United States Treasury Auctions
The U.S. Treasury uses an auction process to sell their securities, known, naturally enough, as Treasuries. The prices that the Treasuries fetch determine their rate or yield. These auctions finance the public debt. Most Treasuries are categorized according to their term or type: bills, notes, and bonds. Treasuries with terms shorter than 1 year are called Treasury bills, aften shortened to T-bills. Treasury notes, or T-notes, have terms not exceeding 10 years, and Treasury bonds have terms exceeding 10 years. Treasury auctions occur regularly and have a set schedule. About 200 public auctions are conducted every year in which more than $4 trillion of securities are sold.
How Treasury Auctions Work
There are 3 steps to an auction:
- announcement of the auction,
- and issuance of the purchased securities.
The auctions are announced in advance in most major newspapers and through press releases. Once an auction is announced, financial institutions may submit bids for particular issues. Retail investors may bid directly through Legacy Treasury Direct (except for 30-year bonds and 20-year TIPS which have not been available in Legacy Treasury Direct since January 2007), or make arrangements to purchase securities through a broker, dealer, or other financial institution. The auction announcement details:
- Amount of the security Treasury is selling
- Auction date
- Maturity date
- Terms and conditions of the offering
- Customers eligible to participate
- Noncompetitive and competitive bidding close times
- Other pertinent information
Detailed information about U.S. Treasury announcements is available in the Code of Federal Regulations (CFR), Title 31 - Money and Finance: Treasury, Subtitle B - Regulations Relating to Money and Finance, Chapter II - Fiscal Service, Department of the Treasury.
When participating in an auction, there are 2 bidding options - competitive and noncompetitive.
To place a competitive bid, a bidder must use a broker, financial institution, or have an established TAAPS account.
With a competitive bid, a bidder specifies the discount rate that is acceptable. This bid may be accepted in the full amount if the rate specified is less than the discount rate set by the auction; accepted in less than the full amount requested if the bid is equal to the high discount rate; or not awarded if the rate specified is higher than the discount rate set at the auction.
Competitive bidding is limited to 35% of the issue amount for each bidder, and a bidder specifies the rate or yield that is acceptable.
To place a noncompetitive bid, an individual investor may use TreasuryDirect. Individuals, organizations, fiduciaries, and corporate investors may use Legacy Treasury Direct, or a broker or financial institution.
Noncompetitive bidding is limited to purchases of $5 million for U.S. Treasury bills, notes, bonds, and TIPS. With a noncompetitive bid, a bidder agrees to accept the rate or yield determined at auction.
Bidding limits apply cumulatively to all methods that are used for bidding in a single auction. Legacy Treasury Direct allows noncompetitive bidding only and does not offer 30-year bonds or 20-year TIPS.
At the close of an auction, Treasury accepts all noncompetitive bids that comply with the auction rules and then accepts competitive bids in ascending order in terms of their yields until the quantity of accepted bids reaches the offering amount. All bidders will receive the same rate or yield at the highest accepted bid.
All auctions are open to the public. The following U.S. Treasury buying services are available:
- Individuals: TreasuryDirect accounts
- Individuals and Institutions: Legacy Treasury Direct accounts
- Institutional Investors: TAAPS
On issue day, the Treasury delivers securities to bidders who were successfully awarded securities in a particular auction. In exchange, Treasury charges the accounts of those bidders for payment of the securities.
Treasury bills are issued at a discount from face value and are paid at their par (face amount) at maturity. The purchase price is listed on the auction results press release and is expressed as a price per hundred dollars.
Treasury notes, bonds, and TIPS are issued with a stated interest rate applied to the par amount and have semiannual interest payments. For TIPS, the interest payments and the final payment at maturity are based on the inflation-adjusted principal value of the security. In some cases, the purchaser may have to pay accrued interest.
Redeem, Reinvest, or Sell
A Treasury bill can be held to maturity or sold before it matures. If a bill is held to maturity, the bill's principal can be used to buy another security or the bill can be redeemed.
General Auction Timing
The following is the current pattern of financing for marketable U. S. Treasury bills, notes, bonds, and TIPS. Treasury borrowing requirements, financing policy decisions, and the timing of Congressional action on the debt limit could alter or delay the pattern. Holidays or special circumstances may alter the schedule slightly. If the day of issuance falls on a holiday, or Saturday or Sunday, then the securities will be issued on the next business day.
4-week bills are offered each week. The offering is announced on Monday, the bills are auctioned the following Tuesday, and they are issued on the Thursday following the auction.
13-week and 26-week bills are also offered each week. The offering is announced on Thursday, the bills are auctioned the following Monday, and they are issued on the Thursday following the auction.
Cash Management bills are offered from time to time, depending on borrowing needs. The time between announcement, auction, and issue is usually brief (1-7 days).
2-year and 5-year note auctions are usually announced on the 3rd or 4th Monday of each month. The 2-year notes are generally auctioned 2 days later; the 5-year notes, 3 days later. Both are issued on the last day of the month.
10-year note auctions are usually announced on the 1st Wednesday in February, May, August, and November. The reopening of 10-year notes is usually announced at the beginning of March, June, September, and December. All 10-year notes are generally auctioned during the 2nd week of the above-mentioned months and are issued on the 15th of the same month.
30-year bonds are usually announced on the 1st Wednesday in February and August. The reopenings of 30-year bonds is usually announced on the 1st Wednesday in May and November. All 30-year bonds are generally auctioned during the 2nd week of the above-mentioned months and are issued on the 15th of the same month.
Treasury Inflation-Protected Securities (TIPS)
5-year TIPS are usually announced the 3rd week of April. The reopening of 5-year TIPS is usually announced the 3rd week of October. All 5-year TIPS are generally auctioned the last week of the above-mentioned months and are issued on the last business day of the month. However, these TIPS will continue to have a mid-month maturity date. Therefore, investors who purchase these securities at auction will be required to pay the interest accrued between the 15th of the month and the issue date.
Note: 5-year TIPS issued in October 2004 will have an initial maturity of 5½ years and will be reopened in April 2005 and October 2005.
10-year TIPS are usually announced at the beginning of January and July. The reopening of 10-year TIPS is usually announced at the beginning of April and October. All 10-year TIPS are generally auctioned the 2nd week of the above-mentioned months and are issued on the 15th of the same month.
20-year TIPS are usually announced the 3rd week of January. The reopening of 20-year TIPS is usually announced the 3rd week of July. All 20-year TIPS are generally auctioned the last week of the above-mentioned months and are issued on the last business day of the month. However, these TIPS will continue to have a mid-month maturity date. Therefore, investors who purchase these securities at auction will be required to pay the interest accrued between the 15th of the month and the issue date.
Note: The 20-year TIPS issued in July 2004 will have an initial maturity of 20½ years and will be reopened in January 2005 and July 2005.
How Excessive Government Debt Crowds Out Other Investments
Because Treasuries do not have a credit default risk, they have the lowest interest rates over other investments. If a corporation issues a new bond, the interest rate would have to have a certain spread above interest rates paid by US Treasuries with similar maturity. The spread would have to compensate the bondholder for the additional risk of lending to a corporation.
Likewise, banks will not issue loans without some spread over the interest rate on Treasuries, because all loans have some risk. It would not make sense for a bank to charge the same interest rate, as a comparable Treasury, on a loan when it can simply buy US Treasuries to earn the same rate of return for no credit default risk. Therefore, banks are only going to lend money with an interest rate higher than what they could earn if they bought Treasuries with the same maturity. The spread between the interest rates on the loan and the interest rates on comparable US Treasuries will be inversely proportional to the creditworthiness of the borrower.
Supply and demand determines interest rates. When the government issues excessive amounts of debt, then that increases the supply of debt securities, which lowers their prices for all levels of demand. Because the yield and price of debt securities are inversely proportional, lower prices correspond to higher yields, which will have to be paid by the issuer of the debt.
When the federal government issues an excessive amount of debt, by issuing more Treasuries, prices become depressed and yields increase. When the interest rates on Treasuries rises, corporations will get less for their bonds, and bankers will demand higher interest rates on their loans. Thus, consumers will borrow less and spend less, and firms will borrow less for business investments, which will lead to a downturn in the economy.