Objectives, Scope, and Methodology

To understand the steps that Treasury and the Federal Reserve took  during the week of the September 11 attacks and during the following  weeks to assure required debt obligations and payments were made on  time and ensure liquidity in the financial market, we conducted interviews  with knowledgeable Treasury and Federal Reserve officials and staff. To understand major actions Treasury, the Federal Reserve, and primary  dealers have taken since the September 11 attacks to increase the  resiliency of Treasury’s auction process and participation, we interviewed  Treasury and Federal Reserve officials and staff involved in conducting  primary dealer visits, the auction process, and systems. Compensating Balances Are No Longer Used

Treasury replaced compensating balances with direct payments to banks  for certain services in 2004. This effectively eliminated the alternative  source of funds Treasury had drawn on during the September 11 attacks. Some Federal Reserve Actions and Financial Market Behavior Are Informative When Considering Alternative Funding Sources for Treasury

Immediately after the September 11 attacks, many financial institutions,  including some foreign central banks, looked to the Federal Reserve to  provide liquidity through various methods. Despite Actions Intended to Increase Auction Resilience, Exploring Funding Alternatives Outside of the Auction Process Is Appropriate

Regardless of the progress of resiliency efforts, the nature, duration, and  effects of any potential future wide-scale disruption are unknown. In  addition, since compensating balances are no longer used, Treasury has at  least one less source of funds to rely upon. Finally, Treasury’s cash  management policy of maintaining minimal cash balances to lower  borrowing costs further limits Treasury’s access to cash during a wide- scale disruption. The relevant parties with whom we spoke, including  primary dealers, agreed. Relevant Parties Validated Design Features and a Potential Tiered Approach to Treasury Funding Options Has Emerged from Discussions

These parties also generally agreed that the main design features to be  considered when weighing alternatives for backup funding options are the  situations for use, source of funds, type of collateral, transaction type,  approvals, determination of cost, amount limit, time limit, inclusion under  debt ceiling, disclosure, and length of authority (if required). Discussions with Treasury and Federal Reserve officials and other  relevant parties have led us to conclude that a two-tiered approach could  enhance Treasury’s ability to obtain funds during a wide-scale disruption. The first tier  consists of two funding options involving a range of appropriate financial  institutions, namely (1) a credit line and (2) a private placement of a CM  bill. The second tier involves a direct draw from the Federal Reserve that  would provide Treasury a last resort source of funds when other options  are not viable. Obtain a Line of Credit with Financial Institutions

A credit line would provide Treasury a prior transparent commitment or  understanding with several financial institutions to provide funds to  Treasury during a wide-scale disruption. Private Placement of a Cash Management Bill

A private placement of a CM bill would involve a prior arrangement to  issue a CM bill after communicating with certain senior executives at  financial institutions who would have the ability and authority to purchase  a CM bill that meets Treasury’s immediate funding needs. Explicitly Authorize a Treasury Draw Authority with the Federal Reserve

In the event that the first tier options involving financial institutions  proved insufficient, turning to the Federal Reserve as a last resort funding  source would require a change in law to allow the Federal Reserve to  directly lend to Treasury. Appropriate limitations, adequate flexibility, and  accountability would have to be included in the design. All these  factors make it prudent to explore other funding options for Treasury to  use during a wide-scale disruption.
Why GAO Did This Study

The September 11, 2001, attacks significantly affected the financial markets that the U.S. Treasury (Treasury) relies on. To understand how Treasury could obtain funds during a future potential wide-scale financial market disruption GAO examined (1) steps Treasury and others took during the September 11 attacks and after to assure required debt obligations and payments were made on time and ensure liquidity in the markets, (2) major actions Treasury and others have taken since the attacks to increase the resiliency of the auction process, and (3) the opinions of relevant parties on the main design features of any backup funding options. We conducted interviews with Treasury officials and others and reviewed appropriate documents.

What GAO Found

In response to the effects of the September 11 attacks on the financial markets, Treasury canceled a scheduled 4-week bill auction after communicating with the Federal Reserve Bank of New York (FRBNY). Treasury then used compensating balances from banks across the country to help meet its obligations on time. Compensating balances were replaced by direct payments in 2004. Also, in response to the attacks' financial effects, the Federal Reserve lent billions of dollars to both domestic and foreign financial institutions through a combination of methods to help markets recover. Federal Reserve actions and market behavior in the aftermath of the September 11 attacks are informative when considering potential alternative funding sources for Treasury during a future wide-scale financial market disruption. Treasury, the Federal Reserve, and primary dealers have added contingency sites and systems intended to increase the resilience of the auction process. Regardless of resiliency efforts, the nature and impact of a potential future wide-scale disruption are unknown. In addition, Treasury has at least one less source of cash since the compensating balances Treasury relied upon during the September 11 attacks are no longer used. Finally, Treasury's cash management policy of minimal cash balances to lower borrowing costs further limits Treasury's access to cash during a wide-scale disruption. All these factors make it prudent for Treasury to explore other funding alternatives to use during a wide-scale disruption. Relevant parties with whom we spoke, including primary dealers, agreed. They also generally agreed on a list of main design features including source of funds, situations for use, approvals, and costs, among others, that should be considered when weighing alternative funding options. Discussions with Treasury, the Federal Reserve, and other relevant parties have led GAO to conclude that a two-tiered approach is promising. The first tier consists of two funding options involving a range of appropriate financial institutions, namely a credit line and a private placement of a flexible security known as a cash management (CM) bill. The second tier involves a direct draw from the Federal Reserve that would provide Treasury a last resort source of funds when other options are not viable. A credit line with several financial institutions would involve a prior transparent commitment or understanding by certain financial institutions to provide funds to Treasury. A private placement of a CM bill would involve a prior arrangement to issue a CM bill after communicating with certain senior executives at financial institutions who would have the ability and authority to meet Treasury's immediate funding needs. Finally, a direct draw from the Federal Reserve would require a change in the law to allow the Federal Reserve to directly lend to Treasury. Appropriate limitations, adequate flexibility, and accountability would have to be included in the design.