Fed Averts Fight With Japan Over Securities Trading

The Federal Reserve Board said Monday that Japanese companies may continue operating as dealers in the lucrative primary market for U.S. government securities.

The long-awaited Fed ruling averted a major confrontation between the United States and Japan over the fast-growing business of financial services. American firms had complained of being excluded from the tightknit financial market in Tokyo devoted to handling Japanese government securities.

The Fed could have retaliated against Japanese companies under a law regulating primary dealers, the 42 firms that buy and sell billions of dollars worth of Treasury securities in direct dealings with the Federal Reserve itself. Seven Japanese firms belong to the exclusive list of primary dealers. The federal legislation says a foreign firm cannot act as a primary dealer in the United States if its home country discriminates against American firms.

Shaping Economic Policy

The Fed voted 5 to 1 to accept a staff report asserting that there has been “much progress” by the Japanese in opening their securities market. “The structure of the market now compares favorably with the state of development in other industrial countries, and the actions that have been taken in recent years to open the market are substantial,” the staff report said.

The question of opening financial markets has a significance beyond the narrow issue of how to handle dealers in government securities. American policy makers and members of Congress are worried that the United States could suffer an erosion in financial markets and services just as it lost ground to Japanese incursions in the field of manufactured goods and industrial products. The Fed’s action Monday in accepting the staff report deferred any immediate conflict between the United States and Japan over financial issues.

Japanese firms will continue unhindered as highly visible participants in the primary market for U.S. government securities, the system used by the Fed in efforts to shape economic policy.

Act as Wholesalers

The Fed buys and sells Treasury securities in huge volumes. When the Fed wants to increase the supply of money, it buys securities, injecting more funds into the economy. When it seeks to slow activity, it sells Treasury securities to help sop up funds.

The primary dealers doing business with the Fed act, in effect, as wholesalers, distributing the U.S. government securities to banks and other customers. Foreign firms’ participation is widespread, with 13 companies from abroad among the 42 dealers working with the Fed.

In Japan, by contrast, the government traditionally sold all of its 10-year bonds through an underwriting syndicate overwhelmingly dominated by Japanese financial institutions, the staff report said. In April, however, Japan opened the process, permitting 40% of the bonds to be sold through a competitive auction open to all bidders, including American companies.

The other 60% are still sold through the Japanese syndicate, but its members must pay the competitive auction price. Therefore, “the pricing of almost all new issues of government debt now is established directly or indirectly by competitive bidding,” the Fed staff said. “So far, these auctions of 10-year bonds appear to have been handled in a fair manner with respect to foreign firms.”

One Dissenter

Also, the Tokyo syndicate handling 60% of the bonds is admitting more foreign firms as members--now 71 out of a total of 824. The foreign firms within the syndicate have increased their share of its activities, handling 8% of the business in October, 1988, compared to 1% in 1986.

These improvements cited by the Fed staff contributed to the board’s decision to allow the Japanese firms to continue operating as primary dealers in this country without any penalties or restrictions. Although the Fed refused to move against the Japanese firms, “this doesn’t mean that this issue is complete,” Federal Reserve Vice Chairman Manuel Johnson said. “We still have a ways to go toward the evolution of a more efficient international financial system.”

The lone dissenter at Monday’s meeting, Fed member Martha Seger, said the improvement by the Japanese was not sufficient. The federal law requires Japan to offer “the same competitive opportunities” as are available in the United States, she said.

The staff report said the Fed should keep the pressure on Japan. The staff suggested that, “given the global importance of Japanese financial markets, Federal Reserve officials continue to take every opportunity to urge Japan to liberalize its markets further and to improve further the openness of competition among market participants.”