U.S. Treasury Seal
UNDER SECRETARY
DEPARTMENT OF THE TREASURY
                        WASHINGTON


                    November 3, 1997

The Honorable Fred Thompson
Chairman
Committee on Governmental Affairs
United States Senate
Washington, D.C. 20510

Dear Mr. Chairman:

This letter presents the views of the Department of the Treasury on S. 1296, the "Postal Financing Reform Act of 1997." S. 1296 would substantially alter the present financial relationship between the Postal Service and the Treasury. The Treasury recognizes the needs of the Postal Service for financing flexibility and has spent considerable effort since 1993 to create new customized financing vehicles to serve those needs. However, Treasury opposes the sweeping changes proposed by the bill because they would raise serious Federal financial policy concerns.

The purpose of the bill is to make "the relationship between the Treasury and the Postal Service similar to the relationship other government-sponsored enterprises such as Fannie Mae and Freddie Mac have with the Treasury." To that end, S. 1296 would permit the Postal Service to borrow, invest, and bank outside of the Treasury. We believe that the comparison of the Postal Service to Government-sponsored enterprises is flawed, however, since the Postal Service is an establishment in the Executive Branch; it is not a Government-sponsored enterprise with private shareholders.

S. 1296 would allow the Postal Service to borrow, invest and conduct banking relationships in more expensive ways than it presently does with the Treasury, and thus increase taxpayer exposure to loss from such Postal Service transactions, as well as increase the costs for customers of the Postal Service. These changes would also undermine the longstanding objectives of Congress and the Treasury to consolidate the financing of all Federal and federally assisted debt within the Treasury, reduce the cost of such financing, and effectively manage Government funds. As long as the Postal Service retains its public mission, its governmental status, and other special statutory benefits (such as being exempt from Federal and State taxes), Treasury believes that the Postal Service should continue to operate within the Federal financial system. Our specific concerns with the legislation are outlined below.

Borrowing

Under existing law, the Postal Service is authorized to borrow up to $15 billion, with fiscal year limits on the net increases in the amounts of obligations outstanding of $2 billion for capital improvements and $1 billion for operating expenses. The Postal Service is required to consult with the Treasury prior to issuing any debt, and Treasury has the right of first refusal to purchase such obligations. Treasury financing for the Postal Service is carried out exclusively by the Federal Financing Bank (FFB). FFB financing of the majority of Postal Service debt is at rates only 1/8th of 1 percent above market yields on Treasury securities of comparable maturity. We believe it is the least expensive, most efficient method of financing such debt.

S. 1296 would eliminate Treasury's right of first refusal and permit the Postal Service to borrow from the Treasury (with the approval of the Secretary) and/or in the market. The amount of any Postal Service loan from the Treasury would be determined by the Secretary and the Postal Service. However, the Postal Service's right to borrow in markets would not be subject to similar Treasury approval. Up to $2.5 billion of outstanding Postal Service obligations purchased by the Secretary could be exempted from the statutory maximum amount limitations on Postal Service debt obligations, if the Secretary and the Postal Service jointly determine that such an exemption is necessary. The bill would not prescribe the interest rate on Postal Service loans from the Treasury or other terms and conditions of the loans.

Treasury objects to the proposed elimination of the Treasury right of first refusal on Postal Service debt. We also object to the deletion of provisions regarding the determination by the Secretary of the interest rate on Postal Service loans from the Treasury. These provisions run counter to financial policies designed to provide cost effective financing for Federal and federally assisted programs, and to protect taxpayers from loss.

The policy that Federal entities borrow solely from the Treasury reflects important considerations. While Postal Service obligations are not explicitly backed by the full faith and credit of the United States, the market is likely to perceive such obligations to have an implicit Government guarantee.

Moreover, the proposed market borrowing authority would not, in our view, result in cost savings to the Postal Service. Despite the perceived Federal backing, we would expect that market interest rates on Postal Service obligations would be between 20 and 35 basis points higher than the rates on marketable Treasury securities of comparable maturity based on comparable financing in the current strong financing market.

While the proposed borrowing language contemplates that the Postal Service could borrow at the same time from both Treasury and in the market, longstanding Federal financial policies would preclude Postal Service borrowing from the Treasury once the Postal Service had borrowed in the market. Otherwise, the availability of borrowing from the Treasury would effectively serve as a Federal guarantee of timely payment of the market borrowing.

We believe that FFB financing of Postal Service obligations continues to be the least expensive, most efficient way to finance such debt and to serve the interests of both the Postal Service and taxpayers.

Investment

Under existing law, the Postal Service may request the Secretary of the Treasury to invest excess monies in the Postal Service Fund in obligations of, or guaranteed by, the Federal Government and, with approval of the Secretary, in such other obligations or securities as the Postal Service deems appropriate. S. 1296 would amend this authority to provide that the Postal Service may directly invest in obligations of, or guaranteed by, the Federal Government and in such other obligations or securities as the Postal Service deems appropriate, if such investment is closely related to Postal Service operations, as determined by the Board of Governors. We oppose this proposed change to Postal Service investment authority.

Pursuant to Treasury investment policy, at the request of a Federal entity, Treasury invests excess monies in public debt securities having maturities suitable to the needs of the entity, as determined by that entity, and bearing interest at rates determined by the Secretary of the Treasury, taking into consideration current yields on outstanding marketable Treasury securities of comparable maturity. Under this policy, the Treasury is in essentially the same position as if it had borrowed in the market and the investing agency is in essentially the same position as if it had invested in marketable Treasury securities.

To implement this policy, Treasury has designed market-based nonmarketable Treasury special issues that permit Government managers to invest directly with the Treasury in securities priced on the basis of outstanding Treasury securities in the market. Fund managers may select any marketable Treasury issue for purchase from (or sale back to) the Treasury at current market prices. The market-based special issue is Treasury's preferred vehicle for Government investment accounts and is used by approximately 150 Federal funds. Under this procedure, Federal entities are not charged transaction or account administration fees.

We are concerned that the proposed Postal Service market investments in Government securities could have a disruptive market impact if the Postal Service were to conduct large purchase or sale transactions in the Government securities market. The Treasury market-based nonmarketable special securities program was specifically designed to promote stability in the market by providing Federal entities with the ability to conduct large volume investments without a disruptive impact on the market. Elimination of Treasury's approval of Postal Service investments could reintroduce such instability.

The Department also opposes the proposed investment of Postal Service funds in Government-guaranteed obligations. These obligations do not provide the maximum safety, the wide range of maturities suitable to the needs of the investing entity, and facility for prompt redemption prior to maturity to meet emergency situations as direct Treasury securities provide. Also, unlike investment in Treasury securities, investment in guaranteed securities places the investing officer in the position of providing additional support and budget outlays beyond those provided in the budget for the program agency that guarantees the securities. To the extent Postal Service investments in Government-guaranteed securities were funded or carried out through Postal Service debt issued to the Federal Government, or perceived to be backed by the Federal Government, it would represent a "double dip" into Government subsidies.

S. 1296 would also allow the Postal Service - without Treasury approval - to invest in obligations or securities that are not Government-guaranteed, such as equities, which would be riskier investments than it currently makes. Investment in such obligations or securities without Treasury approval might significantly broaden the Postal Service's investment portfolio. As described above with regard to Government-guaranteed securities, these obligations or securities do not provide the maximum safety, the wide range of maturities suitable to the needs of the investing entity, and facility for prompt redemption prior to maturity to meet emergency situations as direct Treasury securities provide. So long as the Postal Service has authority to borrow from the Treasury, the risk of such investments is ultimately borne by taxpayers. This concern would be even greater if the Postal Service were permitted to fund its market investments with market borrowings perceived to be backed by the Federal Government.

The proposed investment of Postal Service funds in non-Government obligations, whether Government-guaranteed or not, would also increase Treasury borrowing from the public and would be recorded for budget purposes as an off-budget outlay, thereby increasing the total Federal deficit. Considering the potential size of Postal Service investments, the effect would not be insignificant.

The broad borrowing and investment discretion provided in S. 1296 would permit the Postal Service to borrow and invest to secure arbitrage profits. Such profits would be obtained when the Postal Service borrows and invests the proceeds of such borrowing at interest rates higher than the rates at which it borrows. As a matter of general policy, we believe that funds generated by Government programs supported by the credit of the United States should be invested exclusively in Treasury obligations. Government entities should not be able to borrow from the Treasury or in the market and invest so as to secure arbitrage profits. Such profits would allow the private users of services, such as postal services, to avoid paying the full cost of those services and would result in a hidden subsidy paid by taxpayers.

Banking

The Postal Service - like any other Federal entity - is required to deposit its receipts into the Treasury's General Account, which is maintained by the Federal Reserve. Treasury is required by law to credit all such deposits to the Postal Service Fund, and disbursements of the Postal Service are required to be made from the Fund. The Secretary of the Treasury must approve any deviation from this practice. S. 1296 would eliminate the Secretary's authority over Postal Service deposits and permit such deposits to be held outside of the Treasury.

The Department opposes the proposed Postal Service deposit authority. We believe that as a matter of sound Government fiscal policy, all Federal entities should bank within the Treasury, unless specifically authorized by the Secretary of the Treasury to do otherwise. The proposal to have the Postal Service bank in the private sector, yet have the flexibility to move its funds among the private sector, Federal Reserve Banks, and the Postal Service Fund at the Treasury, might be of financial benefit to the Postal Service, but would not serve the interests of the Government as a whole. Permitting the Postal Service to make outside deposits and move its funds in and out of the Postal Service Fund at the Treasury would undermine the Secretary's ability to manage the Government's cash balances and would increase Federal borrowing costs because Treasury would be required to replace any outside deposits made by the Postal Service with funds borrowed from the public. If other Federal entities were granted similar authority, the adverse consequences on Treasury's management of Government funds would be severe.

The Office of Management and Budget has advised that there is no objection from the standpoint of the Administration's program to the presentation of this report and that the enactment of S. 1296 would not be in accord with the program of the President.

Thank you for your consideration of Treasury views on this important issue. Please do not hesitate to contact me, if I can be of further assistance.