What Was a Certificate of Indebtedness?
Certificates of indebtedness were short-term coupon-bearing government securities once issued by the U.S. Treasury, which were replaced by Treasury bills (T-bills) in 1934.
A certificate of indebtedness was something of an "IOU" from the U.S. government, promising certificate holders a return of their funds with a fixed coupon, much like any other type of U.S. Treasury security.
- Certificates of Indebtedness preceded T-Bills, acting as “IOUs” issued by the U.S. government.
- Investors in the certificates could go back to the bank where it was purchased and liquidate the securities for cash.
- Certificates were sold at par and paid fixed coupons, whereas T-Bills are sold at a discount to par, and return par value to investors.
- CDs, bond certificates, promissory notes, etc. are all modern forms of certificates of indebtedness.
Understanding Certificates of Indebtedness
To ease fluctuations in government balances at the Federal Reserve banks, the U.S. Treasury raised money in smaller amounts—several hundred million dollars at a time—by issuing certificates of indebtedness that could be used later to satisfy tax liabilities or to fund bond subscription payments.
Certificates of indebtedness were first introduced around the Civil War. The Act of March 1, 1862, allowed for the creation of certificates that paid 6% interest, were no less than $1,000, and payable in a year or less. These were called "Treasury Notes" but also "certificates of indebtedness" to mark the difference between these and demand notes. Later, certificates of indebtedness were issued during the Panic of 1907, in $50 denominations. These served as backing for the rise in banknotes in circulation.
The short-term certificates were used to finance World War I and were issued monthly, and sometimes, bi-weekly. Treasury officials set the coupon rate on a new issue and then offered it to investors at a price of par. An investor who wanted to liquidate their certificate would go back to the bank where they bought them and ask the bank to repurchase the securities.
Certificates of indebtedness were used to bridge periods of budget gaps, including the financing of World War I.
In modern terms, a certificate of indebtedness is generally used to refer to a written promise to repay debt. Fixed income securities such as certificates of deposit (CDs), promissory notes, bond certificates, floaters, etc. are all referred to as certificates of indebtedness as they are forms of obligation issued by a government or corporate entity, giving the holder a claim to the un-pledged assets of the issuer.
Certificates of Indebtedness vs. T-Bills
When Treasury officials expanded Treasury bill issuance in 1934, they simultaneously stopped offering certificates of indebtedness. By the end of 1934, T-bills were the short-term instruments of Treasury debt management. Unlike Treasury bills, which are sold at a discount and mature at par value without a coupon payment, certificates of indebtedness offered fixed coupon payments. Certificates of indebtedness typically matured in one year or less, much like the T-bills and notes that succeeded the now-defunct certificates.
There are still zero-percent certificates of indebtedness, which are non-interest-bearing securities. These securities have a one-day maturity and are automatically rolled over until redemption is requested. These securities serve one purpose: They are meant to serve as a way to build funds in order to purchase another security from the Treasury.