Financing Government Debt Foreign Government Borrowing Tax Payer Receipts Issuance of Government Debt
Foreign Government Borrowing Traditional Means of Financing World War I Major Lending Countries at War United States Forced to Fund the War through Increased Taxes and Debt
Tax Payer Receipts War Revenue Act of 1917 Increased Income Tax Rate Decreased Minimum Tax Rate Income Level
Revenue Act of 1917 War Income Tax on Individuals Tax Rates from 1916 ActTax Rates from 1917 Act Net Income (dollars) Normal Rate (percent) Additional Rate (percent) Like Normal Rate (percent) Like Additional Rate (percent) Combined Rate (percent) 020204 5,00020215 7,50020226 10,00020237 12,50020248 15,00020259 20,000212710 40,0002221016 60,0002321421 80,0002421826 100,0002522231 150,0002622535 200,0002723041 250,0002823446 300,0002923750 500,00021024054 750,00021024559 1,000,00021125065 1,500,00021225066 2,000,00021325067
□ Issuance of Government Debt Fixed Price Securities Determined by Government 1914 Peace Time Debt totaled $968 Million 1919 Interest Bearing Debt Magnified to $25.2 Billion
1920’s - Government Noticed Fixed Price Debt was consistently over-subscribed Indicated Under-pricing of Issued Debt 1929 - Explored the British Treasury Bill Market Important Amendments to Debt Offering System Securities offered when needed Auctioned to competitive bidders First Auction was held for $100 Million in 90 day Bills on December 10 th, 1929
Changes Since 1929 Treasury Notes and Bonds Still Offered at Fixed Prices until 1970 By 1983 Auctions were changed to reflect the yield instead of the discounted price Most significant change came in 1992 with the introduction of the single-price format
Finance United States Debt Current Debt: $10,717,998,123,287.70 (2/5/09) Goal: Finance government borrowing at the least cost Issue securities at regular and predictable schedule Easier for investors to predict future offerings Factors Deficit?, economic outlook, maturing issues Input from primary dealers, general public
Multiple per week 2 Types of Bids: Non-Competitive Smaller Firms, Individual Investors Specify amount only Competitive Primary Dealers, Institutional Investors Specify amount wanted and yield Single Price Auction – All winning bidders get same yield Let’s try it.
Scenario: Treasury Auction for $30B in 5-yr notes Bids: Non-Competitive: 1) $1.0B Competitive: 2) $4.5B1.69% 3) $7.3B1.70% 4) $6.5B1.72% 5) $8.7B1.74% 6) $3.8B1.75% $2.0B1.75% 7) $5.2B1.76% - Total so far: $28B $2.0B remaining to auction - Pro rata share = $2.0B/$3.8B = 52.6% Stop Yield Total: $30B ………… Price too low—Receive zero
How can they make sense? (Remember primary goal) Fundamentally Different than regular auction Many items, many bidders, many winners Multiple Price (Traditional) Auctions Winner’s Curse – causes bidders to bid lower amounts (more cautious) Single Price Auctions Fear of winner’s curse eliminated Bidders bid full reservation price Less complex = more participation = Demand Higher Price
History of Debt Financing and the Beginning of Auctions Goal of US Treasury: Finance public debt at least possible cost Done by auctioning government securities in single price auctions Single price auctions get Treasury best price for securities
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