Treasury Auctions

Sean Bell, Treasury Auction

& Low-CarddrawingExpert

Treasury Auctions

So—what is a Treasury Auction??

The tool used by the Federal Gov’t to efficiently raise funds for operating expenses and to service the national debt.

Specifically….. A method of selling gov’t securities via U.S.

Treasury Department (semi-) public auction. Goal: to maximize price received, while minimizing sales expenses.

2003 auctions = $3.42 trillion total sold

Treasury Auctions

Why Should You Care? 1) A steady, if unspectacular, investment option 2) U.S. national debt growing exponentially

Just keeping up with the interest is a huge cash drain

So, the Federal Gov’t has used sales of Gov’t securities to finance deficit spending and associated debt servicing costs

How big is the debt? Take a look at past and present…

U.S. DebtClock

U.S. DeficitGrowth

Treasury Auctions

Discussion Topics:

1) What & Why of Treasury Auctions

2) Definitions 3) How an Auction Works 4) Scandal and Evolution

Treasury Auctions Definitions:

Treasury Bills, Notes, and TIPS (General term = Bonds) Government securities “backed by the full faith and

credit of the U.S. Gov’t” BILLS: Maturity period a year or less

Do NOT pay interest---instead, sell at a discount to “Par” (face) value, then mature at full value---the difference is the yield

The discount determined by the auction $1 million max purchase per auction per buyer

NOTES: 2-10 year maturity period Pay fixed interest every 6 months until maturity

TIPS (Treas. Inflation Protected Sec.) are indexed off CPI to adjust interest paid (2X/yr).

5, 10, and 20 year maturity, at present time BONDS: Bonds no longer sold, though many still maturing—10

to 30 years. Twice annually interest payments

Treasury Auctions Definitions:

“Auctions”---only for the sale of T-Bills, Notes, and TIPS (NOT for U.S. Savings Bonds)

Most auctions since 1992 single-price format or “Dutch Auction”; 1998 ALL

Silent, conducted electronically today Consist of 2 types of bids:

COMPETITIVE & NONCOMPETITIVE

Routine, stable, scheduled

Treasury’s stated goal is to meet financing needs with the lowest possible cost over time

AuctionSchedule

Treasury Auctions COMPETITIVE BID

Typically pro investors, a smaller % of bids

Specify rate offered and quantity desired

Used to determine the market rate/yield

Only those bids at or below the winning bid stop rate will be filled

A few other stipulations: see matrix

NON-COMPETITIVE Anybody else, that

just wants to buy at market

Specify only amount desired

Accept wherever the market rate ends up: the “bid stop”

Deducted from total issue before competitive bids: if enough to cover N-C bids, ALL will filled

Treasury Auctions

Discussion Topics:

1) What & Why of Treasury Auctions 2) Definitions

3) How an Auction Works 4) Scandal and Evolution

Treasury Auctions HOW an AUCTION WORKS: Bidding

General Public/Brokers directly through Treasury-Direct electronic

money transfer system for individuals Using tender form, mailed to Treasury

Primary Dealers Small number (about 30) dealers meeting Fed

requirements for trading volumes, stability, etc. Brokers also able to trade in “when-issued”

securities --available pre-auction only to brokers Helps establish price the auction will go at

TAAPS electronically aggregates bids and conducts auction

Treasury Auctions HOW an AUCTION WORKS: TAAPS

Auction cycle time keeps reducing Several hours in late 1980’s Under two hours early 90’s 2003 goal < 2 minutes

Goal is to reduce investor risk by decreasing time from bid to auction; theory is prices higher w/less risk

Treasury Auctions Example Auction:

Single price, “dutch” auction Lowest yield bid = highest price for treasury Lowest discount = highest price for treasury

Treasury auction total issue $10.0 billion

Noncompetitive bids $6.0 billion

Amount left for competitive bidders $4.0 billion

Competitive bids received:

A) 5.50% (lowest yield/highest price) $750 million

B) 5.51 $750 million

C) 5.52 $750 million

D) 5.53 $750 million

E) 5.54 $750 million

F) 5.55 (highest yield/lowest price) $750 million

Treasury Auctions Example Auction:

$10B Securities sold $6B non-competitive: sold at bid stop $4B Competitive: also sold at bid stop 33% of buyers at yield stop allocated before

running out No bids at 5.56% or higher accepted

AUCTION METRICS: High bid: 5.50%

Stop Yield: 5.55%

Awarded at stop: 33%

Average bid: 5.525%

Treasury Auctions Other-than-Auction Transactions:

Auctions are the Primary Market for gov’t securities…along with the Primary Dealers and “when-issued” securities

“wi market” trading from announcement day to day of auction

Secondary Market exists to trade previously issued bonds, OTC

Primary markets in New York, London, Tokyo

Creates continuous, 24 hr. trading

Treasury Auctions

Discussion Topics:

1) What & Why of Treasury Auctions 2) Definitions 3) How an Auction Works

4) Scandal and Evolution

Treasury Auctions Salomon Brothers Scandal:

Infamous 1991 attempt by Salomon to corner bond market

Fraudulently placed orders in customers’ names

Created “significant” overpricing on issue for about 6 weeks (.16-.25%)

Interestingly, created situation which probably benefited gov’t

But created lack of confidence: back to risk/return…drives down Treasury revenue

Treasury Auctions Evolution:

Effects of Technology and Procedures drive changes

Technology including: Automated order entry systems Computerized verification of bidder eligibility

Procedures Response to various scandals, irregularities Staying current w/ trends (i.e. globalized

money markets opening Primary Dealer network to foreign firms in 90’s)

Treasury Auctions Evolution Conclusions:

Treasury goal to minimize transaction/auction expense

Adaptive and willing to use new technology and tools

Can be slow to change policies Change seems reactionary

Treasury Auctions

U.S. Treasury…1784, 1833, and now~

Questions?