New York -- Standing before senior officials of the Federal Reserve Board, the Treasury and the Securities and Exchange Commission last week, an indignant Sen. Donald W. Riegle Jr., ** D-Mich., thundered, "The cozy relationship between the primary dealers and their regulators must be thoroughly examined and, I believe, ended."
Being one of the 39 dealers permitted by the Federal Reserve Bank of New York to bid directly on U.S. government securities has been likened to being a member of an exclusive club.
But if so, it is a club many shun joining -- and others leap to get out of. Of the 18 original primary dealers who signed on in 1960 when the current system was constituted, only nine continue to be involved in the market, and many of those have changed hands and substantially restructured.
The Bank of New York, the nation's oldest bank, became the first issuer of debt for the federal treasury when its founder, Alexander Hamilton, became Washington's Treasury Secretary. But it not only declined to enter the market in recent years, but also quickly dumped a government securities operation acquired along with Irving Bank in 1988.
Still, Salomon Brothers Inc.'s admission that it cornered a small segment of the treasury market has led to intense scrutiny of the primary dealers. They are the small group of financial firms responsible for marketing the nation's vast debt.
Buying securities directly from the federal government -- the right and obligation of primary dealers -- carries prestige. And for some firms, it can be highly profitable.
Salomon has not disclosed its earnings from the treasury market, but various estimates have pegged the number to be well in excess of $100 million.
Partly because of the potential for direct profits, and, more important, because of the growing interest in global investment, primary dealership status has been sought by foreign investment firms. In recent years, the only new entrants into the market have been based abroad: Barclays Bank of Great Britain and Union Bank of Switzerland in 1989, and Swiss Bank Corp and Germany's Deutche Bank in 1990.
Overall, however, the number of primary dealers has been shrinking from its peak of 46 in 1988.
Several firms have recoiled from the Fed's requirement that each primary dealers must conduct about 1 percent of the overall volume in the market -- a staggering number given the market's daily turnover of about $111.2 billion.
Four banks gave up their franchises in 1989, another five in 1990, and two this year (Security Pacific Bank and Continental Bank). According to the New York Federal Reserve Bank, all have given identical reasons -- unwillingness to commit the vast amount of capital required for participation, in view of the high risks and the potential for profit.
Market share numbers are not revealed but overall earnings dating back to 1987 were informally disclosed by the Fed at a meeting of an industry trade group. In 1987, pre-tax profits were $600 million but that declined to $300 million in 1988, and the dealers lost $10 million in 1989.
Last year there was a cumulative profit of $800 million. Still, according to the New York Fed, the results were unevenly spread. Some 30 percent of the participants were unprofitable.
"If you look at the frequency these firms lose money you wouldn't think it was such an elite club," said E. Gerald Corrigan, president of the New York Fed.