Time to Open The Treasury's Auction Club?

nitro · Mar 27, 2008

Please comment on this old article. Is it still relevant?

http://query.nytimes.com/gst/fullpage.html?res=9D0CE7D9143CF93BA3575AC0A967958260

MARKET WATCH; Time to Open The Treasury's Auction Club?

By DIANA B. HENRIQUES
Published: September 8, 1991

The Federal Government has always depended upon rich and powerful men to help it make ends meet. For the past two centuries, the plutocratic assistance has been provided by the likes of John Jacob Astor and J. P. Morgan and, of course, Jay Cooke, the legendary banker and devout abolitionist who almost singlehandedly sold the Treasury bonds that financed the Civil War.

Today, the rich and powerful men on which the Government relies are the usually obscure executives of the 39 firms known as "primary dealers," the firms through which the Federal Reserve Bank of New York buys and sells Treasury securities to adjust the nation's money supply. The Fed also requires primary dealers to bid regularly at Treasury auctions and to make a market in Treasury debt. In return, the primary dealers are the only institutions, besides banks, that are allowed to submit auction bids on behalf of other investors -- and thus, they can spy out market trends and attract new customers seeking their guidance.

This vague but apparently valuable "franchise" is coming under intense scrutiny in the wake of disclosures that executives at Salomon Brothers, a primary dealer, submitted phony customer bids to circumvent Treasury limits on how much each bidder can purchase.

Some critics ask why auction bids should be channeled through this club at all. Richard Sylla, an economic historian at New York University, said the system offers some protection in that the Treasury will not lack for bidders -- a comfort, given the projected growth in Federal deficits in the next few years. No one can be forced to remain a primary dealer, however, so the assurance is hardly ironclad. "And the disadvantage," said Professor Sylla, "is that the Government is, in effect, sponsoring a cartel."

Jacob Dreyer, chief economist for the Investment Company Institute, also questioned "whether the market would not be better served if there were more bidders" -- the nation's mutual funds, for example.

E. Gerald Corrigan, president of the New York Fed, explained at Congressional hearings last week that the Fed simply cannot do business with everyone when it needs to adjust the money supply. That, he added, "necessarily implies that some will be chosen and some will not." But it is not clear why those chosen to handle the Fed's money-modulating business should, ex officio, get the right to play a privileged role at Treasury auctions.

In the distant past, as Professor Sylla noted, the Government turned to tycoons to sell its debt because it could not find buyers otherwise. But the perverse lesson of the Salomon case is that demand for Treasury securities debt is so strong today that people are breaking the rules to buy more of them. "It does strike me as a little funny," said Professor Sylla. "In a global financial system, perhaps it just doesn't make sense to limit the bidding anymore."
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Time to Open The Treasury's Auction Club?

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