Pencil, paper, billion-dollar deals Low-tech bidding for Treasury debt under scrutiny

September 15, 1991|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK — New York--The gathering place is merely a corner in the lobby of a lower Manhattan building, though the building is hardly ordinary by the glass-and-steel standards of a modern financial hub. The low, block-long stone edifice, inspired by palazzos of great Italian banking families of the Renaissance, was built in the early 1920s as New York was emerging as a global financial power.

Furnishings in the corner are stark: a few dozen cubicles, phone jacks (without phones), a cabinet, and two common pressed-wood boxes, one dead center and another near a gate separating the corner from the rest of the lobby.

Despite such austerity and antiquity, this is the digestion point for the richest diet of money in the world. In this corner of the Federal Reserve Bank of New York, up to 90 percent of the trillions of dollars of debt annually issued by the U.S. government is sold.

Several times a week, the corner becomes crowded with representatives of a group known as primary dealers -- currently 39 banks and brokerage firms pledged to purchase the debt. Using pencil and paper and a pressed-wood deposit box, they provide the crucial bids that determine how much the federal government must pay on its massive borrowing.

In the wake of Salomon Brothers scandal, some have questioned whether a system relying on scribbled bids from such a small group of participants is still appropriate. Salomon, the Wall Street giant, forged customer orders to skirt limitations on how much of the bonds it could purchase, setting the stage for what, in essence, was price-fixing of government debt.

"It strikes me as absurd to have orders for purchases of billions of dollars of Treasury securities scribbled onto scraps of paper and stuffed into wooden boxes in the last seconds before an auction deadline," Sen. Donald W. Riegel Jr., D-Mich., complained last week in congressional hearings.

The system is "by no means state of the art," added Richard Breeden, chairman of the Securities and Exchange Commission. The SEC supervises almost all financial markets, with the notable exception of the Treasury market, which is under the joint supervision of the Treasury Department and the Federal Reserve system.

Proposals being broached in Congress concern broadening the number of direct bidders through the use of computerized ordering, and changing the auction system itself.

Others, however, defend a system considered for years to be above reproach. After all, until the Salomon episode, there has not even been a hint of scandal, in sharp contrast to the monthly announcements of improprieties stemming from the all-electronic market for stocks.

Moreover, the current auction process has allocated trillions of dollars worth of federal debt to global investors without prompting the precipitous interest rate shifts that a poor system could trigger.

In view of the Treasury's need to finance debt, and the Federal Reserve's desire to influence monetary policy, E. Gerald Corrigan, president of the New York Federal Reserve Bank, says there must be a finite group of private firms doing business directly with the government. And some large firms will pay a central role.

Today, bids are based on interest rates that firms are willing to accept. The firms willing to accept the lowest rates can buy the most debt from the government, limited only by a rule (which Salomon broke) stating no firm may purchase more than 35 percent of the securities offered at an auction. High bidders may receive only part of their order, or none.

The most frequently mentioned new bidding structure would be a "Dutch Auction," in which all the securities are sold at a single price high enough to satisfy the entire supply. This would theoretically hurt the seller -- the federal government -- by knocking out the lowest bids. But it could encourage the notion of a fairer, safer market, and thus prompt better prices in the long run.

The most radical change would be to decentralize the entire bidding process, by allowing orders to come in through a vast, computerized, network. Rather than 39 competitive bids, there might be thousands.

To see how different such an electronic market could be, contrast the prospect of flickering computer screens with the current system.

Typically, representatives for the primary dealers gather about noon on the day of an auction at their allotted space at the New York Fed.

From a locked cabinet they receive their own, special phones: odd-looking models lacking a dial. Plugging the phones into pre-assigned wall jacks with dedicated lines to home office trading floors, they begin grunted conversations to determine how many million dollars they should bid for, and how much they should pay.

Not bidding, or bidding ludicrous prices, is not permissible. And in this system, unlike many used throughout the financial markets, no computer can be switched, or telephone unplugged.

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