Frequently

Examples:• Fall 2001: High levels of settlement fails in the

August 5-year and 10-year notes after 9/11 • Second half of 2003: Chronic settlement fails

in the May 2013 10-year note • 2005: High levels of open interest in futures

contracts led to market dislocations

Outcome: Increasing Fails

17

Average Daily Treasury Settlement Fails*

0

50

100

150

200

250

7/4/

90

1/4/

91

7/4/

91

1/4/

92

7/4/

92

1/4/

93

7/4/

93

1/4/

94

7/4/

94

1/4/

95

7/4/

95

1/4/

96

7/4/

96

1/4/

97

7/4/

97

1/4/

98

7/4/

98

1/4/

99

7/4/

99

1/4/

00

7/4/

00

1/4/

01

7/4/

01

1/4/

02

7/4/

02

1/4/

03

7/4/

03

1/4/

04

7/4/

04

1/4/

05

7/4/

05

$ Billions

* Fails to ReceiveSource: FRBNY

18

Risks •Large and Persistent Fails•Impaired Liquidity in Cash Market•Loss of Price Convergence in Futures Market•Operational Cost of Resolving Fails•Ultimately Higher Borrowing Costs for Treasury

19

Imbalances could be mitigated or alleviated through a temporary

increase in the supply of Treasuries.

20

Possible Sources of Additional Supply

• FRBNY securities lending facility– Additional supply limited to 65% of SOMA holdings– Holdings of some securities are small– No auction participation beyond rollovers– Primary mission of portfolio not securities lending

• Large holders– Most securities are already made available– Individually rational reductions in lending during

episodes of chronic fails• Development of a backstop Treasury securities

lending facility– Design to provide additional supply, while not

impeding normal market functioning

Specials Financing

Demand for BorrowingSecurities Increases

Cost of Borrowing Increases

Zero Bound on RPs Limits Cost of Borrowing

Spillover into Fails

Buy-in Rule Triggered

Unable to Enforce Buy-in RuleBecause of Supply Constraints

BUT

21

22

Desirable Outcomes• Facilitate settlement of

cash market transactions• Improve functioning of the

specials market– Do not want to damage

specials market– Promote market pricing

through zero RP rate – Do not want to distort

risk/reward trade-offs

• Strengthen futures market– Promote price convergence

Treasury Constraints• Continue to provide

certainty of supply• Supplier of last resort

– Encourage market-driven solutions to supply-demand imbalances

– Stay out of market unless risk of systemic problems

– Do not want to be perceived as rewarding shorts

Effects of a Treasury Securities Lending Facility

Potential AdditionalSupply

Allows Enforcement ofBuy-in Rule

Encourages Pricing ThroughZero Bound

Encourages Availability of Existing Supply

Already in the Market

Additional Supply Through Securities Lending Facility As Last Resort

23

24

Desired Attributes of a Backstop Securities Lending Facility

• Clarity and confidence of availability – Non-discretionary, standing facility– Unlimited supply, renewable terms

• Discourage use unless market severely stressed– Price set at a penalty rate

• Not designed to address transitory needs– Term greater than overnight needed

25

Example of How a Backstop Securities Lending Facility Could

Work• Treasury Stands Ready to Lend Any

Security at Implied Negative RP Rate• Quantity Unlimited• Borrow for Fixed Term• If Needed, Borrower Could Renew for

Same Term

Specials Market1. Normal Functioning 2. Current Fails Situation

3. Prompt Delivery / Desired Outcome 4. Backstop Securities Lending Facility

Quantity

Interest Rate

0

GC rate

Demand

Supply

Quantity

Interest Rate

0

GC rate

Demand

Supply

Negative RP rates encourage additional supply and curtail demand.

Quantity

Interest Rate

0

GC rate

Demand

Supply

Supply may actually decline at near zero RP rates because of fear of not having the security returned.

Buyers presently have no incentive to reverse in securities at negative RP rates.

26Quantity

Interest Rate

0

GC rate

Market Supply

Implied Floor / Securities Lending Facility Rate

If Demand continues to increase, Treasury stands ready to supply the market with additional securities at the implied floor.

27

Many Questions Would Need to be Answered• Policy

– Eligible participants– Pricing mechanism– Term of loan

• Statutory/Regulatory– Nature of transaction (loan, or sale and buyback)– Authority

• Standing• During Budget Surpluses • Debt Ceiling

– Interaction with buy-in rule– Clarification of tax regulations– Possible legislative changes

• Operational– Institutions to conduct transactions– Collateral arrangements– Accounting

• Systems modifications • Treatment of interest accrual• Treatment of interest payments• Affect on amounts of debt outstanding

Presentation to the U.S. Treasury and the Treasury Borrowing

Advisory Committee

August 2, 2005

Presentation Question: Please discuss the impact of currency movements on the Treasury's cost of borrowing. Are foreign investors exerting significant downward pressures on the Treasury's financing costs or are other forces at work which have limited increases in yields? Main Points:

Currency movements can impact Treasury's cost of borrowing through a lower exchange rate creating more stimulative financial conditions.

Foreign official investors exert downward pressure on Treasury's cost of borrowing through funding the current account deficit. Foreign private and official investors have exhibited a tendency recently of buying longer maturity instruments.

These are just some of the factors limiting the increase in yields; others include:

• A decrease in risk premiums • An increase in the global savings rate • Structural changes in the bond market

However, the impact of some of these factors could wane.

1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

80

90

100

110

120

130

140

150

160

2

4

6

8

10

12

14

16

18

US Trade-weighted Dollar Index (DXY) 29-Jul-05 89.35US 10 Year Yield 29-Jul-05 4.28

leve

lpercent

Updated 29-Jul-05(cash’dx.cl)

29-Jul-05

89.35

4.28

1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006130

120

110

100

90

80

70

0

2

4

6

8

10

12

14

US Real Trade-weighted Dollar (Inverted and Advanced by 18-months) Dec 06 90.30Core CPI Ann%Chg Jun 05 2.09

leve

lpercent

Updated 1-Aug-05(work’fx_us_real.m.lag)

Dec06

90.30

Jun05

2.09

*Source: A US Investment Bank.

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

20

40

60

80

0

20

40

60

80

Total Official Net Purchases of US bonds (treasury,agency and corporate bonds)Total Private Net Purchases of US Bonds (treasury, agency and corporate bonds)

Lev

el

May 05

70.68

57.43

13.25

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 20050

500

1000

1500

2000

2500

3000

3500

4000

0

500

1000

1500

2000

2500

3000

3500

4000

Cummulative Sum of Total Official Net Purchases of US Bonds (treasury,agency and corporate bonds) May 05 887.13Cummulative Sum of Total Private Net Purchases of US Bonds (treasury, agency and corporate bonds) May 05 4151.98

leve

lpercent

Updated 27-Jul-05(work’bond_off_sum)

May 05

887.13

4151.98

Source: Department of Treasury.

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

-150

-100

-50

0

50

100

150

200

-150

-100

-50

0

50

100

150

200

One Period MSum:12

US Net portfolio flows - monthly funding requirement (monthly c/a + monthly net FDI)L

evel

Level

Updated 26-Jul-05(work’fund_gap_m)

May 05

-6.13

-72.69

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

-200

-150

-100

-50

0

50

100

150

200

-200

-150

-100

-50

0

50

100

150

200

One Period MSum:12

US Net private portfolio flows - monthly funding requirement (monthly c/a + monthly net FDI)

Lev

elL

evel

Updated 26-Jul-05(work’fund_gap_priv)

May 05

-19.33

-230.29

Source: Department of Treasury, Bureau of Economic Analytics.

2000 2001 2002 2003 2004 2005

100

200

300

400

500

600

700

100

200

300

400

500

600

700

Foreign Private Institutions: Holdings of Treasury Bonds (Bil $) May 05 707.31Foreign Private Institutions: Holdings of Treasury Bills (Bil $) May 05 77.90

leve

l US$

May 05

707.31

77.90

2000 2001 2002 2003 2004 2005

200

300

400

500

600

700

800

900

1000

200

300

400

500

600

700

800

900

1000

Foreign Official Institutions: Holdings of US Treasury Bonds (Bil.$) May 05 1012.80Foreign Official Institutions: Holdings of US Treasury Bills (Bil.$) May 05 229.00

US$

US$

Updated 18-Jul-05(haver_usint’fhofftbn)

May 05

1012.80

229.00

Source: Department of Treasury.

Sou

rce:

Dep

artm

ent o

f Tre

asur

y.

Maturity Structure of Foreign Holdings of US Long-Term Debt Total Debt

0

5

10

15

20

One orless

1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10-15 15-20 Over 20

Year

(%)

Jun-02 Jun-03 Jun-04

Maturity Structure of Foreign Holdings of US Long-Term Debt Treasury

0

5

10

15

20

25

30

One or less 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10-15 15-20 Over 20

Year

(%)

Maturity Structure of Foreign Holdings of US Long-Term Debt Corporate

02468

10121416

One or less 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10-15 15-20 Over 20

Year

(%)

Maturity Structure of Foreign Holdings of US Long-Term Debt Agency

0

5

10

15

20

25

One or less 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10 10-15 15-20 Over 20

Year

(%)

Source: Department of Treasury.

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

020406080100

120

140

020406080100

120

140

Chi

na C

umm

ulat

ive

Hol

ding

s of

Tre

asur

y B

onds

($

Bil)

M

ay05

1

50.1

9C

hina

Cum

mul

ativ

e H

oldi

ngs

of A

genc

y B

onds

($

Bil)

M

ay05

1

44.5

1C

hina

Cum

mul

ativ

e H

oldi

ngs

of C

orpo

rate

Bon

ds (

$ B

il)

May

05

42.

12

LevelLevel

Upd

ated

27-

Jul-

05(w

ork’

ch_t

rea_

sum

)

May

05

150.

19

144.

51

42.1

2

Sou

rce:

Dep

artm

ent o

f Tre

asur

y.

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

456789

2345678910

US

10-y

ear

Bon

d Y

ield

2

9-Ju

l-05

4

.28

US

10-Y

ear

Fow

ard

1 Y

ear

Rat

e

29-

Jul-

05

5.1

2level

percent

(cas

h’us

10yy

.cl)

29-J

ul-0

5

4.28

5.12

World Gross National Savings Rate (%)

21.0

21.5

22.0

22.5

23.0

23.5

24.0

24.5

25.0

25.5

26.0

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

National Savings as a % of GDPBy Region

10

15

20

25

30

35

40

US Euro Area UK Japan Asia NIEs DevelopingAsia

Middle East

1983-90 Avg 1991-98 Avg 1999 2000 2001 2002 2003 2004

National Investment as a % of GDPBy Region

10

15

20

25

30

35

40

US Euro Area UK Japan Asia NIEs DevelopingAsia

Middle East

1983-90 Avg 1991-98 Avg 1999 2000 2001 2002 2003 2004

Source: IMF World Economic Outlook (April 2005).

Sou

rce:

A U

S In

vest

men

t Ban

k.

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

Tre

asur

y T

erm

Pre

miu

mLevel

Level

05Q

2

0.75

Sou

rce:

Fed

eral

Res

erve

Boa

rd. D

eriv

ed fr

om a

thre

e-fa

ctor

arb

itrag

e-fre

e te

rm s

truct

ure

mod

el.

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

1.0

1.5

2.0

2.5

3.0

3.5

1.0

1.5

2.0

2.5

3.0

3.5

OE

CD

Rea

l GD

P 10

-yea

r m

ovin

g st

anda

rd d

evia

tion

0

5:1

0

.98

OE

CD

Con

sum

er P

rice

Inf

latio

n 10

-yea

r m

ovin

g st

anda

rd d

evia

tion

0

5:1

1

.13

levelpercent

Upd

ated

26-

Jul-

05(w

ork’

oecd

_gdp

_msd

)

05:1

0.98

1.13

Sou

rce:

OE

CD

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2468101214

2468101214

US

10-y

ear

Bon

d Y

ield

J

ul 0

5

4.1

6U

S 10

-yea

r In

flat

ion

Exp

ecta

tions

*

Jun

05

2

.50

levelUS$

Upd

ated

27-

Jul-

05(w

ork’

trea

s_m

)

Jul 0

5

4.16

Jun

05

2.50

*Sou

rce:

Fed

eral

Res

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boa

rd fo

r dat

a fro

m 1

979

to d

ate.

His

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is d

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odel

.

Fixe

d In

com

e Is

suan

ce b

y Se

ctor

in 1

0-Ye

ar n

ote

Equi

vale

nts

(Bill

ions

)

050100

150

200

250

Jan-9

7 Apr-97

Jul-9

7 Oct-97 Ja

n-98 Apr-98

Jul-9

8 Oct-98 Ja

n-99 Apr-99

Jul-9

9 Oct-99 Ja

n-00 Apr-00

Jul-0

0 Oct-00 Ja

n-01 Apr-01

Jul-0

1 Oct-01 Ja

n-02 Apr-02

Jul-0

2 Oct-02 Ja

n-03 Apr-03

Jul-0

3 Oct-03 Ja

n-04 Apr-04

Jul-0

4 Oct-04 Ja

n-05 Apr-05

AB

SM

BS

AG

ENC

YG

OVT

CO

RP

Sou

rce:

A U

S In

vest

men

t Ban

k.

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

050100

150

200

250

300

-100

-5005010

0

150

200

250

300

350

Non

farm

Non

fina

ncia

l Cor

pora

te B

usin

ess:

Fin

anci

ng G

ap (

Adj

uste

d fo

r M

SFT

Div

iden

d, S

AA

R, B

il.$)

Level

05Q

1

119.

32

Sou

rce:

Fed

eral

Res

erve

Boa

rd F

low

of F

unds

M R

esea

rch.

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

-1000

100

200

300

400

500

600

700

0200

400

600

800

1000

1200

1400

1600

1800

2000

One

Per

iod

MSu

m:4

Pens

ion

Fund

, Lif

e In

sura

nce

Com

pani

es a

nd M

utua

l Fun

ds: F

low

s in

to C

redi

t Mar

ket I

nstr

umen

tsLevel

Level

05Q

1

401.

68

1337

.76

Sou

rce:

Fed

eral

Res

erve

Boa

rd F

low

of F

unds

.