To understand the formal context that led to the first T-Bill auction in 1929, it must be viewed as a series of 1920’s events beginning with the end of World War 1.
At the end of the war, the United States carried a war debt of approximately $25 billion between 1917 and 1919. To understand this number, the debt in 1914 was $968 million. Factor that debt with a war surtax placed on American incomes by President Woodrow Wilson and a 73 percent personal income tax rate, the 1920 economic recovery for the US was bleak.
How was the United States to pay down the debt financed strictly by Americans through sales of Liberty and Victory bonds and short term debt instruments called Certificates of Indebtedness. Further how was the Treasury to not payout more in issued Treasury interest than what is received through income taxes especially when income taxes was the only revenue of repayment and a public outcry existed to reduce those rates.
Lastly, how was an economic recovery to be sustained. President Harding signed the Revenue Act of 1921 and reduced the top income tax rate from 73 to 58 percent coupled with a small reduction of the surtax on incomes and raised Capital Gains taxes from 10 to 12.5 percent. With reduced revenue, the Treasury was then forced into serious debt management mode especially in the short term.
During the war years, the government issued short term, monthly and biweekly subscriptions of Certificates of Indebtedness that had maturities of one year or less. By wars end in 1919, $3.4 billion of Certificates of Indebtedness were outstanding. The Treasury set the coupon rate at a fixed price and sold the Certificates at par value. The coupon rates were set in increments of 1/8 percents, just above money market rates. Instances of over subscription and this occurred often, the Treasury gave preference to small orders and small distributors so the market wasn’t dominated by single entities, particularly banks so a secondary market could be established. Sales were so good, the Treasury opened a War Loan Deposit Account at banks that payed 2 percent interest to transfer monies easier. The problem with this system was after the war.
The government held subscription offerings four times a year on the 15th of every third month, in line with tax receipts so payouts can be arranged. Problems occurred when the government payed out monies in surpluses when they never knew what the surplus would be or if a surplus would even exist. Plus banks became such steady customers for themselves and their own customers, they oversubscribed in many instances and credited the War Loan account without paying out actual cash. Despite moving to a cash refinancing system with payouts in new Certificates and cash repurchasings at or near maturities, the Treasury reduced its debt burden to $22 billion by 1923. Yet an answer was needed because of the creative finance structure of the market and because the government was never sure regarding its ability of refinance.
Formal legislation was signed by President Hoover to incorporate a new security with new market arrangements because the Treasury didn’t have the authority to change the present finance structures. Zero coupon bonds were proposed up to one year maturities issued at a discount of face value. The Zero Coupon Bonds would shortly come to be known as Treasury Bills due to its short term nature. The legislation changed the Treasury’s fixed price subscription offerings to an auction system based on competitive bids to obtain the lowest market rates. After much public debate, the public won the right to decide rates based on the competitive bid system. All deals would be settled in cash and the government would be allowed to sell T-Bills when funds were needed not necessarily on tax dates.
During the first offering, the Treasury offered $100 million, 90 day bills with payment due seven days later on settlement day. The auction actually saw investors bid for $224 million in bills with an average price of 99.181. Quoting bills three decimal places was part of the passed legislation. The government now earned cheap money to finance their operations.
By 1930, the government sold bills at auctions the second month of every quarter to limit borrowings and reduce interest costs. All four auctions in 1930 saw buyers refinance with newer bills. By 1934 and due to the success of past bill auctions, Certificates of Indebtedness were eliminated. By the end of 1934, T-Bills were the only short term finance mechanisms for the government. 1935 saw President Franklin Delano Roosevelt sign the Baby Bonds Bill that would later allow the government to issue Series HH,EE and I bonds as another mechanism to finance its operations.
Today, the US Government holds market auctions every Monday or as scheduled. Four week, 28 day T-Bills are auctioned every month, 13 week, 91 day T-Bills are auctioned every three months and 26 week, 182 day T-Bills are auctioned every six months.
What started out as a question whether debt can be transferred to future generations was a misnomer in the 1920s as the government through skilled debt management produced a surplus every year of the 1920’s. Despite early and continuous problems of over subscriptions and under pricing of fixed price offerings, the government still financed its needs. It helped when investors were willing to pay par value for an issue and wait the scheduled length of time to receive their coupon payment. A tricky problem then because the government never knew if it was paying out too much, too little or just enough. Proceeds were payed out using surplus tax revenues yet who could know if those receipts came in as scheduled or if the economy would hold up in uncertain economic times.Prior problems were eliminated when the T-Bill system came into effect. That market today is unquestionable one of the largest markets traded in the world.
December 2009 Brian Twomey
Brian Twomey is a currency trader and adjunct professor of Political Science at Gardner-Webb University