May 3, 2011
The Committee convened in closed session at the Hay Adams Hotel at 11:30 a.m. All Committee members were present. Assistant Secretary for Financial Markets Mary Miller, Deputy Assistant Secretary (DAS) for Federal Finance Matthew Rutherford and Director of the Office of Debt Management Colin Kim welcomed the Committee, including the newest members of the Committee Steve Walsh and Steve Rodosky. Other members of Treasury staff included Fred Pietrangeli, Jennifer Imler, Amar Reganti and Bret Hester. Federal Reserve Bank of New York members Brian Sack and Joshua Frost were also present.
DAS Rutherford opened with an update on near-term fiscal developments. He reviewed the overall expectations for receipts in FY 2011, noting that in the President’s budget forecasts receipts will total $2.313 trillion, or 15.3 percent of GDP. If the forecast is met, this would represent a 7.0 percent increase in receipts from FY 2010.
Rutherford then reviewed the composition of the receipt base. Over the past 5 years, withheld receipts have comprised 69 percent of the tax base, while non-withheld and corporate receipts have averaged 17 and 14 percent, respectively.
Results of the April tax season were then discussed in some detail. It was noted that receipts for the month came in above Treasury’s expectations. In particular, non-withheld receipts rose 29 percent on a year-over-year basis. Despite the tax agreement passed in December, withheld receipts also posted slight gains, rising 1 percent. Rutherford highlighted that corporate tax receipts fell 6 percent, largely due to accelerated depreciation for capital expenditure provisions contained in the tax agreement.
Treasury’s March announcement that it would wind down its MBS portfolio was then discussed. Rutherford noted that the decision to sell MBS was consistent with Treasury’s general pattern of divestment of financial assets acquired during 2008 and 2009. Taxpayers have now recovered more than half ($120.9 billion) of Treasury’s original $225 billion MBS investment. To date, Treasury has sold $14.1 billion in MBS. Overall, he indicated that Treasury has been very pleased with the program, as markets have absorbed the additional supply without any meaningful price action.
DAS Rutherford then turned to forecasts of the deficit. A recent survey of the primary dealers revealed that they expect the deficit in FY 2011 to total $1.431 trillion, approximately $50 billion below CBO’s January estimate and $215 billion below OMB’s February estimate. It was noted that forecasters generally assume that the deficit will fall to below $1 trillion by FY 2013.
The proximity to the statutory debt limit was reviewed. Rutherford underscored that Treasury was only $64 billion (as of April 28) below the $14.294 trillion limit. He noted that Treasury expects to reach the debt limit on May 16.
Although Rutherford expressed confidence that the limit would be raised in a timely manner, the first of Treasury’s extraordinary actions was employed on Monday, May 2. He noted that effective Friday, May 6, the State and Local Government Securities (SLGS) window would be closed. Furthermore, it was highlighted that if Congress does not act by May 16, the Treasury would be forced to use other extraordinary measures.
Director Kim then briefly discussed demand for Treasuries. He commented that coverage ratios remain very high for all of Treasury’s products. He also noted that Treasury’s investor class data, which is released twice a month, continued to show healthy participation by a variety of accounts.
Kim then turned to the portfolio. He indicated that Treasury continues to make progress on its goal of gradually reducing rollover risk. As Treasury has transitioned from bill to coupon financing, the share of bills in the portfolio has fallen to below 20 percent, while coupons have risen to approximately 74 percent. Additionally, Kim briefly discussed the Supplementary Financing Program (SFP), noting that Treasury could increase issuance under the program once the debt ceiling is raised. Any decision on this front would be made in conjunction with the Federal Reserve.
Director Kim then discussed the TIPS program. He noted that Treasury remains pleased with the market’s capacity to digest the gradual increase in TIPS supply. For the calendar year, Treasury expects to issue approximately $125 billion in TIPS. As a percentage of the portfolio, TIPS have stabilized at approximately 7 percent.
Kim next reviewed measures of rollover risk. The average maturity of the portfolio continues to extend. Currently this measure stands at 60.4 months, above the long-term average of around 58 months. Additionally, the amount of Treasury debt maturing in the next 1-, 2- and 3-years ahead remains at historic lows. Kim mentioned that Treasury continues to study alternative products that may assist in reducing rollover risk.
Finally, Rutherford concluded with a discussion of the long-term fiscal outlook. He presented several charts from the President’s FY 2012 budget, but noted that some of the information in the budget is somewhat dated, given the President’s April deficit reduction proposal. The President’s plan to reduce the deficit borrows from the recommendations of the Bipartisan Fiscal Commission and builds on the $1 trillion in deficit reduction in the President’s 2012 budget.
Rutherford compared the three budget plans currently circulating around Washington, including the President’s plan, the Fiscal Commission plan, and the plan presented by Representative Ryan. Generally speaking, Rutherford expressed optimism that a bi-partisan agreement would be reached. He underscored that it was encouraging that Republicans and Democrats generally agree on the amount of deficit reduction that is needed, and the time period over which it is expected to take place.
A spirited discussion followed Rutherford’s presentation.
Several members noted that Treasury’s efforts to extend average maturity is contributing to strains in the T-bill market. Another member noted that among the large developed sovereign issuers, the U.S. actually had the largest share of bills as a percentage of its debt portfolio.
Several members stated that Treasury has made significant progress extending the average maturity and that the percentage of debt maturing in 1-, 2-, and 3-years ahead was at the lowest levels in decades. Another member noted that the current auction calendar would allow the average maturity to gradually increase to about 66 months by the end of FY13 before leveling off. That observation spawned a discussion of whether or not Treasury should continue to further extend the average maturity of the debt. A few members expressed the view that Treasury should continue to extend based on the fact that the average maturity of U.S. debt is shorter than other developed sovereigns.
Other members felt that in order to adequately answer the question of whether to further extend the average maturity, Treasury needed to have a better understanding of the cost and benefits associated with such a policy. Several members suggested that Treasury consider studying term premia. The Committee suggested that Treasury examine these issues at the August 2011 refunding.
Members then discussed whether strong April tax receipts provided sufficient room for Treasury to reduce coupon issuance over the near term. Members generally felt that given both the volume of maturing issues next year and lingering economic uncertainty, Treasury should keep coupon issuance steady. It was decided to review this issue at the August meeting.
The Committee next turned to the charge regarding the state of pension plans. The presenting member began by discussing the historical growth of pension plans.
The member noted that retirement assets totaled approximately $17.5 trillion as of the end of 2010. State and local government plans are almost exclusively defined benefit (DB) plans, while in the private sector defined contribution (DC) plans are more common.
In terms of size, state and local government DB plans became larger than corporate DB plans in 1997. Since then, state and local government DB plans have grown 66 percent (4 percent annually), while corporate DB plans have grown by 25 percent (1.7 percent annually). As of 2010, state and local DB plans were 57 percent of the total DB market ($3 trillion out of $5.2 trillion).
The presenting member compared private and public DB plans, noting that DB plans are structured quite differently in the private and public sectors. In general, public DB plans offer higher benefit payments but require larger contributions from both the employer and employee. The member also noted that, freezing or modifying a public DB plans is generally more difficult (due to collective bargaining agreements, legal protections, etc). This reduces the degrees of freedom for public plan sponsors.
The presenting member stated that regulatory, legislative and accounting changes over the past several decades have made DB plans increasingly complex and have contributed to cash flow and earnings volatility for employers. As a result, 21 percent of Fortune 1000 companies have frozen their DB plans. DB plan freezes and labor force turnover have resulted in a 40 percent decline in workers covered by DB plans.
The presenting member next turned to a discussion of the assets that pension plans hold.
Since the Pension Protection Act was enacted in 2006, corporations have increasingly focused on liability-driven investment strategies. As a result, corporate DB plans have shifted from equities into fixed-income and also increased the duration of their fixed-income assets to better match the duration of their liabilities (typically, greater than 12 years). Over the past decade, the fixed income allocation of corporate DB plans has expanded from 26 percent to 39 percent, while allocation in public DB Plans has declined from 29 percent to 27 percent. Both have increased allocations to alternative strategies such as real estate, private equity and hedge funds.
The presenting member noted that asset allocation trends between corporate and public plans were diverging and surveys indicate that the divergent trend between corporate and public DB plans is likely to continue over the next few years. Forty-one percent of corporate DB plan sponsors intend to increase their allocation to corporate bonds over the next 1 to 2 years (with 35 percent planning to increase their allocation to government bonds). Both corporate and public plans intend to reduce exposure to US equities.
The member noted that corporate DB plan sponsors are primarily concerned with volatility, while public DB plan sponsors are more concerned with improving their funding status. This difference in focus is likely the result of differences in regulatory and accounting standards, as well as the lower funding status of public plans.
Regarding DC asset allocation plans, the presenter stated that participants in corporate DC plans have been gradually de-risking, but still appear to have portfolios that are riskier than public DC plans. Cash, stable value and fixed-income have increased from 24 percent to 33 percent over the past 5 years, while total equity allocation has declined 4 percentage points, driven by a decrease in sponsoring company stock
Changes in the risk profile of public DC plans, meanwhile, appear more muted. Equity allocation has declined slightly, offset by an increase in alternative investments, while fixed-income assets have been re-allocated to stable value.
The presenting member next discussed pension fund liabilities.
The member noted five factors that drive liability growth. Four factors drive future growth of liabilities. These include benefit accruals, salary growth, increasing longevity and inflation. Discount rates drive present value growth.
The presenter discussed the importance of funding gaps. The presenter started with a discussion on how to measure the funding gap. Funding gaps are the difference between the value of a pension plan’s assets and liabilities.
The main drivers for the value of pension assets are investment returns, benefit payments and contributions. The main drivers for pension liabilities are service and interest costs, benefit payments and changes in actuarial assumptions.
Due to differing accounting standards, funding gaps for public and private funds are not directly comparable. The choice of discount rate is particularly important in calculating the funded status of a pension plan.
Corporate DB plans are discounted using high-quality corporate bond yields, a practice that reflects the credit risk of plan sponsors. The discount rate will change with market yields and risk perception. In 2010, the discount rate ranged from 5.5 to 6 percent.
State & Local DB plans are discounted using an assumed long-term rate of return on plan assets. These long-term rates rarely change, and are not necessarily tied to actual plan returns. Currently, the average public plan discount rate is about 8 percent. Discounting a rate that reflects sponsor credit risk, such as a long-term municipal rate, may be a better alternative.
The presenter noted that projected benefits will peak at $380 billion per year in 2026. If employees’ future service and salary increases are also included, annual projected benefit payments for state and local governments will peak at $658 billion per year in 2041.
When including the full costs of future service and salary increases on a present value basis, the total state and local funding gap is estimated to be $3.9 trillion (of which the state portion is $2.5 trillion). The fiscal adjustment required to satisfy these liabilities varies significantly from state to state. The presenter suggested that states would, on average, have to dedicate 16 percent of their current revenue to fully fund their pensions, which could translate into a 0.8 percent increase in taxes (increasing tax rates from 9.8 to 10.6 percent). The presenter noted that there were other levers states could use to address funding gaps including spending cuts in other budget areas, increasing employee contributions for pension funds, reducing Cost of Living Adjustments (COLAs), or increasing the retirement age.
The presenter next discussed the private sector funding gap. After declining to about 77 percent in 2008, the funding gap for S&P 500 companies has improved to about 85 percent as of 12/31/10 ($192 billion). In aggregate, $192 billion of pension underfunding seems manageable when compared to the volume of stock repurchases or dividend payouts.
The presenting members stated that DB plans face several risks that are difficult to hedge using pre-existing market instruments. In thinking about new products, Treasury might want to consider additional instruments that might be attractive to pension funds such as ultra-long treasuries, wage inflation-linked treasuries, and health inflation-linked treasuries. The presenter cautioned that while the above products may generate new demand, it is important to also analyze the practical implications of issuing a new type of security. For example, dealers have balance sheet constraints that limit their ability to warehouse new issues (particularly for new types of securities).
In closing, the presenter stated that state and local government retirement plans should be structured to satisfy the needs of retirees, employees and taxpayers. Clear disclosure is needed so that plan beneficiaries, plan sponsors and investors in state and local government debt can make informed decisions.
The meeting adjourned at 1:00 PM.
The Committee reconvened at the Department of the Treasury at 5:00 p.m. The only members present were the Chairman and the Vice Chairman. The Chairman presented the Committee report to Undersecretary Goldstein.
A brief discussion followed the Chairman's presentation but did not raise significant questions regarding the report's content.
The Committee then reviewed the financing for the remainder of the April through June quarter (see attached)
The meeting adjourned at 5:45 p.m.
Deputy Assistant Secretary for Federal Finance
United States Department of the Treasury
May 3, 2011
Matthew E. Zames, Chairman
Treasury Borrowing Advisory Committee
Of The Securities Industry and Financial Markets Association
May 3, 2011
Ashok Varadhan, Vice Chairman
Treasury Borrowing Advisory Committee
Of The Securities Industry and Financial Markets Association
May 3, 2011
Treasury Borrowing Advisory Committee Quarterly Meeting
Committee Charge – May 3, 2011
Taking into consideration Treasury’s short, intermediate, and long-term financing requirements, as well as uncertainties about the economy and revenue outlook for the next few quarters, what changes to Treasury’s coupon auctions do you recommend at this time, if any?
The State of Pension Funds
We would like the Committee to comment on the current state of public and private pension funds in the U.S. How do public and private pensions differ in their approach to asset-liability management? Please discuss how these approaches affect their investment decisions in fixed income markets. Is there anything Treasury should consider when thinking about the overall composition of the Treasury debt portfolio and/or other Treasury products?
Financing this Quarter
We would like the Committee’s advice on the following:
- The composition of Treasury notes and bonds to be issued on May 15, 2011.
- The composition of Treasury marketable financing for the remainder of the April 2011- June 2011 quarter, including cash management bills.
- The composition of Treasury marketable financing for the July 2011-September 2011 quarter, including cash management bills.