WASHINGTON – The Treasury Department's suspension of sales of state and local government series securities appears likely to continue into September. But market participants say they have been able to do without SLGS because interest rates are low and there is little or no likelihood of earning arbitrage.
The suspension is one of the extraordinary measures Treasury is taking to avoid breaching the nation’s debt limit.
Treasury generally sells between $5 billion and $12 billion of these securities each month, according to a March report by the Congressional Budget Office.
Treasury is also taking other measures. It has suspended contributions to the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund that are not immediately needed to pay beneficiaries. And it has stopped investments in the Government Securities Investment Fund (G Fund) of the Federal Employees' Retirement System.
State and local government series securities, referred to as SLGS, are non-marketable special purpose securities purchased by state and local governments to avoid violating federal arbitrage laws and regulations. Issuers most often use SLGS as alternatives to open-market Treasuries for advance refunding escrows as SLGS' maturities can be tailored to those of the bonds being refunded. But issuers can invest bond proceeds in them for other purposes as well.
The SLGS window was closed on March 15.
“We’d rather have the window open but so far we haven’t seen any significant problems,’’ said Thomas D. Vander Molen, a partner at Dorsey & Whitney in Minneapolis. “It is preferable and easier to be able to buy SLGS.’’
With Treasury rates well below muni rates for several years, the refund requirement hasn’t been a problem, say bond attorneys.
“Where the average bond yield is somewhere between 3% and 5% and the investments are barely breaking 1%, I hope that the IRS isn’t going to go looking in the bushes for arbitrage,’’ David A. Caprera, of counsel at Kutak Rock in Denver said in an email. “Because if they do, they might find Sean Spicer but they are unlikely to find any ill-gotten gains.’’
Linda Schakel, a former Treasury official and partner at Ballard Spahr here, said the suspension of SLGS sales has occurred “fairly regularly.’’
The SLGS window has been closed nine times since 1995, according to Treasury: October 18, 1995 to March 28, 1996; May 15 to July 7 in 2002; Feb. 19 to May 26 in 2003; Oct. 14 to Nov. 21 in 2004; Feb. 16 to March 16 in 2006; Sept. 27-28 in 2007; May 6 to Aug. 1 in 2011; Dec. 28, 2012 to Feb. 4 in 2013; and May 17 to Oct. 16 in 2013.
Bond attorneys say there’s been no significant disruption to the municipal bond market since the SLGS sales were suspended, but they would prefer a return to normal.
“Right now it’s just a bit of an inconvenience, but not a disaster,’’ Schakel said.
“It’s gone through pretty smoothly,’’ agreed Sam Gruer, managing director at Cityview Capital Solutions in Millburn, N.J. “There really has been no hiccup. There have been enough bidders.’’
Treasury’s arbitrage rules contain a safe harbor under which the department will not question the price of investments if the issuer, among other requirements, obtains at least three bids from disinterested investment providers.
Getting to back to normal is problematic because it will require both chambers of Congress and the Trump administration to strike a deal on the debt limit. Treasury Secretary Steven Mnuchin has said he wants Congress to raise the debt limit by the end of July. But Office of Management and Budget director Mick Mulvaney reportedly wants spending reforms included in any such measure.
Congress returns for legislative work next week with only a seven-week window to avoid rattling financial markets with the specter of a possible default.
Administration officials said they had until the fall to deal with the debt limit. But Congressional Budget Office estimates of lower-than-expected revenues may mean that date comes sooner. The CBO recently reported that receipts for the first seven months of fiscal year 2017 totaled $1.928 trillion, which was $60 billion to $70 billion less, or 3% smaller, than it had expected when it published its January 2017 report.
CBO will release its estimate of May tax revenues on June 7, giving lawmakers and investors a clearer picture on how soon a hike in the debt limit is needed to avoid a default.
