By the end of World War I, the U.S. had run up a national debt of about $27 billion. To put that number in context, consider that the debt in 1914 was under $3 billion. Factor in the burdens of a war surtax placed on American incomes by President Woodrow Wilson and a personal income tax rate of up to 73%, and it's clear that 1920 was a bleak year for the U.S. economy.
The U.S. couldn't pay down its debt through sales of Liberty and Victory bonds and short-term debt instruments called certificates of indebtedness. In addition, the Treasury could not pay out more in Treasury interest than it received through income taxes, especially when the public wanted those rates reduced.
This is what led to the first T-bill auction in 1929.
President Warren Harding signed the Revenue Act of 1921 and reduced the top income tax rate from 73 to 58%, coupled with a small reduction of the surtax on incomes. The bill also raised capital gains taxes from 10 to 12.5%. With overall revenue reduced, the Treasury was forced into a serious debt-management mode, especially in the short term.
During the war years, the government issued short-term, monthly, and bi-weekly subscriptions of certificates of indebtedness that had maturities of one year or less. By the war's end in 1919, the outstanding amount of the federal debt exceeded what could comfortably be repaid.
The Treasury set the coupon rate at a fixed price and sold the certificates at par value. The coupon rates were set just above money market rates. Institutions over-subscribed to these investment options. The government was paying out money from surpluses, not knowing what the surplus would be or even if one would exist.
The Birth of T-Bills
The U.S. Treasury didn't have the authority to change government financial structures or introduce new ones. So, formal legislation was signed by President Herbert Hoover to incorporate a new security with new market arrangements.
Zero-coupon bonds were proposed with up to one-year maturities, to be issued at a discount from face value. Zero-coupon bonds would come to be known as Treasury bills due to their short-term nature.
The legislation changed the Treasury's fixed-price subscription offerings to an auction system based on competitive bids in order to ensure the lowest market rates. All deals would be settled in cash, and the government would be allowed to sell T-bills when funds were needed.
During the first offering, at the end of 1929, the U.S. Treasury offered the first of its issues of 13-week bills.
The government now had a way to obtain cheap money to finance its operations.
By 1930, the government sold bills at auctions in the second month of every quarter to limit borrowings and reduce interest costs. All four auctions in 1930 saw buyers refinance with newer bills.
By 1934, and due to the success of past bill auctions, certificates of indebtedness were eliminated. By the end of 1934, T-bills were the only short-term finance mechanisms for the government.
In 1935, President Franklin Delano Roosevelt signed the Baby Bonds Bill that would later allow the government to issue Series HH, EE, and I bonds as other mechanisms to finance its operations.
Today, the U.S. Government holds market auctions every Monday or as scheduled. Four-week, 28-day T-bills are auctioned every month; 13-week, 91-day T-bills are auctioned every three months; 26-week, 182-day T-Bills are auctioned every six months.
The Bottom Line
The debate over whether debt should or could be transferred to future generations ended in the 1920s as the government, through skilled debt management, produced a continuous surplus. Despite early and persistent problems of over-subscriptions and inconsistent pricing mechanisms of fixed price offerings, the government still managed to finance its needs.
A number of financial problems were eliminated when the T-Bill system was created. That market today is one of the largest in the world, and some investors are even able to buy Treasuries directly from the Fed.