Elimination of 3-year Treasury auction – playing with the unknown

The Treasury announced that they will eliminate the 3-year Treasury note from the quarterly auctions. Yesterday saw its last auction, a lack luster showing. This will be the second time that the 3-year note has been dropped from the financing schedule. There has also been talk of cutting some of the TIPS program especially for the 5-year maturity. The research in this area suggests that the debt management policies of the Treasury have important impact on liquidity, but there has been limited work discussing the policy implications of changing the debt mix.

We are far from the budget surplus problems of the late 1990’s when some pundits discussed a world without benchmark Treasuries. Hence, arguments of shrinking supply would be misplaced, but the impact of lumpier issuance is not trivial. Lumpy issuance may lead to discontinuities in the Treasury curve which can cause more mispricing of private securities. Benchmarking would be more difficult and liquidity would suffer.

The 2001 IMF paper, “The Financial Implications of the Shrinking Supply of US Treasuries” http://www.imf.org/external/pubs/ft/supply/2001/eng/032001.PDF is a good review of all the issues. Unfortunately, it has been a number of years since these topics have been discussed. Their conclusion is telling, “Thus, any benefits of paying down the public debt would need to be weighed against the costs of having to resuscitate public debt securities markets, quite possibly within the next decade.” They go on to state that it is not clear what will be all of the implications of changing the debt mix for investors who may not be able to find private alternatives. While issuing debt to maintain the status quo is not appropriate, these are important issues with serious externalities.

While there is less public issuance of Treasury securities, there has been an increasing percentage of the debt that is held in federal government accounts. Non-marketable securities represent just under 50% of the total debt outstanding. The mix between public, private and government accounts needs to be closely examined. Just because debt does not hit the public auction market does not mean that it has no impact on public interest rates. Liabilities issued by the government and then held by the government are not assets.