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Birth of a Market

Birth of a Market: The U.S. Treasury Securities Market from the Great War to the Great Depression

Kenneth D. Garbade
Copyright Date: 2012
Published by: MIT Press
Pages: 408
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  • Book Info
    Birth of a Market
    Book Description:

    The market for U.S. Treasury securities is a marvel of modern finance. In 2009 the Treasury auctioned $8.2 trillion of new securities, ranging from 4-day bills to 30-year bonds, in 283 offerings on 171 different days. By contrast, in the decade before World War I, there was only about $1 billion of interest-bearing Treasury debt outstanding, spread out over just six issues. New offerings were rare, and the debt was narrowly held, most of it owned by national banks. In Birth of a Market, Kenneth Garbade traces the development of the Treasury market from a financial backwater in the years before World War I to a multibillion dollar market on the eve of World War II. Garbade focuses on Treasury debt management policies, describing the origins of several pillars of modern Treasury practice, including "regular and predictable" auction offerings and the integration of debt and cash management. He recounts the actions of Secretaries of the Treasury, from William McAdoo in the Wilson administration to Henry Morgenthau in the Roosevelt administration, and their responses to economic conditions. Garbade's account covers the Treasury market in the two decades before World War I, how the Treasury financed the Great War, how it managed the postwar refinancing and paydowns, and how it financed the chronic deficits of the Great Depression. He concludes with an examination of aspects of modern Treasury debt management that grew out of developments from 1917 to 1939.

    eISBN: 978-0-262-29867-4
    Subjects: Economics, Finance

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Preface
    (pp. ix-x)
  4. Acknowledgments
    (pp. xi-xii)
  5. 1 Introduction
    (pp. 1-10)

    The market for U.S. Treasury securities is a marvel of modern finance. In calendar year 2009 the Treasury auctioned $8.2 trillion of new securities, ranging from 4-day bills to 30-year bonds, in 283 offerings on 171 different days. (See box 1.1 for a description of Treasury securities.) By the end of the year, total Treasury indebtedness stood at $12.3 trillion, $7.2 trillion of which was publicly held marketable debt spread out over 256 different issues.¹ That immense indebtedness, coupled with the creditworthiness of the U.S. government, provided the raw material for the most liquid securities market in the world, where...


    • 2 The Payments System before World War I
      (pp. 13-28)

      This chapter describes the payments system as it existed in the United States between 1900 and the beginning of the First World War. It might seem odd to begin a study of the market for U.S. Treasury securities with a discussion of how Americans paid for their purchases of goods and services, but it is difficult to understand the primary market for Treasury bonds before World War I without understanding national bank notes, it is difficult to understand how America financed its wartime expenditures without understanding why Congress created the Federal Reserve System in 1913, and it is difficult to...

    • 3 Treasury Debt Management before World War I
      (pp. 29-46)

      This chapter describes Treasury debt management in the decades prior to the First World War—including the characteristics of Treasury debt and the primary market for Treasury securities.

      Six Treasury issues, with an aggregate principal value of $963 million, were outstanding in mid-1914 (table 3.1). Congress had authorized each issue for a specific purpose. For example, the War Revenue Act of June 13, 1898, authorized the bonds sold to finance the Spanish–American War:

      [T]he Secretary of the Treasury is hereby authorized to borrow on the credit of the United States from time to time as the proceeds may be...


    • 4 Treasury Finance during World War I
      (pp. 49-68)

      The scale of Treasury financing operations expanded dramatically after the United States entered the First World War and officials had to borrow $25 billion to finance the American participation. A market previously driven primarily by bank demand for collateral (pledged against government deposits and issues of national bank notes) evolved into an investment market, where securities were judged primarily on the basis of their cash flows. One prominent dealer remarked that, “For many years [there were not] enough U.S. bonds suitable for investment purposes to demonstrate by their market value the true credit level of this nation.”¹ By war’s end,...

    • 5 Designing the Liberty Loans
      (pp. 69-90)

      The five Liberty Loans that financed two-thirds of the cost of American participation in World War I were—like the Spanish–American War bonds of 1898—sold in fixed-price subscription offerings. Treasury officials specified the terms of an issue and offered the issue at par; subscribers indicated how much they wanted to buy. Following a three- or four-week subscription period, officials totaled the orders and announced what each subscriber would receive.

      Table 5.1 and figure 5.1 show the amount offered, the amount subscribed, and the amount allotted for each of the five loans.¹ None of the loans failed; to the...

    • 6 Marketing the Liberty Loans
      (pp. 91-108)

      More than a decade after the end of the First World War, the wartime Secretary of the Treasury proudly recalled the Liberty Loan campaigns: “We went direct to the people; and that means to everybody to business men, workmen, farmers, bankers, millionaires, school teachers, laborers.”¹ Secretary McAdoo’s recollection focused on what was perhaps the most striking feature of the Liberty Loans: the immense effort devoted to attracting individual investors. The Treasury had sought out individual investors before, when it financed the Spanish–American War, but the Liberty Loan campaigns went far beyond that earlier episode. During World War I the...

    • 7 Treasury Cash Management: Certificates of Indebtedness
      (pp. 109-122)

      In the absence of any off-setting disbursements, wartime bond sales and tax collections would have produced large, episodic flows of funds into Treasury accounts at Federal Reserve Banks, draining the supply of reserves available to the banking system and putting upward pressure on short-term interest rates. The contraction in reserves would not have been permanent—military expenditures would quickly return the funds to the banking system—but would have been nonetheless disruptive in view of the magnitude of the flows.¹

      Treasury officials adopted two strategies to dampen fluctuations in government balances at Federal Reserve Banks: (1) anticipatory sales of short-term...

    • 8 Treasury Cash Management: War Loan Deposit Accounts
      (pp. 123-130)

      Based on earlier experience in connection with bond sales to finance the Spanish–American War and the Panama Canal, most observers in the spring of 1917 expected that the Treasury would redeposit in commercial banks the proceeds of wartime securities sales until the funds were needed.¹ Shortly after President Wilson signed the declaration of war against Germany,The New York Timesreported that “it is taken for granted that the proceeds of the sale of . . . bonds will not be locked up in the Treasury or deposited exclusively with the Federal Reserve Banks, but will be kept on...

    • 9 Federal Reserve Support of the Treasury Market during World War I
      (pp. 131-142)

      Federal Reserve support of the Treasury market during World War I was founded on two statutory credit facilities: the original power of the Reserve Banks to discount, or purchase, loans made by member banks to their customers, and the subsequently added power of the Reserve Banks to lend to member banks.¹ Reserve Bank discounts were limited to (1) short-term loans “arising out of actual commercial transactions” and (2) short-term loans to purchase or carry Treasury securities.² The authority to lend to member banks was added in 1916,³ when section 13 of the Federal Reserve Act was amended to provide that:...

    • 10 Coda on Treasury Debt Management during World War I
      (pp. 143-144)

      At the end of June 1916, interest-bearing Treasury debt amounted to $1.0 billion. Three years later, it was $25.2 billion, including $3.5 billion in certificates of indebtedness, $4.5 billion in notes, and $17.2 billion in bonds.¹ The explosion in debt provided the raw material for the emergence of a broad market for Treasury securities and marked the end of an era in which Treasury securities were owned primarily by national banks and used primarily as collateral for bank notes and government deposits.²

      Several important changes in Treasury debt management accompanied the wartime growth in debt, including how the Treasury sold...


    • 11 Treasury Finance during the 1920s
      (pp. 147-160)

      At the end of the First World War the American fiscal landscape exhibited two prominent features: the national debt stood at $25 billion—an immense expansion over the $1 billion of pre-war indebtedness—and tax rates were so high that—in the opinion of both Democrats and Republicans—they significantly dampened investment incentives.

      The wartime expansion in the national debt was widely viewed as a temporary phenomenon, an alternative to the taxes that otherwise would have been required. The costs of war had to be funded and the country chose to fund three-quarters of the costs by issuing promises of...

    • 12 Paying down the War Debt
      (pp. 161-184)

      In mid-1919 total interest-bearing Treasury debt stood at $25.2 billion dollars. $3.5 billion of the debt was short-term certificates of indebtedness, $4.5 billion was Victory notes scheduled to mature in May 1923, and $4.0 billion was Third Liberty Loan bonds scheduled to mature in 1928. After that, nothing of any significance was due before 1938.

      By mid-1930 the Treasury had redeemed the Victory notes and the Third Liberty bonds, reduced its short-term indebtedness to $1.4 billion, and retired $4.6 billion of other debt (including—more than a decade early—all $3.6 billion of the Second Liberty bonds that were due...

    • 13 Revival of the Over-the-Counter Market
      (pp. 185-198)

      At the end of World War I, Liberty bonds traded in an active secondary market on the New York Stock Exchange; the Exchange reported aggregate Liberty bond sales of almost $3 billion during 1919.¹ In contrast, there was only a limited secondary market for certificates of indebtedness. An investor who wanted to liquidate an investment in certificates typically went back to the bank where he bought them and asked the bank to repurchase the securities. Banks were not unhappy to undertake such repurchases because they could readily finance certificates with Federal Reserve Bank credit.² Federal Reserve credit, rather than a...

    • 14 Evolution of the Primary Market and the Introduction of Treasury Bills
      (pp. 199-216)

      Following the end of World War I, the Treasury continued to sell large quantities of securities on a regular basis. Between mid-1919 and mid-1930, the Treasury sold a total of $28 billion of securities in 100 cash offerings.¹ In contrast, between 1894 and 1916, it had sold a mere $600 million of securities in nine cash offerings.

      Figure 14.1 shows the volume of cash sales by fiscal year. 1920 was a transition year between the war years (when the Treasury had an almost insatiable appetite for money and borrowed on the strength of marketing campaigns that emphasized patriotic sacrifice) and...

    • 15 Coda on Treasury Debt Management during the 1920s
      (pp. 217-218)

      The 1920s did not present a funding emergency like that faced by Treasury Secretary McAdoo during World War I and Secretary Mellon did not have the opportunities to demonstrate his ingenuity that McAdoo had. Mellon nevertheless made good use of his tenure by paying attention to detail and fostering the evolution of what had once been a “project finance” market into the sort of liquid national securities market needed to sustain a more or less permanent national debt.

      At the end of June 1919, interest-bearing Treasury debt amounted to $25.2 billion, including $3.5 billion in certificates of indebtedness, $4.5 billion...


    • 16 Treasury Finance during the Great Depression
      (pp. 221-246)

      The Great Depression was the central economic event of the 1930s. The National Bureau of Economic Research places a peak in business activity in August 1929 and the following trough more than three and a half years later, in March 1933. Between 1929 and 1933, gross national product fell 44 percent, from $204 billion to $142 billion (in constant, 1958, dollars), employment fell 18 percent, from 46 million to 38 million, and the unemployment rate rose from 3.2 percent to 25 percent. Over the next four years, production and employment recovered to 1929 levels—GNP (in 1958 dollars) was $203...

    • 17 Nonmarketable Treasury Debt
      (pp. 247-260)

      Prior to 1936, federal deficits were financed almost exclusively with marketable Treasury securities, but figure 17.1 shows that deficits after fiscal 1935 were financed with increasing amounts of nonmarketable debt. The nonmarketable debt included savings bonds sold to individual investors and special issues sold to two trust funds, the Unemployment Trust Fund and the Old-Age Reserve Account, established by the Social Security Act of 1935.

      This chapter examines the issuance of nonmarketable Treasury debt in the second half of the 1930s. The chapter begins by describing an early example of a government trust fund and the first instance of a...

    • 18 Treasury Debt Management during the Great Contraction
      (pp. 261-278)

      The success of a Treasury debt manager depends on three things: goals that are compatible with the economic environment, a rationally constructed program for achieving those goals, and the mental agility to respond to unanticipated developments. Andrew Mellon and his Under Secretaries were successful debt managers in the 1920s because they had a clear vision of what they wanted to accomplish: reduction of the war debt, as well as a congenial fiscal environment and a program of early retirements, cash redemptions at maturity, and refinancings calibrated to achieve their objective. In addition they demonstrated that they could take advantage of...

    • 19 Treasury Debt Management during the New Deal
      (pp. 279-302)

      The strategic objectives of Treasury debt managers during the New Deal, from the spring of 1933 to mid-1939, hardly differed from those of Andrew Mellon and Ogden Mills during the Great Contraction. The need to finance chronic deficits, and the need to refinance increasing amounts of maturing debt, prompted continuing interest in extending maturities to avoid a pileup of short-term obligations that might set the stage for a funding crisis. Officials were also mindful that the $6.3 billion Fourth Liberty Loan would mature in 1938. The loan was too large to pay off in a single operation and would have...

    • 20 The Primary Market during the Great Depression
      (pp. 303-312)

      Large, sometimes even massive, oversubscriptions for fixed-price offerings of coupon-bearing Treasury securities (certificates, notes, and bonds) were commonplace in the 1930s. Only five out of sixty-four cash offerings between 1930 and 1938 generated subscriptions smaller than twice what was offered, only fifteen generated subscriptions smaller than three times the amount offered, and—as shown in figure 20.1—on thirteen occasions subscriptions were an order of magnitude larger than what was offered. The average “cover ratio” of debt subscribed to debt offered was 6.9.

      Oversubscribed offerings were more than mere curiosities. They were indicative of an inefficient primary market (because they...

    • 21 Statutory Control of Treasury Indebtedness
      (pp. 313-318)

      Whether issuing securities to finance a current deficit or to refinance maturing debt, Treasury officials have to comply with whatever restrictions Congress chooses to impose. There were three statutory restrictions on Treasury debt management actions at the beginning of the Great Depression:¹

      1. a limit of $10 billion on outstanding bills and certificates of indebtedness,²

      2. a limit of $7.5 billion on outstanding notes,³ and

      3. authority to issue no more than $20 billion of Treasury bonds.⁴

      In contrast, by mid-1939 there was only a single statutory limit of $45 billion on total outstanding indebtedness. This chapter examines why Congress...

    • 22 The Brief Revival and Subsequent Extinction of National Bank Notes
      (pp. 319-332)

      From the opening of the Federal Reserve in the fall of 1914 to the beginning of the New Deal in 1933, the United States used (simultaneously) five different types of currency: gold certificates, silver certificates, United States notes, Federal Reserve notes, and national bank notes. The first three currencies were direct emissions of the federal government. Federal Reserve notes were, for all practical purposes, direct emissions as well, but national bank notes were private liabilities.

      In adopting the Federal Reserve Act in 1913, Congress intended that Federal Reserve notes would, over time, replace national bank notes. Section 18 of the...

    • 23 Coda on Treasury Debt Management during the Great Depression
      (pp. 333-334)

      As a long-run proposition, the most important advance in Treasury debt management during the Great Depression was the introduction of regular and predictable auctions of 13-week Treasury bills. Regular weekly auctions weren’t what Ogden Mills had in mind when he and J. Herbert Case worked together to introduce Treasury bills to the American money markets in 1929, and it certainly wasn’t a straight line from the sporadic bill auctions of 1930 to the regular weekly auctions of 13-week bills in 1938 and 1939, but the program nevertheless satisfied a need for a short-term, highly liquid security and contributed to low-cost...

  10. V L’ENVOI

    • 24 Treasury Debt Management since 1939
      (pp. 337-370)

      World War I marked the beginning of an important change in Treasury debt management. During the two decades prior to the war the Treasury sold securities on a sporadic basis pursuant to specific congressional authority to finance two narrowly defined projects: the Spanish–American War and the Panama Canal. In contrast, during the 1920s the Treasury sold securities on a regular basis to refinance maturing debt; during the 1930s it similarly sold securities to finance the budget deficits of the Great Depression as well as to refinance maturing debt. As a result of the change in the reason for—and...

  11. References
    (pp. 371-380)
  12. Index
    (pp. 381-394)