The Honorable Paul O’Neill
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220
Dear Mr. Secretary:
An article in the February 9 issue of the Wall Street Journal ("Fewer Treasurys Bring More Fund Risk) raises questions regarding the continued issuance of 30-year U.S. Treasury bonds. At the Chicago Board of Trade (CBOT®“), we are very interested in any plans being discussed by the Treasury Department regarding the long bond, not only because of the business impact such action could have on our markets, but also in terms of the ability of market participants worldwide being able to manage their financial risk.
In the quarter century since the late former Treasury Secretary William Simon’s visionary effort to rationalize federal debt issuance, the U.S. Treasury has cultivated the world’s deepest, most liquid long-term bond market. To meet the demand of this new economic environment, the CBOT®, then a commodity exchange, expanded its contract offerings to give financial institutions the opportunity to manage price risks.
Today, the CBOT®’s U.S. Treasury Bond futures contract has grown to be one of the world’s most actively traded futures contracts. In 2000, we traded over 62 million Treasury bond futures contracts as part of a diversified financial product mix that includes U.S. Treasury Note futures and options on futures, 30-Day Fed Funds futures, Municipal Bond Index futures, and Agency Note contracts. We provide global risk management opportunities for the full range of the yield curve, and we are here to serve all markets, whatever the benchmark may be.
If this repository of long-term liquidity and the aforementioned market infrastructure that has grown up around it were to be dismantled, reassembling it would be extremely costly. That is why the CBOT® is very interested in any consideration being undertaken by the Treasury Department to reduce the issuance of 30-year Treasury bonds.
Some have argued that the long bond should be eliminated in light of projected large federal budget surpluses. However, we urge the Treasury Department to exercise extreme caution in modifying its debt issuance calendar in this manner. Specifically, we recommend that Treasury continue to fund at least a portion of government debt with periodic new issuance of 30-year bonds.
Our reasons for this prudential course are straightforward. The bulk of evidence supporting discontinuance of long-term bond issues resides in budget surplus projections computed by the Congressional Budget Office (CBO). These forecasts indicate that over the coming decade a vigorous economy will sponsor sufficiently high growth of tax receipts to make long-term debt service an unnecessary public expense.
However, CBO projections have at times been off the mark by wide margins. Notably, the CBO failed to anticipate the prosperity of the late 1990s that made paydown of Treasury’s debt a feasible prospect. Just as CBO erred in the mid-1990s in making excessively pessimistic projections of future economic performance, it may be erring today in offering overly optimistic projections.
Over any policy horizon but the very longest, both the economy and Treasury’s borrowing needs are cyclical, not trending. Treasury should therefore be reluctant to undertake major restructuring of its debt issuance calendar, if in fact it is considering such action, solely on the assumption that the buoyant economic performance of recent years will persist indefinitely. The recent cooling of GDP growth is a timely reminder of the risks inherent in making such an assumption.
Bond portfolio managers, especially in the life insurance and pension industries, need a risk-free long-term asset such as the Treasury 30-year bond as a useful investment alternative. More importantly, even a small presence by the Treasury at the long end of the yield curve assures that long-term investors have a reliable and transparent risk-free yield against which to accurately evaluate long-dated assets and liabilities that are relatively less liquid and less creditworthy.
To discontinue issuance of 30-year bonds would effectively deny these investors access to an unrivalled reference point for defining value in the long-term debt market. It might also have the unintended and undesirable consequence of raising risk profiles for their investors. This could happen in at least two ways. First, if portfolio managers are forced to invest in shorter-term assets, they would be exposed to greater reinvestment risk. Second, if portfolio managers are forced to seek out long-dated (e.g., 30-year) assets issued by concerns less creditworthy than the U.S. Treasury, they would be exposed to higher default risk.
By maintaining a liquid and active market in long-term government bonds, Treasury will facilitate significant policy objectives.
- The Bush administration’s proposed tax cuts may turn out to be deep enough to absorb much of the surplus. If so, exhausting the surplus on debt retirement could prove dangerously myopic.
- Insofar as the Bush administration is committed to shifting the burden of retirement funding from Social Security to the private pension system, the "anchor" function of the long-term Treasury bond market will be all the more critical. The incremental debt service entailed in maintaining the 30-year bond in this role is likely to be minor when compared to the beneficial stability and market transparency it would create for pension managers.
- To the extent that Treasury seeks to convert nonmarketable debt issues now held in the Social Security and Medicare Trust Funds to marketable issues, the continued existence of an established market in long-term Treasury bonds would be expedient.
Mr. Secretary, I invite you to visit the Chicago Board of Trade on your next visit to Chicago so you can talk to traders and users of these markets and hear first-hand of the benefits the CBOT®’s financial markets provide to the federal government, our economy, and to all users of these markets. My office would be happy to work with your staff on coordinating any such arrangements.
I also would welcome the opportunity to meet with you and members of your staff in Washington at your convenience to discuss these important issues. Celesta Jurkovich, the CBOT®’s Senior Vice President for Government Relations, can be contacted at 783-1190 to facilitate such a meeting.
Sincerely,
Nickolas J. Neubauer
