Overhaul of Treasury Auction System Coming
The Treasury auction process is due for an overhaul since the revelations that Salomon Bros., one of the biggest players in the market, violated the rules and may have artificially affected bond prices.
The changes, some of which were contemplated before the Salomon scandal, would set up rules and procedures similar to those that govern other types of investment.
By and large, the Treasury market has been less automated and less closely supervised than other public debt and equity markets because, until recently, there apparently were few abuses.
Government regulators also believe that manipulation of the Treasury bond market is easy to spot. That’s because there is little disagreement about the risks of Treasury securities, so yields, essentially, should fall in line with interest rate expectations.
If yields are substantially different from what could be expected by looking at similar bonds with different maturities, regulators should quickly know that something is amiss, said Jerome H. Powell, an assistant secretary of the Treasury who is in charge of domestic finance.
Yet Salomon Bros., which has admitted violating the rules at several Treasury auctions, has shown that the system is not perfect.
The Treasury is contemplating changing the auction process by adding automation, certifying large customer orders and, perhaps, conducting “Dutch auctions” to make the system more fair.
Brokers would also be subject to rules about sales practices similar to those of municipal and corporate debt markets.
Such changes probably will have relatively minor impact on individual consumers, Powell said. Most bond brokers are honest, and prices, even when manipulated, tend to change by tiny fractions that would hardly be noticed by the average investor. It might be the difference between a 7.07% rate of return and a 7.09% rate.
Even tiny moves in the Treasury market are of paramount importance to the U.S. government and the taxpayers, however. In these days of $3-trillion deficits, a one basis-point uptick (0.01 percentage point) in bond prices costs the government $250 million in interest each year, Powell said in congressional testimony. That eventually means higher taxes or reduced government services.
In other words, any change that decreases the chance of abuse and increases competition for Treasury bills could have both negative and positive impacts on investors--Treasury yields could fall, but investors may find a more stable and honest market. Meanwhile, there could be a substantial positive effect for anyone who pays taxes.
The proposed changes:
* A move toward automated bidding is being considered. Right now, investment houses participating in Treasury auctions must send representatives, on foot or by subway, to the Federal Reserve Bank in Manhattan to submit their companies’ bids on auction days. Bids are time-stamped and dropped into a box. Anyone who misses the 1 p.m. deadline is disqualified. Automation of this process could be expected to make it easier for thousands of smaller financial institutions to join in the bidding.
A direct attack on abuses is already under way. Federal Reserve banks have started to spot-check large customer orders to make sure they are legitimate. (Salomon subverted the system by making unauthorized bids, supposedly on behalf of the firm’s customers. The phony bids allowed Salomon to buy more than a fair share of several Treasury offerings.)
* Finally, the Treasury is considering uniform price auctions, or Dutch auctions, in which all players submit sealed bids and the seller--in this case, the Treasury--determines which bids to accept. All buyers then pay the lowest of the accepted prices. (In a bond auction, that would mean everyone would receive the highest yield.)
Some believe that this could cost the Treasury money because the current process allows some disparity in prices--i.e., some buyers pay more. Some believe that buyers submit higher bids in Dutch auctions to ensure that they get securities, so it is unclear whether buyers or the Treasury would get the better of this deal.
* The Treasury also wants to adopt rules on sales practices similar to those of municipal and corporate securities markets. Although regulators believe that few Treasury brokers abuse the system, Powell said it would make sense to head off potential problems.
* Last, there is some promise of expanded disclosure and access to government securities price information. That should help bond buyers by making it easier to determine actual or potential prices, especially for inactively traded issues, and to evaluate trades proposed by a broker or dealer.