Are Treasury Receipts Backed by the Government?

Treasury Receipts are financial products designed to provide investors with specific cash flows derived from underlying U.S. Treasury bonds. Understanding how these receipts function and the nature of their government backing is important for assessing their security.

Understanding Treasury Receipts

Treasury Receipts are financial instruments representing claims on the individual principal and interest payments of an underlying U.S. Treasury bond. These instruments are created by “stripping” a standard Treasury bond into its separate components. For example, a 10-year Treasury bond paying interest semi-annually would generate 20 separate interest payments and one principal payment, each of which can be sold as an individual Treasury Receipt.

There are two primary forms of these stripped securities. U.S. Treasury STRIPS (Separate Trading of Registered Interest and Principal Securities) are directly issued by the U.S. Department of the Treasury. In contrast, “custom” or “synthetic” Treasury Receipts are created by financial institutions, such as investment banks, which purchase a Treasury bond and then separate its cash flows to sell them as individual receipts. While both types derive their value from underlying Treasury securities, their creation and direct issuer differ.

The Nature of U.S. Government Backing

The concept of “U.S. government backing” refers to the explicit guarantee provided by the United States government for its debt obligations. This guarantee is commonly known as the “full faith and credit” of the U.S. government. It signifies that the government pledges its entire creditworthiness and taxing power to ensure that all its financial obligations, including U.S. Treasury bonds, notes, and bills, will be paid.

This commitment means that the likelihood of the U.S. government defaulting on its direct debt is considered extremely low. Investors perceive direct Treasury securities as having minimal credit risk due to this backing. The full faith and credit pledge applies directly to the original issuance of debt by the Treasury.

How Treasury Receipts are Backed

The backing of Treasury Receipts ultimately stems from the U.S. government’s full faith and credit, but the directness of this backing depends on the type of receipt. For U.S. Treasury STRIPS, which are direct obligations created and issued by the Treasury Department, the full faith and credit pledge applies directly. This means STRIPS carry the same high level of security as the original, unstripped Treasury bond from which they were derived. Holders of STRIPS are direct creditors of the U.S. government.

For custom or synthetic Treasury Receipts, the situation involves an intermediary. While the underlying payments for these receipts originate from a U.S. government bond backed by its full faith and credit, the receipt itself is typically an obligation of the financial institution that created and sold it. However, to secure these receipts, the creating institution generally holds the underlying U.S. Treasury securities in a segregated account or trust. This arrangement ensures that the government’s payments, when received by the institution, are then passed through to the receipt holder.

Structural Implications for Investors

For custom Treasury Receipts, the underlying U.S. Treasury securities are typically held in a trust or a segregated custodial account by the financial institution that created the receipts. This custodial arrangement is designed to protect the receipt holder, as it aims to ensure that even if the creating institution faces financial difficulties, the underlying government securities remain available to meet the payment obligations to the receipt holders.

While the ultimate source of payments is the U.S. government, the investor’s direct administrative relationship is with this intermediary. Furthermore, the market for custom Treasury Receipts may sometimes exhibit different liquidity characteristics compared to the market for direct, unstripped Treasury securities or even Treasury STRIPS. This can be due to the specific terms of the custom receipts or the depth of their secondary market. Despite these structural nuances, the principal and interest payments ultimately flow from the underlying U.S. Treasury security, which remains backed by the full faith and credit of the U.S. government.