Transparency in the Issuance Calendar

The U.S. Treasury regularly meets with the Treasury Borrowing Advisory
Committee of the Bond Market Association, a group established by
Treasury statute that consists largely of primary dealers, investment
management
firms, and major commercial banks. The Treasury also meets
with the Primary Dealers Committee of the Bond Market Association,
which is composed of senior officials identified by the Federal Reserve
Bank of New York as primary dealers. Both committees often give advice
about how the Treasury should structure its issuance calendar, and the
Treasury often seeks out the Committees advice, although it doesnt
always heed it. For example, the Treasury Department decided to end its
issuance of 30-year bonds in 2001 despite recommendations to the contrary
by the Primary Dealers Committee. That decision, which was
announced in early 2001, took the Street by surprise, as evidenced by the
very sharp gains in bond prices that followed the announcement.
Nevertheless, in general the open dialogue between the Street and the
Treasury Department creates a bit more clarity about the issuance calendar,
although there are never really any certainties about issuance, even to
those who make the issuance decisions.
The Benchmark Status of U.S. Treasury
Securities
Regularization of Treasury issuance has played an important role in creating
benchmark status for U.S. Treasury securities. Treasuries are seen as a
benchmark for a variety of different reasons, although the reasons vary
depending upon how the Treasuries are used by market participants. For
example, many portfolio managers use Treasuries as a benchmark to judge
the performance of their portfolios. Others use Treasuries as a gauge of the
risk-free rate of return, which can be used to price other issues based on a
comparison of credit quality of these issues relative to Treasuries.
Treasuries are also used as a hedging benchmark against other segments
of the fixed-income market and as a reserve asset for many of the worlds
central banks.
322 PART 2 The Major Players

Of course, the Treasury markets benchmark status wouldnt be possible

without its backing by the full faith and credit of the U.S. government.
The backing is what gives Treasuries the risk-free quality investors
seek in a benchmark. Other qualities that contribute to the benchmark
status of Treasuries include their large supply and active trading volume.
This is evidenced by the roughly $4.3 trillion in Treasuries that were outstanding
in early 2006, and the roughly $600 billion of Treasuries that
were trading daily at that time.
Economic Uses of Treasuries
As noted above, Treasuries are used for a variety of purposes other than
as pure investments. One of these is for the financing of Wall Streets large
holdings of fixed-income securities. The Streets primary dealers finance
their holdings via repurchase agreements (repos), which are essentially
short-term loans secured by collateral deemed safe and liquidusually
Treasuries. The repo market is very large, with roughly $3.7 trillion
outstanding in early 2006, the vast majority of which was backed by
U.S. Treasuries.
Treasuries are also used for hedging and speculation. Most interestrate
hedges utilize Treasuries; for example, underwriters of corporate
securities sometimes sell Treasuries to hedge the interest-rate risks associated

with the issuance of new securities. Speculators use Treasury

options and futures to speculate on changes in interest rates as well as to
bet on changes in the shape of the Treasury yield curve and on the interestrate spread between Treasuries and other fixed-income securities. In
April 2006, for example, there were over 2 million 10-year Treasury
futures contracts outstanding carrying a notional value of over $200 billion
(2 million contracts $100,000 of notional value per contract). No other
futures contract on any other fixed-income security comes close. For
example, the number of federal agency futures outstanding is scant at only
a few thousand contracts.
Many loans granted to both individuals and businesses are tied to
Treasury yields. For example, many adjustable-rate mortgages are priced
against Treasury yields. Some agricultural loans are tied to Treasury
yields, such as those issued by the Farm Service Agency (FSA), which
makes variable interest rate and ownership loans to farmers who are temporarily
unable to obtain private credit on commercial terms. Operating
loans to ordinary farmers for one and seven years are tied to the 5-year
CHAPTER 8 The Treasury and the Federal Agencies 323

constant maturity yield plus not more than 1%.10 Most federal student
loans are linked to Treasuries, carrying a variable interest rate that is
indexed to the 3-month T-bill.
Treasuries are used for a variety of regulatory purposes. For example,
many banks hold Treasuries to help fulfill their capital adequacy requirements
as set forth by the Basel Capital Accord, which made capital requirements
more sensitive to differences in risk profiles among banking organizations.
Under the accord, bank supervisors in each BIS country (countries whose
central bank is a member of the Bank for International Settlements) calculate
a banks capital adequacy ratio by adding common stockholders equity to
certain other items, assigning a risk weight to all of a banks assets and
offbalance sheet items, summing these weights to calculate a banks riskbased
assets, and dividing a banks capital by its risk-based assets.
Under the accord, claims against or guaranteed by the full faith and
credit of the United States or the central government of an Organization
for Economic Cooperation and Development (OECD) member country
are given a zero weight. In contrast, claims on other U.S. depository institutions
and OECD banks, claims on or guaranteed by the full faith and
credit of U.S. state and local governments or subsidiary governments in
other OECD countries, claims on or guaranteed by the official multilateral
lending institutions or regional development banks, claims on or guaranteed
by U.S. government-sponsored agencies, and mortgage-backed securities
issued by U.S. government-sponsored agencies are given a 20 percent
weight.11 The zero weight assigned to Treasuries means that banks can
finance their purchases of Treasuries entirely with debt, whereas they
would have to add new equity or other qualified capital to their balance