Gensler, Department of the Treasury
to the
Capital Budgeting Commission
Gary Gensler
Assistant Secretary
(Financial Markets)
Department of the Treasury
April 24, 1998

        Good morning. I would like to thank the Commission for inviting me here today. I would also like to introduce Roger Anderson, Deputy Assistant Secretary for Federal Finance. Before he joined Treasury, Roger was Deputy Comptroller for Finance for The City of New York, where he had extensive experience in municipal finance.

        I will begin by describing the goals and principles that guide Treasury debt management. Then, I will discuss municipal finance and its use of capital budgeting. After laying that groundwork, I will make some comparisons between Federal and municipal finance. Lastly, I will turn to the question at hand, whether the methods utilized by many municipalities to finance capital budgets could be adapted and incorporated into the Federal Government's debt management.

        Treasury Debt Management

        Treasury debt management has three principal goals. The first is sound cash management -- assuring that Treasury cash balances are sufficient at all times. The second is achieving the lowest cost financing for the taxpayers. And the third is the promotion of efficient capital markets.

        In achieving these goals, a number of interrelated principles guide us.

        First is maintaining the "risk free" status of Treasury securities. This is accomplished through prudent fiscal discipline, and lest we forget the budget crisis of three years ago, timely increases in the statutory debt limit. Ready market access at the lowest cost to the Government is an essential component of debt management

        Second, is maintaining the consistency and predictability in our financing program. Treasury issues securities on a regular schedule with set auction procedures. This reduces uncertainty and helps minimize our overall cost of borrowing. Related to this principle, Treasury does not seek to time markets.

        Third, Treasury is committed to ensuring market liquidity. The U.S. capital markets are the largest and most efficient in the world. Treasury securities are the principal hedging instruments across the markets. Liquidity promotes both efficient capital markets and lower Treasury borrowing costs.

        Fourth, Treasury finances across the yield curve, appealing to the broadest range of investors. A balanced maturity structure also mitigates refunding risks. In addition, providing a pricing mechanism for interest rates across the yield curve further promotes efficient capital markets.

        To promote the goals and to follow the principles that I've just described, Treasury employs unitary financing. That is to say, we aggregate all of our financing needs and borrow for one account. While we have many internal accounts, all cash receipts and payments and all borrowings are made through the Treasury. Debt proceeds are not earmarked or segregated. They are used interchangeably with tax receipts to fund all the activities of government -- operating expenses, refunding of maturing debt, and funding of capital expenses.

        Municipal Finance

        Let me now turn to the world of municipal finance. Many of you are more familiar than I am with municipal finance. Let me outline a number of issues, however, as I understand them.

        The majority of states, as well as many localities, have two budgets: an operating budget and a capital budget. Operating budgets are funded by tax and other revenues and are used to fund operating expenses. Typically, state laws or constitutions require operating budgets to be balanced every year. Some states are required to have their operating budgets balanced as proposed or enacted. Others are required to take steps to insure that their operating budgets are in balance at the end of each fiscal year.

        Capital budgets are used to fund capital projects, as defined by state and local laws and are usually funded with bond proceeds. Capital spending, therefore, is not directly included in operating budgets. The principal on the debt is usually amortized and debt service (both principal and interest) is treated as an operating expense.

        Capital budgets allow municipalities to finance multi-year projects outside the annual balance constraints of their operating budgets. Capital budgets are not required to be balanced each year.     Debt issued to finance the capital budgets, however, is generally subject to caps. These caps often cannot be changed except by voter referendums. In addition, debt issued to fund capital construction typically cannot have a maturity beyond the expected useful life of the project being constructed.

        The municipal bond market has numerous different instruments. General obligation bonds are backed by the taxing authority of a jurisdiction. Revenue bonds are backed by a particular revenue stream, either from a lending authority or a specific project. Among the many types of lending authorities, the most common include: Water & Sewer authorities, Housing authorities, and Public Utility authorities. To meet seasonal borrowing needs, municipalities also issue Anticipation notes backed by future tax, grant, or other revenues.

        Comparison of Federal and Municipal Finance

        As I have outlined, there are many differences between Federal Finance and municipal finance. As I noted earlier the three goals of Federal finance are (i) sound cash management, (ii) lowest cost financing, and (iii) the promotion of efficient capital markets. While States and municipalities share the first two of these goals, they pursue them in a legal framework that does not apply to the Federal Government. In addition, we have a unique role in the promotion of efficient capital markets.

        The market for U.S. Treasury securities is the deepest, most liquid, most efficient market in the world. Last year, Treasury issued $2.2 trillion of securities. In contrast, gross issuance in the municipal market was approximately one tenth of this volume. Treasury securities appeal to the widest array of investors spanning the globe. Municipal securities appeal to a narrower range of investors, those domestic investors able to take advantage of the tax characteristics of these securities.


        As outlined earlier, the most significant difference between Federal and Municipal finance is that we employ unitary financing for the federal government. Unitary financing allows us to best meet our goals and abide by the principles previously outlined. Through unitary financing, we are able to issue large liquid issues across the yield curve. Through unitary financing, we are able to be consistent and predictable. Through unitary financing, we preserve the "risk free" status of Treasury securities.

        Municipalities use segregated financing largely due to the legal framework in which they finance. In addition, many municipal bond investors seek diversification through owning bonds issued by different authorities. These factors are not relevant to the Federal Government.

        It may be interesting to share with the Commission a particular aspect in the history of Federal finance. Prior to 1973, the Federal Government actually had multiple issuing authorities. In this environment, many federal agencies issued their own securities to fund their programs. At the time, we had agencies competing in the market with each other and with the Treasury. This led to an inefficient use of Federal credit. Federal agency debt and federally guaranteed debt carried higher interest rates than that issued by the Treasury, sometimes carrying interest as much as two percentage points higher than on comparable Treasury securities.

        To address these concerns, the Treasury requested that Congress create the Federal Financing Bank. All agencies are now required to borrow from the Federal Financing Bank and no longer issue securities directly to the market. This allows the various programs to be financed at the Treasury's lower cost of funds. This important innovation in federal finance was actually initiated by a young Treasury official named Paul Volcker. He later went on to hold a slightly more important post for the nation.

        In conclusion, while there may be aspects of capital budgeting that are applicable to the Federal Government, we do not believe that this would include any form of segregated financing.

        We would now be happy to answer any questions that you may have.

President's Commission to Study Capital Budgeting

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