Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / Why Governments Borrow Trillions at Auction Like Clockwork
Transcript
- Lucas: Every Wednesday morning at 11:30 Eastern, the U.S. Treasury does something remarkably consistent: it sells somewhere between 40 and 60 billion dollars worth of debt. And it does so through an auction process that hasn't fundamentally changed since the early 1990s. Luna: I think most people imagine the Treasury just prints a bond, puts it on a shelf, and waits for a buyer. But the actual process is way more structured — and surprisingly transparent. Lucas: It really is. The Treasury publishes a quarterly refunding schedule months in advance. Investors know exactly when the 10-year note is coming, the 30-year bond, the 2-year note. There's no surprise supply. And on auction day, the system runs like a clock. Luna: Before we get into the mechanics, I want to mention something. This show doesn't run ads. We deliberately keep it ad-free because we think this kind of public finance conversation shouldn't be interrupted by commercials. Lucas: Yeah, that's a choice we're proud of. And if that matters to you, you can support the show at buy me a coffee dot com slash fexingo. It's a simple way to keep this going without any sponsors. Luna: Exactly. And now back to those auctions — because the way the Treasury actually prices debt is fascinating. Lucas: So the Treasury uses what's called a single-price auction. Every winning bidder pays the same price — the highest yield that clears the auction. It's not like an art auction where each buyer pays their own bid. Luna: Right. And that matters because it encourages bidders to bid aggressively. If you know you'll pay the clearing price anyway, you're incentivized to bid low — meaning you accept a higher yield — rather than trying to game the system. Lucas: Exactly. And the bids come in two flavors: competitive and noncompetitive. Noncompetitive bidders — usually small investors — agree to accept whatever yield is set at the auction. They get filled first. Competitive bidders are the big players — primary dealers, hedge funds, pension funds — and they specify the yield they're willing to accept. Luna: How many noncompetitive bids do they actually get? Is that a meaningful part of the auction? Lucas: It's tiny. For a 10-year note reopening, noncompetitive bids might total 50 to 100 million dollars. The overall auction is 40 billion. So the noncompetitive share is less than a quarter of a percent. But it's a symbol — the Treasury wants to signal that the little guy can participate. Luna: And then the competitive bids are ranked from lowest yield to highest. The Treasury starts filling from the low end until the entire offering is subscribed. The highest yield that still gets filled becomes the clearing yield. Everyone pays that yield. Lucas: Right. And there's a key number that tells you how healthy the auction is: the bid to cover ratio. That's total bids divided by total amount offered. A ratio above 2.5 is considered strong. Below 2.0 and people start worrying about demand. Luna: Let's use a concrete example. In October 2024, the Treasury reopened the 10-year note for 40 billion dollars. The bid to cover ratio was 2.6. That meant bidders submitted about 104 billion dollars in bids for those 40 billion in securities. Lucas: And the high yield was 4.14 percent. That became the yield for every winning bidder — including those noncompetitive bidders who didn't specify a yield. So a retail investor who put in a noncompetitive bid got the same 4.14 percent that a primary dealer got. Luna: But here's the question that always bugs me: is this process really fair? Or are the primary dealers — the 24 big banks that are required to bid — essentially rigging it behind the scenes? Lucas: That's a fair question. Primary dealers are required to participate in every auction and to make markets in Treasury securities. But they're also the ones with the most information. They see order flow from clients. They know where demand is. Some critics argue that gives them an edge. Luna: Especially because the Treasury releases the results within minutes — the yield, the bid to cover, the share awarded to primary dealers versus direct bidders and indirect bidders. But those are just aggregate numbers. The individual bids are anonymous. Lucas: Right. And the Treasury has rules: a single bidder cannot win more than 35 percent of the offering. That prevents any one player from cornering the market. But in practice, the primary dealers as a group win around 50 to 60 percent of each auction. Direct bidders — like hedge funds — get maybe 10 to 15 percent. Indirect bidders — foreign central banks, for example — get the rest. Luna: So the process is transparent on the surface, but the big banks still have a structural advantage. They know the plumbing better than anyone. Lucas: That's true. But the single-price auction design does mitigate some of that. Because every winning bidder pays the same yield, there's no penalty for being aggressive. A small pension fund that bids a yield just above the clearing yield doesn't get punished for being conservative. Luna: And the Treasury also runs a parallel system for cash management bills — very short-term debt, sometimes just a few days. Those are sold through a different process, often a competitive auction with a minimum bid amount. Lucas: Yes. And then there's the Treasury's liquidity futures program, which allows primary dealers to pre-sell securities they haven't won yet. That's a whole other layer of complexity. But the core auction — the one that funds the government's borrowing needs — is remarkably stable. Luna: So when you hear that the Treasury is issuing a 30-year bond with a bid to cover of 2.4, you know the auction went fine. When that ratio drops below 2.0, that's a signal that demand is weak — maybe because yields are too low relative to investor expectations. Lucas: And sometimes the Treasury has to accept a higher yield than expected. In March 2020, during the pandemic panic, the 10-year auction had a bid to cover of 2.3, but the yield was 0.85 percent — and the market still struggled. The Fed had to step in with massive purchases. Luna: That's the exception, though. For the most part, the auction system works because it's boring and predictable. The Treasury announces, bids come in, the result is published. Repeat next week. Lucas: And it's not just the U.S. Other countries use similar models. Germany uses a single-price auction for its Bunds. Japan uses a multiple-price auction for JGBs — where each bidder pays their own price. But the U.S. system is the most watched and most imitated. Luna: I think the key takeaway is that the government's borrowing isn't mysterious. It's a public, transparent auction. Every Wednesday, we know exactly how much the Treasury is borrowing and at what cost. That's a level of transparency most people don't realize exists. Lucas: And that transparency is part of what makes U.S. Treasury debt the global risk-free asset. Investors trust the process. They know the auction isn't rigged — at least not in any obvious way. And they know the U.S. will pay its debts because it can always borrow more. Luna: So next time you hear about the government hitting the debt ceiling, remember that the actual borrowing happens every single week in a very systematic way. The drama is political. The mechanics are routine. Lucas: And that routine is what keeps the global financial system running. Without it, there's no benchmark yield curve, no repo market, no liquidity for pension funds and money market funds. It's the plumbing nobody sees — until it breaks.