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Correspondence – August 1982 (7)
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Correspondence – August 1982 (7)
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Records of the White House Office of the Deputy Chief of Staff (Reagan Administration)
Michael K. Deaver's Correspondence Files
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THE WHITE HOUSE
WASHINGTON
August 17, 1982
Dear Elsa:
I am happy you plan to visit Washington, D.C.
I'm sorry I'm not able to tell you with
absolute certainty that we will be here any
special time, but it would certainly be my
pleasure to arrange a VIP White House tour
for you - and see to it that you were es-
corted around the West Wing.
I believe you will find both September and
October good months for visiting Washington.
In October the leaves will have started to
turn and that is one of the prettiest times
of the year back here.
We have arranged for Marc's oldest son to
receive a congratulatory card from the
President on his upcoming wedding.
Sincerely,
MICHAEL K. DEAVER
Assistant to the President
Deputy Chief of Staff
Mrs. Elsa Sandstrom
3580 Winslow Road
Oceanside, CA 92056
ELSA SANDSTROM
3580 Winslow Road
Oceanside, Ca. 92056
Hon. Michael K. Deaver
Assistant to the President
The White House
Shily August 11, 1982
Washington, D. C. 20500
Dear Mike -
plo
Greatly appreciate your response to my letter - it
helped to brighten the day. Suddenly, too, it made me aware of the
passage of time. Here the Reagan administration is almost halfway
through its first term; and I have yet to keep that promise to
myself of a visit to the Reagan White House. This was to be the
culmination of a dream which began way, way back in those early
days when I was privileged to receive appointments to see "Governor
Reagan" in order to put in a plea for him to consider the run for
the presidency. It is so very special also to have your personal
invitation. Then, too, I would like to make the trip before too
many of my California friends leave Washington.
Would it be asking too much of you to suggest a good date -
one that would not find my friends in the White House off somewhere;
especially you, who must do a lot of travelling. I can easily ar-
range my other Washington activities and visits around the White
House date. Two major events here are of importance to me - a
family wedding on August 21 and the California State Central Com-
mittee Convention in San Diego, September 17-19. Anything else,
I can clear. Do not need a lot of advance time - I am used to
packing and taking the first plane
ELSA SANDSTROM
- 2 -
There is another favor which I am going to ask of you, which if
you cannot grant it, I will understand - and no explanations
Mile
necessary. Marc's oldest son is getting married on August 21 in
a lovely church wedding. Believe there is a "special services" lady
in the White House who sends out greetings, etc. Would it be possi-
ble to have a card sent out to this very special bride and groom,
son of a man who served in the California Resgan administration ?
I enclose a card with name and address, should this be possible.
It would be treasured forever!
Thank you again for your thoughtfulness - I know the long, hard
days you put in -
Sincerely,
Elsa
Elsa Sandstrom (Mrs.)
THE WHITE HOUSE
WASHINGTON
August 18, 1982
Dear Jim:
Thanks for the clipping from the
Congressional Record. I found your
idea very interesting, and have taken
the liberty of passing it on to Ed Harper.
I appreciate your thoughtfulness.
Sincerely,
MICHAEL K. DEAVER
Assistant to the President
Deputy Chief of Staff
The Honorable James W. Symington
Suite 400
1700 K Street, N.W.
Washington, D. C. 20006
JAMES W. SYMINGTON
SUITE 400
1700 K STREET,N.W.
WASHINGTON, D. C. 20006
July 27, 1982
Dear Mike,
This is an idea whose time seems to come and
go. Perhaps a Commission of citizens of mixed but
relevant backgrounds could at least examine its
contours and possibilities. A Presidential Commis-
sion, that is.
My idea was to develop a Youth Service Oppor-
tunity Bill - non-compulsive, but attractive enough
to create peer-pressure to join rather than avoid.
Military service would be a shorter commitment than
non-military.
Whether it is appropriate, per se, or timely, I
know not, but thought I'd subject it to your cyclopic
eye.
With best,
t Symington
The Honorable Michael Deaver
Assistant to the President and
Deputy Chief of Staff
The White House
Washington, D.C. 20500
Enclosure
Congressional Record
United States
of America
PROCEEDINGS AND DEBATES OF THE 94th CONGRESS, SECOND SESSION
Vol. 122
WASHINGTON, FRIDAY, OCTOBER 1, 1976
No. 151-Part IV
of the young American. That proposal
died in the early fifties.
But the concept of service and what
THE YOUNG AMERICAN
it can do for the server and the served.
never dies. Clearly, by updating a pro-
SPEECH OF
posel solely limited to military and to
HON. JAMES W. SYMINGTON
men. to one which would incorporate
nonmilitary service and the talents and
05 MISSOURI
energies of our young women, could never
IN THE HOUSE OF REPRESENTATIVES
be considered outdated. Difficult. yes. but
Friday, October 1. 1976
not entimely or unnecessary. I would
Mr. SYMINGTON. Mr. Speaker. be-
hope some thought could be given the
fore I leave. I wish on this last day of the
idea in the coming years
session, to say a word about the future-
not mine, the Nation's. The Nation's fu-
ture rests in the minds and hearts of our
children-the young American. He. and
she. must somehow find or build in their
own society sources of just pride in citi-
zenship. Abroad they must build. too. it
far firmer structure of peace than we
have been able to do.
On the homefront progress has been
slow and unsteady. Distrust between the
generations. the races, and different in-
come levels has found its expression in
antisocial behavior by many a young
American: Their hostility and discontent
has ranged from the runaway to the
rioter. Youth gangs have terrorized 'our
major cities. Schoolchildren have used
and distributed hard drugs. Youth un-
employment is very high. Many high
school graduates have not mastered the
three RM We must arrest these trends.
It seems to me that WC need to engage.
or try to engage. every young American
in his late teens. for R year or two. In
some kind of useful service to the com-
munity. or the State or Nation. Pro-
grams like the Peace Corps, and AC
TION, reach but a handful of our young.
generally those with quite strong family
backgrounds, and the kind of circum-
stances and upbringing that encourage
them to seek service opportunities. Yet
the desire for achievement and recogni-
tion exists in them all, and should be ful-
filled by all.
In my view the Congress, in consulta-
tion with State and local authorities.
school and counseling officials, parents.
business groups. unions. and civic and
nonprofit organizations, should seek to
develop ways to give every youngster a
chance to make a contribution to his so-
ciety. If he is a high school dropout. per-
haps he can still be a teacher aid for
younger children, or help with recreation
programs for the elderly. And there must
be ways-at the local level-not from
Washington, to identify needs and reach
out to the young for help in meeting
them. My grandfather. Senator. and
later Congressman, Jim Wadsworth, be-
lieved strongly in universal military
training. not only for its importance to
the country by way of preparedness. but
for its importance to the life and resolve
Fill
CREATIVE ENTERPRISES, INC.
August 18, 1982
Ms. Shirley Moore
Office of Mr. Michael Deaver
The White House
Washington, D.C. 20505
Dear Ms. Moore,
Many thanks to you and Mrs. Bye for assisting us
in tracking down the photograph of Mrs. Deaver for
the up-coming issue of The Leaves.
I am enclosing a form which needs to be filled out
both for her and her daughter as soon as possible.
The models committee will be getting in touch with
you in the near future for a rehersal schedule in
October, which, by the way, will require perhaps
only an hour.
We are most grateful for your support and assistance
and greatly appreciate Mrs. Deaver's gracious
participation.
With best regards,
Janet Executive E. Donovan
Vice-President
Enclosure
2450 VIRGINIA AVENUE, N.W. SUITE 302 WASHINGTON, D.C. 20037 (202) 833-1341
THE WHITE HOUSE
WASHINGTON
August 18, 1982
Dear Gordon:
Thanks for taking the time to write me
of your idea for March, 1983. It is an
interesting idea, and we'll keep it in
mind as the time gets closer.
I appreciate your input.
Sincerely,
MICHAEL K. DEAVER
Assistant to the President
Deputy Chief of Staff
The Honorable Gordon J. Humphrey
United States Senate
Washington, D.C. 20510
(ac: BillSadlee
GORDON J. HUMPHREY
NEW HAMPSHIRE
United States Senate
WASHINGTON, D.C. 20510
idea
Mr. Michael K. Deaver
August Interestern
in mm
Deputy Chief of Staff
Assistant to the President
The White House
Washington, D.C. 20500
Dear Mike:
As you know, there is a good deal of speculation
over whether the President will or will not run for
re-election. The President has strongly hinted that
he will run, but, obviously, at some point a clear
signal must be given.
I suggest to you an excellent occasion for such
an historical move would be the second Tuesday in
March, 1983, exactly one year in advance of the New
Hampshire Presidential Primary.
Even if the President were unwilling to officially
announce his candidacy at that point, his appearance
in New Hampshire on that date would be a dramatic sign.
My motives are not entirely unselfish. I will be
a candidate for re-election in 1984, myself. Therefore,
I suggest combining our interests. I suggest the
President come to New Hampshire on March 8, 1983, to
speak at a fundraiser for my campaign. His presence
NOT PRINTED OR MAILED AT GOVERNMENT EXPENSE
-2-
in the first primary state exactly one year before
the primary will have an unmistakable significance.
His presence would attract heavy news coverage. The
benefit to me is obvious.
I understand you will be meeting with Arthur
Finkelstein on Tuesday, and I have asked him to raise
the matter with you.
With warm regards, I am
Sincerely,
Ordan Humphrey, USS
GORDON J. HUMPHREY
NEW HAMPSHIRE
United States Senate
WASHINGTON, D.C. 20510
August 18, 1982
Mr. Michael K. Deaver
JAB Idea we
Deputy Chief of Staff
Assistant to the President
The White House
Washington, D.C. 20500
about ?
Dear Mike:
tall
I now understand that your meeting with
Arthur Finkelstein scheduled for yesterday
afternoon was postponed, preventing a discus-
sion of a visit by President Reagan to New
Hampshire in March of 1983 as outlined in my
letter of August 16th.
Recognizing the need to plan the President's
schedule well in advance, I would appreciate
your expeditious consideration of this suggested
appearance on my behalf. Naturally, I stand
ready to discuss any aspect of this matter with
you.
I look forward to hearing from you shortly
and hope for a favorable reply.
With warm regards, I am
Sincerely,
Jordon Cordon J. Humphrey, USS
NOT PRINTED OR MAILED AT GOVERNMENT EXPENSE
MICHAEL K. DEAVER
dear Don
telephone care was appreciated
your response to Jun Baker
your correction and was I may
appropriate wanted you
to minoticed. know That it hadn't many you Thanks. mike
THE WHITE HOUSE
WASHINGTON
Mr. Donald Graham
The Washington Post
1150 15th Street, N.W.
Washington, D.C. 20071
8/18
THE WHITE HOUSE
WASHINGTON
August 18, 1982
:
Dear Bill:
Thanks for your recent letter requesting
the summit conference be held at Keystone
in Colorado in 1983.
We are still looking at sites, but Keystone
is a definite possibility.
Thanks, too, for your offer of assistance.
Sincerely,
MICHAEL K. DEAVER
Assistant to the President
Deputy Chief of Staff
The Honorable William L. Armstrong
United States Senate
Washington, D.C. 20510
cc M.McManus m.
WILLIAM L. ARMSTRONG
COLORADO
United States Senate
WASHINGTON, D.C. 20510
August 11, 1982
Mr. Michael K. Deaver
Deputy Chief of Staff
The White House
Washington, D.C. 20500
Dear Mike:
I understand you are looking at sites for a summit con-
ference next year and stopped by Keystone in Colorado.
While I don't know the details of your requirements, I
wanted to let you know Keystone is a superb facility. Colo-
radans active in political and public life hold an annual
issues conference at Keystone and it is always a great
success.
Obviously, Colorado would be greatly honored to help
the President host a summit conference. If I can be of any
assistance to you on this matter, please don't hesitate to
get in touch.
Best regards.
San William L. Armstrong
Sincerely,
WLA:rpj
THE WHITE HOUSE
WASHINGTON
August 19, 1982
MEMORANDUM FOR:
TRAVELING STAFF ACCOMPANYING THE PRESIDENT
FROM:
MICHAEL DEAVER m
SUBJECT:
HOTEL ACCOMMODATIONS
Please be advised that every attempt is being made to reduce
expenses pertaining to the President's trip to California.
Therefore, it will be necessary for some staff to share hotel
rooms.
Thank you.
P.O. John Rodgers made me do it.
THE WHITE HOUSE
WASHINGTON
August 19, 1982
Dear Mr. Holwill:
Thank you for your thoughtfulness
in sending The Heritage Foundation's
Backgrounder relating to innovative
financing. I appreciate the input.
Sincerely,
MICHAEL K. DEAVER
Assistant to the President
Deputy Chief of Staff
Mr. Richard N. Holwill
Vice President
The Heritage Foundation
513 C Street, N.E.
Washington, D.C. 20002
The
Heritage Foundation
A tax-exempt public policy research institute
The Honorable Michael K. Deaver
Deputy Chief of Staff and
August 16, Thank
Assistant to the President
The White House
1st Floor, West Wing
Washington, D.C. 20500
Dear Mr. Deaver:
In FY 1981, interest payments on the federal debt totalled $83 billion or
12.6 percent of gross federal outlays. This year this expenditure will exceed
14.4 percent and will exceed 15 percent in 1983.
Economist George G. Kaufman of Loyola University in Chicago argues that
in such an environment, the Treasury must employ more creative financing
measures as tools to cut this staggering cost. He discusses a number of these
options in the attached Heritage Foundation Backgrounder.
We feel that his analysis is particularly valuable and that his recommen-
dations could make a positive contribution to economic recovery.
Dr. Kaufman and I look forward to your comments on this article.
June
Richard N. Holwill
Vice President
RNH/dfh
Enclosure
Edwin J. Feulner, Jr., President
Phil N. Truluck, Executive Vice President
Willa Ann Johnson, Senior Vice President
Burton Yale Pines, Vice President
Richard N. Holwill, Vice President
John A. Von Kannon, Treasurer
Board of Trustees
Hon. Frank Shakespeare, Chairman
Hon. Shelby Cullom Davis, Vice Chairman
David R. Brown, M.D.
Hon. Jack Eckerd
Robert H. Krieble, Ph.D.
Joseph Coors
Edwin J. Feulner, Jr.
J. Frederic Rench
Midge Decter
Joseph R. Keys
Hon. William E. Simon
513 C Street, N.E. Washington, D.C. 20002 (202) 546-4400
The T Backgrounder
Heritage
No02
The Heritage Foundation
513 C Street
N.E.
Washington, D.C.
20002
(202) 546-4400
August 9, 1982
FINANCING THE NATIONAL DEBT:
TIME FOR INNOVATION
INTRODUCTION
The U.S. Treasury is faced with financing record federal
budget deficits for a number of years at least. This is in
addition to refinancing record amounts of maturing securities
from an outstanding debt swollen by a long succession of large
annual deficits. At yearend 1981, the interest-bearing federal
debt totalled $1,029 billion, double that of only seven years
earlier. In 1981, the Treasury raised some $100 billion in new
cash and refinanced an additional $607 billion. Although new
cash borrowings will be higher, the overall borrowing estimates
for 1982 are not greatly different. The high interest rates have
made interest payments a large component of federal expenditures
and, paradoxically, a major cause of the deficits., In fiscal
year 1981, interest payments were $83 billion and represented
12.6 percent of total budget outlays, up from $38 billion and 9.5
percent in 1977. The percentage is expected to jump to 14.4
percent in fiscal 1982 and above 15 percent in fiscal 1983.
In such an environment, the Treasury must sell its debt as
widely as possible at the lowest possible perpetual interest
cost. It is useful, therefore, to examine current Treasury
financing practices, recent innovations or "creative" financing
in the private sector, and innovations in Treasury financing.¹
1
This paper does not consider nondebt means of financing federal deficits,
such as the sale of government assets, including land. For an analysis
of asset sales see Catherine England, "Surplus Federal Property: It's
Time to Sell," Backgrounder No. 187 (Washington, D.C.: The Heritage
Foundation) June 4, 1982.
Note: Nothing written here is to be construed as necessarily reflecting the views of The Heritage Foundation or as an
attempt to aid or hinder the passage of any bill before Congress.
2
In analyzing Treasury financing practices, it should be
noted that the Treasury is both similar to and different from
private borrowers. It differs from private borrowers in at least
five important ways:
1. its debt is the highest quality debt in the country, if
not the world, and forms the cornerstone of the national and
international securities market;
2. its financing needs are much larger and more frequent;
3. its financing needs are independent of the interest
costs paid and are not postponable;
4. its financing decisions importantly impact on the level
and structure of other interest rates, on investor expectations,
and possibly on levels of economic activity; and
5. it must consider the consequences of its financing
strategy on current and future tax revenues.
As a result, the Treasury is more constrained in its financing
decisions than are most private issuers.
The Treasury currently sells three basic types of debts:
1. marketable debt to the general public;
2. nonmarketable debt to segments of the public, e.g.,
households, retirement accounts;
3. nonmarketable debt to government agencies and trust
funds, foreign governments, and state and local governments.
The critical question is: in financing the nation's debt,
can the Treasury adopt strategies that will enable it to do so at
lower interest rates? If the Treasury could borrow at lower
rates--and prospects seem favorable--it not only would reduce the
interest-paying burden on the budget (and hence the taxpayers),
but might also help bring down general rates of interest. The
prospect of this should be prompting the Treasury to evaluate
critically its current financing methods. It is particularly
important that Treasury consider innovative and creative means of
carrying its debt burden. Through their creativity, private
sector firms have developed new types of securities that have
permitted them to raise funds with minimum interest expense--even
in an age of high interest rates. Treasury should be equally
aggressive.
TREASURY FINANCING PRACTICES
This analysis considers primarily marketable debt, which
represents about 75 percent of the total dollar value of the
3
Treasury's debt. Individual debt securities are basically differ-
entiated from each other by variations in their term to maturity,
risk of default, and special features, such as option provisions,
permissible changes in coupon rates, and the presence or absence
of coupon payments. Because the Treasury is always in a position
to repay, at least the nominal value of its debt at maturity,
Treasury securities have no risk of default. The Treasury sells
securities throughout the maturity spectrum from less than three
months to thirty years. (As of April 1982, the longest bond
outstanding matures in 2011. It was issued in 1981.)
The choice of maturity depends first on the estimated length
of time for which the funds are required. Treasury financing
needs are of two types: 1) seasonal needs that arise because
expenditures in the accounting year may precede the receipt of
expected tax revenues or the sale of long-term debt; the basic
strategy for financing this need is to match inflows to expected
cash outflows, and short-term issues are sold weekly (generally
on Mondays); 2) longer-term needs because tax revenues are expect-
ed to fall short of expenditures for the entire accounting year,
i.e., an annual budget deficit, or the need to refinance maturing
debt sold to finance earlier deficits.
In periods of budget deficits, the two types of financing
are intertwined. For a given projected deficit, the decision as
to the maturity of the debt depends on:
1. expected interest costs,
2. marketing costs,
3. market receptivity, and
4. outstanding amounts in various maturity sectors.
Longer-term issues are sold according to a regular calendar for
the maturity involved, e.g., monthly or quarterly.2
Unless the yield curve of interest rates is flat, the interest
cost of bonds of different maturities at their time of sale may
be expected to differ. If the yield curve were upward sloping,
so that short-term rates were lower than longer-term rates,
short-term debt would appear to be cheaper. But this might turn
out to be misleading on further analysis of the alternative
maturity options over the same borrowing period. The shape of
the yield curve is widely believed to depend on market partici-
pants' expectations of future short-term interest rates. The
long-term rate at any time is viewed as an average of the current
short-term rate and of all short-term rates expected in the
future until the maturity of the long-term bond. It follows that
2
A more detailed description of Treasury financing procedures is provided
in Treasury Department, "U.S. Treasury Debt Management" (N.D.).
4
if expectations of future short-term rates were reasonably close
to that of the market's, the expected average interest cost of
debt over a given period would be the same regardless of the
maturities selected. If current short-term rates were below
long-term rates, SO that the yield curve sloped upward to the
right, the initial lower costs of issuing short-term debt would
be offset by the expected higher rates incurred when this debt
was rolled over.
However, a particular borrower's expectations may differ
from the market. The maturity of the securities would then
affect the expected longer-run interest cost. If short-term
rates were expected to increase less in the future than was
consistent with the current market long-term rates, it would pay
to issue short-term debt and roll it over at the lower expected
future short-term rates rather than to become locked-in at the
current high long-term rate.
An alternative explanation of the yield curve focuses on
supply and demand conditions for credit in each maturity sector.
Yields on any maturity are not affected by expectations of yields
on any other maturity. Thus, borrowers must predict supply and
demand conditions in maturity sectors other than for fixed coupon
rate bonds with maturities (more accurately durations) equal to
the borrowing period, which for the Treasury is indefinite or,
realistically, infinite. For these bonds, the yield to maturity
approximates the return for the period as a whole. Private
borrowers generally make one or the other type of prediction in
formulating their borrowing strategy. As is discussed later,
such a procedure has been proposed for the Treasury, so that its
expectations of future market conditions should help determine
the maturity strategy it adopts. It can be argued further that
the maturity structure adopted by the Treasury affects the shape
of the yield curve, so that the implications of the maturity
strategy selected should be taken into account if the shape of
the yield curve is a policy objective.
Of course, expectations might not be realized so that the
actual realized borrowing costs of alternative maturity strategies
over a given period might be neither the same as those anticipated
nor the same for all maturity strategies. Actual borrowing costs
might be higher or lower than expected depending on whether
interest rates were higher or lower than expected. But this
could not be known at the time the bonds were sold.
The Treasury has not lacked creativity in managing the
public debt. It has offered the public bonds with a variety of
options. Most long-term bonds are callable at par within five
years of the final maturity date. Thus, in periods in which
interest rates decline, the Treasury may redeem the bonds early
and refinance at lower interest rates. Investors typically
charge an interest rate premium to compensate them for this
disadvantage. Because interest rates have mounted steadily in
the past two decades, calls have not been exercised since World
5
War II. However, because the deferment period on these bonds is
very long, it is unlikely that investors demanded a significantly
higher return or that the bonds sold at significantly higher
yields. Although call provisions are a common feature of its
long-term bonds, the Treasury has apparently not conducted a
thorough study of the additional cost or cost saving of including
a call provision on its bonds.
The Treasury has also used three types of "put" provisions.
In 1957, the Treasury issued two intermediate-term note issues
that investors could resell to the Treasury at par, halfway to
their date of final maturity, upon three months' written notice.
Few of these bonds were actually resold to the Treasury at cash,
although simultaneous exchange offers for these bonds makes it
difficult to analyze what proportion may have been put, in the
absence of the exchange option. Through 1971, the Treasury
issued long-term bonds that could be sold to the Treasury at par
for the settlement of estate taxes if the investor died flower
bonds). Finally, the Treasury permits holders of nonmarketable
savings bonds to redeem their bonds at any time at par plus
accrued interest to the date of redemption.
Because bonds with puts are advantageous to investors, they
may be issued at lower yields. Of course, this advantage is
offset if the bonds are later put, and the Treasury must refinance
at higher interest rates. The Treasury appears not to have
completed any rigorous analyses of the interest cost saving or
expense of incorporating the different types of put provisions in
its issues.
The Treasury has also issued zero coupon securities in
limited quantities in the form of nonmarketable savings bonds and
marketable bills with maturities of less than one year. 3
APPLICABILITY OF INNOVATIONS IN FINANCING TO THE TREASURY
In recent years, numerous innovations have been introduced
in the private bond market, including variable coupon rate (float-
ing) bonds, zero coupon (original issue discount bonds), indexed
(to foreign currency and commodities) bonds, convertible (into
real commodities) bonds, putable bonds, and bonds with warrants
to buy future bonds at a given yield. These have been developed
to tailor the securities to the particular and changing needs of
both issuer and investor and thereby reduce interest rates. It
has been suggested that the Treasury might also be able to reduce
its interest costs and broaden its market by adopting some of
3
The Treasury has also experimented with a number of auction techniques
and advance refunding of low coupon long-term debt with few years remaining
to maturity into longer-term securities. These techniques are not discussed
in this paper.
6
these innovations. Before analyzing the pros and cons of the
applicability of the major types of such innovations to Treasury
financings,⁴ a few introductory words of caution are in order.
The most innovative types of debt securities are, on the
whole, considerably more complex than the traditional option-free
fixed coupon rate bond. They frequently incorporate two or more
effectively separate securities, such as a straight debt issue
and an option to sell the security at a predetermined price
and/or an option to convert the security into another security at
a predetermined price. The tax treatment is also more complex.
Because they are more complex in construct, they are more difficult
for both issuers and investors to understand, they consume more
of the issuers', investors', and security dealers' time, and are
considerably more difficult to price correctly.⁵
Second, as noted earlier, the Treasury differs in some
important ways from private borrowers. A number of the recent
innovations on the private market reduce interest costs by reduc-
ing the investors' or issuers' tax liabilities. The Treasury,
however, is a tax-exempt issuer and must be concerned with the
tax revenue implications of its bonds. A reduction in interest
costs would not be beneficial if the cost savings were offset by
reduced tax revenues from investors.
In recent years, returns on long-term bonds have been highly
volatile and frequently negative as interest rates have fluctuated
around an upward trend. Treasury bonds issued at par have declined
in value by as much as 40 percent. Because the Treasury bond
market was traditionally viewed by investors as not risky or, at
least, less risky than the stock market, many investors feel
"burned" and are skeptical about additional commitments in the
market. Fixed income securities have been found to have neither
fixed nor at times even positive income! If bond investors
wanted to assume risk, they would buy stocks. As a result,
long-term saving has been discouraged and investors have charged
4
The analysis was aided by interviews with a cross-section of participants
in the Treasury security market. These persons are credited at the end
of the study.
5
Because of the complexity, a number of Treasury security dealers have
expressed serious reservations about the appropriateness of more innova-
tive securities for the Treasury. They believe that the Treasury market
should be as simple, clean, liquid, and free of "gimmicks" as possible.
Moreover, fine tailoring to the needs of small sectors of investors,
which may be efficient for private issuers who sell only in relatively
small and infrequent amounts, would not necessarily be efficient or
reduce interest costs for the Treasury, which sells in relatively very
large and almost continuous amounts. On the other hand, their colleagues
in the corporate market have contributed significantly to the development
and widespread use of "creative" techniques.
7
interest premiums, because of uncertainty about inflation, when
investing in longer maturities. This has been increasing the
cost of long-term debt to all borrowers, including the U.S.
Treasury.
Variable Coupon Rate (Floating) Bonds (VRBs)
Variable coupon rate bonds, sometimes referred to as floaters,
protect the investor against unexpected increases in interest
rates that would decrease the market value of a fixed coupon rate
bond. Conversely, they protect the issuer against unexpected
decreases in interest rates that would increase the opportunity
cost of fixed-rate debt by discouraging refinancing at lower
interest costs. The coupon rate on VRBs is tied to a market
interest rate index, or reference rate, in such a way that the
two rates move lock-step together and, if designed correctly,
that the market price of the VRB is at all times equal to that of
a hypothetical fixed-rate bond with the chosen index rates as its
coupon. Thus, if the index rate were a short-term rate and there
were no limitations on the permissible changes in the coupon
rate, the market price of a VRB would remain close to its par
value. The longer the term of the reference rate to which the
VRB is tied and the interval at which the coupon rate on the VRB
may change, the more its market price can move away from par
value. Variable coupon bonds effectively provide price protection
for shorter-term bonds and low marketing costs for longer-term
bonds.
To the extent inflationary expectations are impounded in
market rates of interest, VRBs indexed to short-term interest
rates protect investors against expected increases in the rate of
price inflation after the initial purchase of the bond. However,
if the expected rates of inflation impounded in the interest
rates at the time the bonds are purchased are not realized,
variable coupon rate bonds leave investors either more or less
protected than is warranted by the actual realized inflation
rate. Because it is easier to predict inflation over shorter
than longer periods, investors are less likely to charge inflation
uncertainty premiums on top of expected inflation interest premiums
on VRBs than on fixed rate bonds of equal maturity. If interest
rates change for other, noninflation related reasons, the rate on
the variable rate bond also changes.
The VRBs offer several advantages to Treasury and the public:
1. A lower initial interest cost relative to long-term
fixed rate bonds as any inflation risk premium will be lower.
2. A broadened long-term market by attracting risk averse
investors who wish to preserve capital.
3. If constructed correctly, a more easily understood
format for investors.
8
There are, however, disadvantages:
1. Interest costs would be no less than on fixed rate
short-term bonds with the same index rate, and marketing costs of
fewer rollovers would not be significantly lower, particularly
for larger denomination bonds.
2. For instance, the Treasury would have paid significantly
higher interest rates throughout most of the last two decades if
it had issued VRBs rather then long-term fixed rate bonds. This
would have more than offset any interest cost saving when the
bonds were first sold.
3. Treasury would be in competition for small depositors
with other financial institutions, in particular, thrift institu-
tions.
In sum, the VRBs would be a useful addition to the Treasury's
arsenal of securities if issued in small denominations, say under
$100,000, tied to a one-, two-, or three-year reference interest
rate, and tailored to households and other small investors who
experience high transaction costs in the purchase and rolling
over of short-term debt for which the Treasury incurs high market-
ing costs. There is less need for large denomination VRBs, as
larger investors can stay short economically and should be better
equipped to assume interest rate risk.
Price Level Adjusted (Indexed) Bonds (PLABs)
Price level adjusted bonds, sometimes referred to as purchas-
ing power or indexed bonds, also protect investors and issuers
against unfavorable interest rate changes, but only those actually
caused by inflation.6 These bonds carry a basic fixed coupon at
a rate that would exist for the particular maturity if there were
no inflation (the "real" interest rate). The purchasing power or
real value of the bond is protected against changes in the price
level by corresponding changes in the value of both the nominal
coupon payment and principal payment by an equal percentage.
Unlike VRBs, which protect against expected changes in inflation,
PLABs protect against actual (expected and unexpected) changes in
inflation when the inflation occurs. This is particularly impor-
tant to many issuers of regular fixed-rate bonds.
6
It is also possible to index bonds to prices other than the price level,
e.g., gold, foreign currencies, etc. Such bonds have many of the charac-
teristics of price level adjusted bonds but are more limited in their use
and are not analyzed in this study. This was not always so. Before
1933, bonds indexed to gold appeared to have been more popular in the
U.S. than those indexed to the price level. In its efforts to ban gold
indexed bonds in 1933, Congress also banned price level indexed bonds.
Both bans were repealed in 1977. J. Huston McCulloch, "The Ban on Indexed
Bonds, 1933-77," American Economic Review, December 1980, pp. 1018-21.
9
Because nominal interest rates increase when inflationary
expectations are revised upward, which is generally before the
expected faster inflation rate actually occurs, the issuer will
pay higher coupon rates on bonds that carry nominal interest
rates before the faster inflation increases revenues. With
PLABs, Treasury interest payments and tax revenues would move
more closely in tandem. By protecting against changes in purchas-
ing power, PLABs eliminate any risk premium that investors might
charge for incurring such risk exposure. This would reduce
interest costs in periods of uncertainty about inflation. Inves-
tors would incur only real interest rate risk. By increasing
investor certainty, the long-term market should be strengthened.
PLABS are in use in a number of countries that have experienced
rapid price inflation, such as Brazil and Israel.
But PLABs are relatively complex securities for issuers to
design properly and for investors to understand. As has become
readily evident in recent years from attempts to index other
payment programs, such as social security, it is critical to
select the correct price index to which to index bonds. Selection
of a price index that inaccurately reflects the true rate of
inflation can result in significânt over or under payments and
unwarranted redistributions of income. As for VRBs, coupon in-
creases on PLABs are generally designed to be subject to income
taxes. Unlike VRBs, the principal value is also indexed and will
increase with inflation, establishing a potential tax liability
upon sale or maturity. Equal treatment with VRBs would require
subjecting any such increments to ordinary income taxes. But
alternative taxing schemes have been proposed. One bill, intro-
duced in Congress by Representative James K. Coyne (R-PA), would
exempt such gains (or losses) from federal income taxes. Although
possibly desirable on other grounds, such as encouraging saving,
this tax treatment, by making PLABs superior to other Treasury
bonds, would drive the others out of the market.
A criticism often leveled at PLABs, and indexing schemes in
general, is that they tend to weaken both the government's and
the public's resolve to restrain inflation. By taking out the
"hurt," it is argued, the incentive to combat inflation is reduced.
But the reverse may also be argued. If these bonds were indexed
perfectly, with equal protection for everyone, inflation would do
little, if any, economic or social damage and would reduce any
advantage to the government, the frequent winner from inflation
in nonindexed environments. The real strength of anti-inflationary
resolve is questionable, however, in light of the economic policies
adopted during periods when PLABs were not used. These policies
aided and abetted the very inflation that gave birth to the
pressures for indexing.8
7
"Long-Term Savings Restoration Act" (H.R. 4842), October 27, 1981.
8
A good summary of the literature on PLABs is David F. Babbel, "Indexed
Bonds: A Bibliography," International and Monetary Institute, San Francisco,
N.D.
10
PLABs offer advantages to Treasury and the public:
1. They lower interest costs at the time the bonds are
issued by eliminating both the inflation and uncertainty premiums.
2. They provide investors with fair protection against
government-caused inflation.
3. They encourage long-term saving and support the long-term
sector in periods of rapid inflation.
Among the disadvantages:
1. Determination of correct "real" interest coupon rates is
difficult.
2. The correct treatment of increases in principal values
over time, in connection with the federal debt ceiling, presents
a problem.
3. PLABs are complex for Treasury to design and for investors
to understand.
4. Choice of the correct price index, a critical matter, is
difficult.
5. Tax treatment is complex.
6. PLABs can be very costly to Treasury if inflation accele-
rates rapidly.
Zero Coupon (Original Issue Discount) Bonds (ZCBs)
Zero coupon bonds make a single cash payment at maturity.
The return is derived from the annual appreciation (amortization)
of the difference between the buying price and the maturity
payment. For a positive return, the buying price has to be less
than the maturity payment, and the bond must be sold by the
issuer at a discount from its fixed maturity value. Because
there are no coupon payments to reinvest, the yield to maturity
on default and option-free ZCBs is guaranteed at the time the
bond is traded. (The yield to maturity computation assumes the
full reinvestment of all coupon payments at the initial interest
rate.) Thus, there is no reinvestment risk due to interest rate
changes after the purchase of the bond to cause the realized
return on the bond to differ from the promised return if held to
maturity.9 This is an advantage to investors, who believe interest
rates are likely to decline and would like to lock-in the current
"high" rates. It is an advantage as well to issuers, who believe
9
George G. Kaufman, "The Case for the Long-Term Zero-Coupon Treasury
Bond," The Bankers Magazine, Autumn 1973, pp. 35-39.
11
rates are likely to rise and would like to lock-in the current
"low" cost of financing. By avoiding coupon reinvestment, inves-
tors also reduce transaction costs.
Zero coupon bonds offer other advantages. Because they do
not spin off cash before maturities, they are longer-term bonds
than coupon bonds of the same maturity. This makes them desirable
to investors who wish to assume greater risk of price changes, to
issuers who wish to postpone cash repayment as long as possible,
and to financial intermediaries, such as life insurance firms and
pension funds, who have scheduled liabilities to meet in the
distant future. Moreover, ZCBs permit the latter types of insti-
tutions to match cash inflows to their scheduled cash outflows
and to immunize themselves against unexpected interest rate
changes. The demand for immunization on the part of these insti-
tutions has increased significantly in recent years as the unex-
pected increase in interest rates has severely depressed bond
prices and the volatility in rates has increased their risk
exposure. In the absence of zero coupon bonds, immunization
becomes a relatively complex and costly undertaking. Investors
effectively have to create artificial ZCBs out of existing coupon
bonds. Unlike variable rate bonds (VRBs) or price level adjusted
bonds (PLABs), zero coupon bonds offer no protection against
changes in actual or expected inflation rates. Indeed, ZCBs
increase interest rate risk exposure over coupon bonds of equal
maturities.
In the past year, ZCBs have come of age on both the corporate
and municipal bond markets. Their sudden popularity stems not
only from the reasons cited, but also from tax advantages.
Private taxable issuers are permitted to charge off the annual
amortized appreciation of the original issue discount as interest
expense against taxable income even though no cash outflow was
incurred. (Until recently, the charge could be computed on the
more favorable straight-line basis rather than on the accurate
bond book or exponential basis.) This is equivalent to the
issuer receiving an interest-free loan from the Treasury for the
amount of the taxes due.
Taxable investors, on the other hand, must report the annual
amortization of the original issue discount as interest income in
the year it occurs even though there is no cash receipt until
later and must pay ordinary income tax on this amount. Thus,
they effectively make the Treasury an interest-free loan of the
tax payment. This makes ZCBs an unfavorable investment vehicle
for them. Tax-exempt investors, such a pension funds, life
insurance companies, and IRA accounts, face no such disadvantage,
however, and represent the primary buyers of these bonds. Because
private taxable issuers can afford to sell ZCBs at higher pre-tax
yields for the same after-tax cost as on regular coupon bonds and
tax-exempt investors pay no taxes on the higher coupons, corporate
ZCBs represent a potential revenue loss to the Treasury.
12
Municipal zero coupon bonds were developed after the success
of the corporate counterparts. If sold correctly by the state or
local government issuer, the original discount is considered
coupon interest and exempt from federal taxes rather than capital
gains subject to such taxes. Thus, these bonds are attractive to
taxable investors in high marginal tax brackets. They involve no
loss of tax revenue to the Treasury above that associated with
tax-exempt bonds in general.
Zero coupon bonds issued by the Treasury are treated for tax
purposes similarly to those of private issuers except that the
tax on the annual amortization of the original issue discount,
which is ordinary income, need not be paid by the investor until
the bond is either sold or matures, whichever occurs first. Thus
the effective tax rate is somewhat lower. However, this would
still make Treasury ZCBs relatively poor investment vehicles for
high marginal tax investors, although the tax deferral provision
might make long maturities more attractive to these investors.
But they would be attractive investments to tax-exempt investors,
who prefer higher credit quality securities than corporates.
(Treasury ZCBs might be at a slight interest rate disadvantage to
corporate ZCBs relative to coupon issues because of the corporate
issuers tax-free loan from the Treasury advantage, but this
should be negligible.)
The recent dramatic growth in corporate ZCBs indicates that
there appears to be a major and broad market for these securities
ranging from large institutional investors to smaller investors
with IRA accounts. The demand for ZCBs has been sufficiently
great in recent months to bid up their prices to where they yield
considerably less than comparable coupon issues. 10 Because sales
to taxable investors would be a small percentage of total sales
and these investors may be expected to be mostly in the lower
marginal tax brackets, any loss of tax revenue by the Treasury
from the tax deferment feature should be small relative to the
sale of regular coupon issues. Of course, ZCBs are not good
instruments for investors who require regular and known cash
payments. (Large investors could obtain cash payments by selling
off part of their portfolios of ZCBs, but would incur price
risk.)
10
For example, ZCBs maturing in 2002 sold by Hospital Corporation of America
at the end of May 1982 and rated A by Standard and Poor's yielded 12.80
percent, about 300 basis points less than a 15 5/8 percent coupon HCA
bond sold at the same time. While the coupon bond was estimated to yield
260 basis points above that on a comparable Treasury coupon bond, the ZCB
was estimated to yield 40 basis points less. At least some of the yield
difference between the two HCA bonds reflects the high call protection on
the ZCBs (typically callable only at their par value). But this cannot
explain their yielding less than the comparable Treasury bond. Caution
must be used in comparing market yields to maturity on ZCBs and regular
coupon bonds as the two yields are not mathematically comparable when the
yield curve is not flat.
13
Because ZCBs are sold at discounts from their face amounts,
use by the Treasury would require a modification in the wording
of the statutory limitation on the amount of Treasury securities
outstanding. The current wording specifies the limit in terms of
"face amount." The wording could be changed to "amortized amount"
without altering the intent of the statute. 11 A similar provision
is now included for bonds sold at a discount but "redeemable
prior to maturity at the option of the holder,' e.g., savings
bonds. In addition, an understanding should be reached with
Congress concerning ZCBs' exemption from the current limit of $70
billion on Treasury bonds with coupons in excess of 41/4 percent.
The Attorney General has ruled that original issue discount
yields are exempt from this limitation. But it would be best for
the Treasury to first clear this with Congress so that it would
not appear as an end-run around a congressional limitation.
Lastly, provision should be made for Congress to appropriate the
required interest payments semiannually when due and not postpone
the appropriation to the maturity date of the bond. That is,
Congress should not be tempted to "balance the budget on the back
of ZCBs. If However, this would be a problem only when ZCBs are
first issued. In time, the pattern of principal payments due at
different dates could be made equivalent to the cash flow pattern
that would have existed on the replaced coupon issues and could
require the same annual congressional appropriations.
The introduction of zero coupon bonds by the Treasury would
not be a radical departure from its current financing practices.
As noted, both Treasury bills and savings bonds carry zero coupons.
The Treasury bill was first introduced in 1929 to supplement
coupon-bearing certificates of indebtedness, the major short-term
financing instrument. It quickly became the preferred security
of investors and the certificate finally was discontinued in
1966. Because ZCBs make only a single payment, both their pricing
and tax treatment are considerably simpler than for coupon bonds,
and they are efficient trading instruments. 12
The following advantages to Treasury and the public are
offered by zero coupon bonds:
11
Alternatively, the ZCBs could be issued with a "face amount" of 100 and a
provision that interest accumulates at a given rate and cannot be withdrawn
until maturity, so-called "compound interest bonds," e.g., State of
Washington bonds sold June 2, 1982. Bidders would bid on the final
accumulation value at a given maturity date.
12
In mid-June, the Federal Home Loan Mortgage Corporation sold the first
government agency zero coupon bond issue. Unlike Treasury OIDs, federal
agency OIDs are taxed similarly to corporate OIDs and investors must pay
ordinary income tax annually on the amortized appreciation. The 10-year
ZCB is estimated to have sold at about 35 basis points below the yield on
a comparable current coupon Treasury security and almost 100 basis points
below the yield a current coupon FHLMC bond of the same maturity would
have required.
14
1. They broaden the market and accommodate large and expand-
ing needs for longer-term bonds with no reinvestment risk.
2. They reduce interest cost, at least in the current
environment, relative to coupon issues of comparable durations.
3. They are simple instruments to understand.
4. They are a better credit risk, than are regular coupon
bonds, relative to ZCBs from private issuers, for which repayment
is far away and in one chunk.
Among ZCB drawbacks are:
1. The Treasury could incur a small loss of tax revenues.
2. ZCBs lock-in high interest rates even if inflation and
interest rates decline.
3. They are not useful for investors who require regular
cash inflows prior to maturity.
4. They require modification of the language of the federal
debt ceiling statute.
5. They require an understanding with Congress concerning
the limitation on issuance of new Treasury bonds with coupon
rates above 41/4 percent.
In sum, the sale of zero coupon bonds in a wide variety of
maturities and in both small and large denominations should be
advantageous to the Treasury. Initially, the maturities might be
11/2 (to supplement the current 1- and 2-year issues), 5, 10, and
20 years. Small denominations should be tailored for IRA accounts;
larger denominations, for tax-exempt institutional investors.
Putable Bonds
Putable bonds offer protection against significant capital
losses from unexpected interest rate increases by permitting
investors to sell the bonds back to the Treasury, on specified
dates after a specified deferment period, at no less than a pre-
determined price at or below par (or for ZCBs, the amortized)
value. The higher the put exercise price, the more valuable the
put option to the investor, and the lower the interest rate that
the investor is willing to accept. Thus, after the deferment
period, a putable bond is similar to a consecutive series of
shorter-term bonds, but the investor is protected against lower
income from a decline in interest rates (and may experience some
capital loss depending on how far the put price is below par or
amortized value). As noted earlier, the Treasury put out two
issues of regular put bonds in 1957. Put bonds have been recom-
mended for Treasury use at this time for two primary reasons:
15
1. to permit increased sale of long-term maturities in
today's depressed and uncertain markets and relieve the pressure
of the short-term sector which impinges most on savings flows
into thrift institutions;
2. to intensify pressure on the government to resist infla-
tionary policies by putting into place the penalty of an overhang
of immediately higher interest costs on a significant proportion
of the outstanding debt, rather than simply on maturing debt, if
inflation accelerates.
Opponents of Treasury putable bonds at this time argue that
it is unlikely that an overhang of higher refinancing costs, even
if substantial, would influence macroeconomic policy greatly and
that the pressures from the short-term sector would not be greatly
relieved. After all, the life of putable bonds is considered by
investors to be as short as the term to the first permissible put
date rather than to the final maturity date. The nearer the
first put date, the effectively shorter term the maturity of the
bond. Moreover, even if the pressure were relieved significantly,
goes the argument, there is no credible empirical evidence that
the shape of the yield curve could be substantially changed by
altering the maturity structure of the debt. The last announced
deliberate attempt to do this was in the early 1960s when "Opera-
tion Twist" was aimed at raising short- and lowering long-term
rates. Analyses of this experience agree generally that it was
not successful.
Putable bonds have been issued in recent years by at least
one federal government agency--the Federal Home Loan Mortgage
Corporation. Treasury should initiate a study of the costs and
benefits of these bonds as well as the Treasury's own earlier
putable bond issues.
Both Treasury and the public could gain from putable bonds:
1. They would lower immediate interest cost.
2. They would encourage long-term saving by offering inves-
tors protection against higher interest rates attributable to
poor governmental economic policies.
3. They would broaden the long-term market and relieve the
pressures of the short-term market.
4. They would encourage noninflationary government macro-
policies.
5. They are an easily understood security.
6. They are not a new instrument for Treasury.
The main disadvantage is that there would be potentially
higher interest costs if inflation and interest rates continued
to rise.
16
In sum, there is some possible interest cost benefit from
reintroducing bonds with regular put provisions, but the put
exercise price should be considerably below par to provide protec-
tion against severe price declines, e.g., near 85 for 20-year 12
percent bonds which would require an interest rate increase from
12 to 14 percent before the put would become attractive. More
important, this should strengthen the long-term sector by provid-
ing investors with a "safety-net" protection against a repeat of
the carnage of recent years. If current anti-inflationary macro-
policies are successful, final as well as initial interest costs
of new debt may be reduced.
Selling Only Short-Term Debt
The arguments for the Treasury's selling only short-term
debt at this time are based on confidence in the success of the
government's current anti-inflationary economic policies. Propo-
nents believe that the financial markets have not yet fully
impounded either the past success in slowing the rate of inflation
or the expected further success. Current long-term interest
rates thus are higher than justified by the economic outlook, and
the Treasury should not lock itself into these rates for long
periods. Emphasizing short-term securities also would send a
strong signal to the financial community that the Treasury is
confident of the success of the anti-inflation programs. This
alone might hasten the decline in market rates.
Opponents of this strategy argue that it would only intensify
already heavy pressure on the short-term sector and, if anything,
increase the disintermediation of funds from thrift institutions.
Because retirement of the debt is unlikely so the needs of the
Treasury are likely to be long-term, the Treasury should concen-
trate as much as is financially feasible on lengthening the
maturity of its debt. The average maturity of the marketable
debt is currently 4 years. Although this is above the low of 2½
years in 1975, it is shorter than the 5½ years in the 1950s, when
retirement of at least some of the debt largely incurred during
World War II was not imaginable. Almost one-half of the debt has
a maturity of less than one year. Thus, if interest rates decline,
the interest cost savings would be substantial, even in the
absence of further shortening.
Opponents also doubt that the Treasury should be betting
heavily on interest expectations and that the market would respond
favorably to any implied anti-inflation signal associated with
financing only short-term. It is unlikely that this signal would
be any stronger than explicit verbal announcements or successful
in changing investor expectations until the success of such
policies became clearly evident for some period of time. The
government has exhausted its credibility based on words; only
specific policy actions and results will restore it significantly.
Indeed, more words might have the opposite effect. Short-term
debt is generally viewed as more liquid and thus as more infla-
tionary than an equal dollar amount of long-term debt. If later,
17
the Treasury reentered the long market, would this signal that it
expected rates to rise even more? Use of such a strategy in
recent years would have resulted in considerably higher interest
costs.
RECOMMENDATIONS
Major
The current financing needs of the Treasury are so large
that it cannot afford to neglect any sector in search of the
lowest interest rates. Nor should the impact on the market of
the mode of Treasury financing be underestimated.
To the extent that new types of securities add to the arsenal
of alternative instruments and permit the Treasury to better meet
the demands of investors, thereby reducing interest costs, they
should be given careful consideration. It is important, however,
to keep the Treasury security market as simple, clear, understand-
able, and credible as possible. But this should not deter reason-
able experimentation.
o Zero Coupon Bonds
The Treasury should begin to sell zero coupon bonds (or
equivalent compound interest bonds) as soon as possible. There
appears to be a large and expanding market for such bonds in a
wide range of maturities stretching from 18 months to 30 years.
This market is comprised of large tax-exempt institutional inves-
tors, such as life insurance companies and pension funds, who
demand high credit long-term single payment bonds for interest-
rate immunization and minimization of reinvestment risk and
costs; and smaller tax-exempt individual retirement funds (IRA
and Keogh Plans), which want to lock-in current high interest
rates on higher quality bonds than are currently available. If
relative interest rates on Treasury zero coupon bonds are compar-
able to those on the corporate and municipal markets, the Treasury
should, at least at first, realize significant interest cost
savings and small, if any, revenue losses.
The rapid growth of zero coupon corporate and municipal
bonds in the past 12 months suggests that there is little risk to
the Treasury in selling ZCBs. However, sales by the Treasury may
first require a minor wording change in the debt ceiling statute
from "face" to "amortized" value for ZCBs, and the Treasury
should confer with Congress concerning the relationship of yields
on ZCBs to the 4½ percent coupon limitation on its long-term
bonds. The Treasury should also amortize the interest payments
semiannually and receive a guaranty from Congress that the interest
funds will be appropriated when due.
18
Variable Coupon Rate Bonds
The Treasury should sell long-term VRBs in smaller denomina-
tions, such as $1,000 to $100,000, designed for household inves-
tors. Interest rates should be somewhat lower than on regular
fixed rate securities, say, at no less than 90 percent of the
one-, two-, or three-year Treasury security rate, with the coupon
rates changing at the maturity of the corresponding index rate,
i.e., the coupon rate would change every two years if it were
tied to a two-year rate. Such VRBs would provide households with
a secure and relatively costless security protected against major
loss in purchasing power from inflation, which is priced so as to
draw funds out of thrift institutions (a stated objective of
Treasury financing policy).
Putable Bonds
The Treasury should give serious consideration to issuing
long-term bonds with put options. Unlike its previous putable
bonds, the put exercise price should be well below the par value
(or amortized value in the case of zero coupon bonds), e.g., at
85 for a 20-year par bond at today's interest rates, to provide a
"safety net" to protect investors only against relatively large
increases in interest rates. Such bonds should provide some
immediate interest cost reductions, encourage long-term saving,
strengthen the long-term bond sector, and, possibly, provide
additional incentive for the government to pursue effective
anti-inflationary policies. The Treasury should conduct a thorough
analysis of its experiences with put (as well as call) options on
past issues.
O Price Level Adjusted Bonds
There is no immediate need for PLABs, if the Treasury issues
small denomination variable coupon rate bonds. But PLABs may be
desirable in the future, particularly if inflation accelerates,
to encourage long-term saving and financing. The ability to
match interest payments and tax revenues is less important for
the Treasury, which can borrow efficiently in the short-term
market, than for many private borrowers, such as households, who
do not have this option. Because PLABs are more complex than
most other types of bonds, require careful design to be efficient,
and represent a more major innovation, the Treasury should begin
a thorough study of the theoretical underpinnings of PLABs and
the experiences of other countries with their use.
Minor
O The Treasury should continue to urge Congress to remove
altogether the $70 billion ceiling on long-term bonds with coupon
rates above 4½ percent.
O The Treasury should restructure its nonbill sale calendar
to concentrate all of its sales in only two weeks of every month,
19
say, the second and fourth weeks. This would not be a major
adjustment from the current calendar, would increase market
certainty, and would provide the market additional time to distri-
bute and absorb the new issues, thus encouraging the lowest
interest costs.
O The Treasury should reduce its minimum denomination on
all issues to $1,000 from the present minimum of $5,000 on coupon
securities less than three years to maturity and of $10,000 on
bills. This would broaden the market to households and smaller
investors, who must now use money market funds, and provide them
with yields equal to those offered others. By broadening the
demand for Treasury issues somewhat, it might reduce interest
costs moderately. In today's environment, this reduction in
denomination is unlikely to exert significant pressure on thrift
institutions, and it would produce equal treatment of all investors
regardless of size or influence.
Adoption of these recommendations should:
O ease the burden of the Treasury in financing the large
federal deficits projected over the next few years and in refinanc-
ing the maturing debt;
O reduce the interest cost of the debt and thereby also the
size of future deficits and the overall level of interest rates;
and
O provide support for the long-term debt market and thereby
encourage long-term personal saving.
While the achievement of these objectives is desirable at all
times, it is particularly desirable at present, when the tremendous
size of the federal government deficts are widely considered a
major cause of the high levels of interest rates, crowding out
private investment, and thereby possibly delaying and weakening
economic recovery.
Prepared for The Heritage Foundation
by George G. Kaufman
Loyola University of Chicago
20
Acknowledgements
The analysis and conclusions in this paper are in part based on personal
and telephone interviews with the following experts in the Treasury securities
market. Their assistance is greatly appreciated. Needless to say, the analysis
and conclusions are the author's and may not be indicative of the views of
those interviewed.
David Bunting, Managing Director, First Boston Corporation.
James Coyne, U.S. Representative of the Eighth District, Pennsylvania
Dick Davis, Director-Fixed Income Research, First Boston Corporation
Brian Fabbri, Vice President and Economist, Salomon Brothers
Charles Hayworth, Deputy Director-Office of Government Finance, U.S. Treasury
Department
Andrew Kalotay, Vice President, Salomon Brothers
Leon Kendall, Chairman, Mortgage Guaranty Insurance Corporation
Lewis Ranieri, Managing Director, Salomon Brothers
C. Willis Ritter, Haynes and Miller, Washington, D.C.
Edward Roob, Senior Vice President, The First National Bank of Chicago
Edward Snyder, Vice President, National Bank of Detroit
Beryl Sprinkel, Undersecretary for Monetary Affairs, U.S. Treasury Department
Mark Stahlnecker, Deputy Assistant Secretary for Federal Finance, U.S. Treasury
Department
David Taylor, Executive Vice President, Continental Illinois National Bank and
Trust Company of Chicago
Frederick Whittemore, Managing Director, Morgan Stanley
Ed Yeo, III, Managing Director, Morgan Stanley
MICHAEL K. DEAVER
Jue
Iin racing off for a few days
va cation but writed you to know
that October dates are Jime although
we already have housequests. I can
arrange good other accomalations
th a good time he cause me have a
THE WHITE HOUSE
WASHINGTON
Mr. Joe Thompson
1808 West Avenue N-4
Palmdale, CA 93550
8-20-82
state visit on Oct 12 it and that
is something to see. will get to
work on toms elc. Iil get be ch
of you might yther Labor day.
theers /
mike
August 2, 1982
Dear Mike,
We accept your invitation to the Capitol. Karyl, the girls
and myself will arrive October ninth and stay through the following
Tuesday or Wednesday.
Our visit during the reunion was very special to me. Over
the years some things, including our compatibility, do not seem to
change. It was difficult for me to comprehend that my friend, with
whom I was reminiscing, is one of the key men in our Country's admin-
istration.
You seemed concerned that your speech took the edge off the
festivities. It did and for good reason. Your speech was thought-
ful, humorous, reminded us of the problems of Government and also
pointed out the obvious, that we live in a great and respected
Nation. You gave us something to ponder on. The subdued response
was attributed to the thought process that your remarks precipitated.
In other words, your remarks hit home.
Any assistance during our stay that you can give will be
appreciated. Should your schedule permit, perhaps we could get
together for a few moments.
1/80 As ever
Joe
Joe Thompson
1808 West Avenue N-4
Palmdale, CA 93550
(805) 947-3200
THE WHITE HOUSE
WASHINGTON
August 31, 1982
Dear Mr. Peterson:
Thank you for your follow-up request for
Mr. Deaver to attend the fundraiser for
Claude Hutchinson.
A close look at Mr. Deaver's schedule
shows that it will not be possible for
him to attend, but he wishes Mr. Hutchinson
the best of luck in his campaign.
Sincerely,
SHIRLEY MOORE
Staff Assistant to
Michael K. Deaver
Mr. Roger C. Peterson
88 Ashbrook Place
Moraga, CA 94556
88 Ashbrook Place
Moraga, CA 94556
August 6, 1982
MICHAEL K. DEAVER
DEPUTY CHIEF OF STAFF
WHITE HOUSE
WASHINGTON, D. C. 20500
Dear Mike,
I am coordinating a campaign fund raiser for California's
8th Congressional District Republican candidate, Claude Hutchison.
He is running against Ron Dellums.
Bill Mazzocco has contacted Shirley Moore to request you
and Carolyn's attendance. We have arranged with Herman Rowland,
President of Herman Goelitz Candy Company, Inc. to have the fund
raising party at his facility in the Oakland, Calif. area.
Since I personally know both individuals well, I thought
the tie-in between the "Jelly Belly"* jelly beans and Claude
Hutchison's campaign to unseat Oakland's Ron Dellums was an
opportunity no thoughtful Republican could overlook.
I also have a business association with Bill Mazzocco.
We discussed the White House connection and we hope you in some
way could support the rally that is developing in the East Bay to
elect our candidate.
We would like to suggest some dates:
September 25 or 26
October 16 or 17
I realize your schedule is predicated on the President's
schedule and we, of course, would be happy to arrange the "Jelly
Belly" fund raiser at some other more opportune time you suggest.
Please add us to your schedule.
Hope to hear from you soon.
Yours truly,
Roger C. Peterson
Roger C. Peterson
RCP
Encl. (2)
*Reg. U.S. Trademark