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Treasury-Federal Reserve Study of
the U. S. Government Securities Market

THE CHANGING STRUCTURE OF THE DEALER MARKET IN
GOVERNMENT SECURITIES

Staff study prepared by
Paul Meek
Assistant Vice President
Federal Reserve Bank of New York
August 1967

THE
FEDERAL
RESERVE
RANK of
SE LOUIS

Research Library

TABLE OF CONTENTS

Page
1. Introduction

2. The Dealer Market in 1966

3. Changes in the Financial Environment
a. The further development of the money market
b. The increasing professionalism of customers
of the Government securities market
4. Changes in the Dealer Community, 1961-66
a. The
new dealers
b.
Changing
shares of trading activity
c. The broadening of dealer activities
5. Changes in Dealer Performance as Underwriters of
Treasury Offerings
a. Treasury bill offerings
b. Regular exchange offerings
c. Advance refundings
6. Dealer Financing
a. The nonbank dealers
b. The bank dealers
c. Dealer financing and market performance
7. Structural Change and Market Performance

10
10
13
IT
17
18
21
25
26
28
35
38
38
44
46
47

1. Introduction
The years 1961-66 were years of change in the dealer market for
Government securities. New dealers, both nonbank firms and bank dealer departments, entered the industry and a few nonbank firms withdrew. The net effect
was to increase competition in an already highly competitive industry. In
addition, banks and other investors became more active in trading Government
securities for short-term gains and in taking speculative positions in new
Treasury issues--in part, because of the diminished risks characteristic of
the steadier interest rate environment that accompanied the balanced economic
expansion from 1961 to mid-1965. Despite a substantial increase in the volume
of aggregate transactions in Government and Federal agency securities, the
dealers became increasingly concerned during the 1961-65 interval whether the
profits being earned were adequate to justify existing commitments of capital
and specialized personnel in the industry.-*- At the same time some observers
questioned whether the increased participation of banks as primary dealers
might not lead to a withdrawal of nonbank dealers. This, it was said, would
impair the ability of the dealer market to function under adverse conditions
in intermediate- and longer term issues, in which trading risks are greatest
and the bank dealers are least active.
The present paper is concerned first, with the changing composition
of the dealer community and its adaptation to environmental changes over the
interval, 1961 to mid-1965, and secondly, with the functioning of the dealer
market subsequently as the monetary-fiscal policy mix used to deal with an overheating economy imposed heavy strains on financial markets. Broadly speaking,
the dealer market handled an expanding volume of trading activity on generally

1. The question of dealer profitability is the subject of another paper.
William G. Colby, "Dealer Profits and Capital Availability in the U. S.
Government Securities Industry, 1955-1965

2
diminishing trading margins over the balanced phase of the economic expansion.
It seems probable that this enhanced the ability of the Treasury to float its
issues, of the Federal Reserve to carry out open market operations, and of private investors to utilize the market to serve their liquidity and investment
requirements. As was to be expected, once imbalances began to develop in the
economy and in financial markets, the dealers experienced growing difficulty in
maintaining orderly and smoothly functioning markets, particularly in
intermediate- and long- term securities. As expectations in 1966 became more
volatile and then progressively more apprehensive about the impact of current
and prospective demands on financial markets, many dealers and trading participants that had contributed to the resiliency of the market earlier practically
withdrew from participating except in Treasury bills. Even here participation
dropped sharply. Thus, the functioning of the Government securities market outside the short-term area came to depend increasingly upon only a few dealers,
principally the large nonbank dealers, who continued to make markets in all maturities, albeit on a reduced scale. Investors experienced a notable deterioration in the market's capacity to bid for Treasury securities in any volume even
at prices significantly below quoted markets.
The deterioration in the market's performance in 1966 appears to be
explainable on purely cyclical grounds•

It seems doubtful that structural

changes within the dealer industry from 1961 through mid-1965--e.g. the entry
of new bank and nonbank dealers--contributed importantly to the result. The
very heavy use of borrowed money characteristic of the industry encourages a
large volume of stabilizing speculation when risks of loss are small or moderate, but makes the conservation of capital a dominant consideration for most
participants when such risks become large.

3
This kind of market mechanism serves effectively in transmitting the
effects of monetary policy to the economy. Official moves toward either stimulation or restraint are transmitted very rapidly through financial markets as
Government securities dealers seek to raise or lower their positions by large
amounts and as their capacity for making effective markets varies. Thus, the
deterioration in that capacity in 1966 reduced the shiftability of intermediateand long- term Government securities, contributed to the rise in interest rates,
and helped restrict the availability of credit to finance spending.
There is some risk as well in relying on a dealer mechanism so heavily
dependent on borrowed money--the risk that the capital of the industry may be so
impaired or threatened-by falling prices that dealers will hardly make bids at
all for long - term securities. Such a development affecting financial markets
could conceivably lead to defaults by financial institutions or other debt
holders unable to meet unforeseen cash drains and these defaults could escalate
into a general financial crisis. It would appear that the Treasury and Federal
Reserve System have a real interest in seeing that the Government securities
market, in particular--and possibly other debt markets as well--do not cease to
function in periods of restraint. This question, however, is beyond the scope
of the present paper.
The present study describes briefly the nature of the dealer market
for Government securities and examines recent changes in the financial environment within which the dealers function--specifically the further development of
the money market and the increased professionalism of customers. Then, the paper
reviews the changing share of various dealers and dealer groupings in market
activity over the interval, 1961 to mid-1965^ detailing the reduced share of the
larger dealers and the rising share of bank dealers. A selective analysis is
made of the performance of dealers as underwriters in Treasury bill auctions and

4
in the Treasury's exchange refundings with attention focussed primarily on the
same interval. The study then takes up the financing of dealers1 positions,
examining inter alia how monetary restraint makes dealer financing more expensive and difficult to obtain and thereby makes for thinner and more volatile
markets. Finally, the paper examines the marked change in the relative performance of dealers in the first half of 1966, a development that underscored the
dependence of customers in that period on a few core dealers for markets in
intermediate- and long-term Government securities. As the reader will recognize, the form and content of the study are conditioned in some degree by the
author's continuing responsibilities at the Trading Desk of the Federal Reserve
Bank of New York.
2. The Dealer Market in 1966
In 1966 there were 20 primary dealers

that were making markets in

Government securities and doing business with the Federal Reserve Bank of New
York. Each of these dealers bought and sold Government securities as a
principal--that is, for his own account, undertaking the risks of loss and
possibilities of gain that are implicit in owning outright the marketable debt
obligations of the United States Government.

(Like any other marketable obli-

gation, these securities are subject to fluctuations in price with changes in
economic conditions and investor expectations.) Taken together, the dealers
provide a secondary market for Government securities that is unequalled elsewhere in the world in the size of transactions it will accommodate or the narrowness of the spreads between bid and offer prices at which business can be
done.
The availability of this market, and the absence of credit risk in
the obligations in which it deals, have given short-term Treasury obligations
a ready marketability that has made them a preferred liquidity reserve for many.

Domestic banks and other financial institutions, nonfinancial corporations, state
and local government agencies, and other economic units hold Treasury bills, in
particular, for both the income and the liquidity they provide. Foreign central
banks and international institutions find Treasury bills an ideal medium for
holding their international reserves. Marketability and prime quality have also
enhanced the attractiveness of intermediate- and long-term Treasury obligations
to various investors. The excellence of the secondary market facilitates both
the open market operations of the Federal Reserve System and the Treasury's
management of the national debt.
The dealers that make up the market are a varied group. Eight are
dealer departments of commercial banks and twelve are nonbank firms. All contact
customers throughout the United States by phone and many of the nonbank dealers
maintain regional offices. On a day-to-day basis the bank dealers normally operate quite independently of the investment or municipal bond underwriting operations of their banks. In fact, they tend to be more closely allied to the
management of the bank's reserve position, which can be affected considerably by
their operations. The bank dealers seek to service bank customers and to develop
customers of their own, and to do so profitably, but the strategies pursued, and
the risks run, vary considerably from bank to banko
The nonbank dealers are even more diverse. Four that loom large in
the Government securities business are departments of large firms that are also
major underwriters of corporate and municipal bonds and, in varying degrees, of
corporate stocks as well.

(One of the leading nonbank firms specializing in

Government securities merged into a leading brokerage and underwriting firm in
1964.) Several other dealers are similarly involved in corporate and municipal
securities. For three nonbank firms, however, dealing in Government securities
is their principal activity. Five of the nonbank dealers are also dealers in

6
bankers' acceptances, and nearly all of the dealers—bank as well as nonbank--deal
in Federal agency securities.
Dealers look to three sources of gross profit in their operations:
current trading, taking speculative positions, and net interest earned after payment of financing costs. Trading profits are normally thought of as arising from
day-to-day activity in buying securities at one price and selling them at a
slightly higher price. Taking speculative positions involves essentially the
management of a dealer's total position with a view to profiting by meeting anticipated customer needs and by expected movements in interest rates. Dealers,
like other merchants, must normally have some inventory to be in business, but
they have considerable leeway for adding to or reducing inventories, or for
changing the maturity distribution of holdings in trying to buy low and sell
high. The management of position takes in a longer time period than daily
trading, but dealers cannot usually separate the two components of what are
commonly reported as trading profits. The third element of return to dealers
is the difference between the interest income earned on the securities owned and
the interest paid on loans to carry the securities. Dealers speak of a positive
carry when the difference is in their favor and of a negative carry when they
pay out more in interest than they receive. Activity, positions, and interest
rate relationships are key elements in the calculus of dealer profit.
An important characteristic of the dealer market is the huge volume of
activity that is carried on by nonbank dealers in relation to the equity capital
invested in the business. In 19^5 reporting dealers had average daily transactions in Government securities and Federal agency issues (sales and purchases)
of $2.0 billion and average daily positions of $3.7 billion. The nonbank dealer
firms, which held $2.9 billion of these positions, usually borrow 95 to 98 per
cent of the value of their inventories in hand, depending on the maturity of the

7
securities being financed and the type of lender. In this situation, a change
of one per cent in the value of a firm's portfolio could mean a loss or a gain
equal to one-fifth to one-half the firm's capital employed in the Government
securities market. Obviously, the conservation of capital is a key consideration to a nonbank dealer in conducting his operations. The bank dealers appear
at least equally sensitive to the risk of loss, although the portion of bank
capital invested in the business is ordinarily small.
The necessity of protecting dealer capital is perhaps the major determinant of the quality of the performance of the dealer market--the size and
closeness of the markets dealers make to all comers in the various maturity
categories. At all times a dealer is prepared to buy or sell Treasury bills or
other short-term issues in far larger amounts and at narrower spreads than would
be the case with long-term bonds. The price risk involved in short-term issues
is less than for longer maturities and the volume of trading activity is very
large, enabling a dealer to vary his holdings readily as his market judgements
change. The size and closeness of quoted dealer markets also varies with dealer
expectations of interest rate movements. In the period 1962 to mid-1965, when
interest rates moved narrowly within a gradually rising trend, dealers were
notably more willing to deal in larger size and at narrower spreads for any maturity than they had been in earlier years. In the subsequent period of economic
boom in which interest rates rose rapidly and prices of Government securities
fluctuated widely, the size of dealer markets again contracted and the price
spreads at which they were willing to trade widened. Investors may be able to
take the long view, but the dealer must be agile, changing his markets quickly
to preserve his capacity for making markets at all.
Dealer portfolios tend to reflect both the nature of activity with
customers and the response of dealers to changing economic circumstances. In

8
1965, 76 per cent of daily average dealer positions in Government and Federal
agency securities were in Treasury "bills and Treasury coupon securities maturing
in less than one year. Price risks are small in these securities and 8l per
cent of market activity in Treasury issues was concentrated in them. Federal
agency securities, for the most part maturing within one year, accounted for
another 9 P e r cent of portfolios. Holdings of 1 to 5 year issues and issues
maturing in over five years constituted 4 and 11 per cent, respectively, of
1965 average positions.
Aggregate dealer positions in Government and Federal agency securities
were $3-7 "billion in 1965, almost $1 "billion higher than in i960.

(See Table I.)

Between the two years holdings of issues maturing in less than a year expanded by
$950 million while holdings of longer maturities declined. Positions in Federal
agency securities rose by $200 million to $339 million. Dealer exposure to risk
increased markedly in 1964 and 1965, however, as positions in securities maturing
in over five years rose sharply to average $391 million in 1965-

This shift of

emphasis apparently stemmed from dealer judgements that opportunities for profit
were best in these maturities, given the gradual flattening of the yield curve,
and that Treasury market purchases to keep down interest rates" on new Treasury
issues provided protection against marked price declines. As a consequence of
its exposure, the dealer community sustained sizable losses as interest rates
rose well above 4 l/4 per cent on all Government securities in the last half of
1965.
The continued escalation of interest rates in 1966 to levels not seen
in a generation was accompanied by a decline in positions in coupon issues maturing in over one year to only $45 million in the first half of 1966, far lower
than at any time in the preceding six years. Holdings of Treasury bills and
short-term coupon issues also fell back. In contrast, average dealer positions

TABLE III

AGGREGATE DEALER POSITIONS IN
U.S. GOVERNMENT AND FEDERAL AGENCY SECURITIES
(daily averages, in millions of dollars)

Treasury Bills
Treasury Coupons
under 1 year
1 to 5 years
over 5 years
Subtotal
Total Government
Securities
Federal Agency
Securities
Total Government
& Federal Agency
Securities

i960*

lg6l

1962

1963

1964

1965

(1st
half)
1966

1,551

1,9.13

2,424

2,542

2,634

2,632

1,840

317
587
116

439
335
56

499
272
122

333
383
146

268
308
217

186
139
391

304
14
31

1,020

830

893

862

793

716

349

2,571

2,743

3,317

3,404

3,427

3,348

2,189

138

115

194

233

244

339

511

2,709

2,858

3,511

3,637

3,671

3,687

2,700

^Beginning May i960
Source:

Market Statistics Division, Federal Reserve Bank of New York

10
in Federal agency securities rose sharply as agency financing increased rapidly
and dealers experienced difficulty in distributing new issues in an atmosphere
of rapidly rising rates. Late in 1966 and early in 1967* when the interest rate
outlook changed, dealers built up their positions sharply in all areas to profit
from the rise in prices they expected.
3• Changes in the Financial Environment
a. The further development of the money market
The money market has grown substantially in recent years, providing
banks and other corporations, state and local governmental bodies, and others a
more efficient mechanism for adjusting their liquidity positions. The demand
for short-term assets by these economic units has mushroomed with the expansion
of the economy and the further development of intensive cash management. Commercial banks, sales finance companies, the Treasury, Federal agencies, and
other borrowers have tapped this demand by issuing short-term obligations tailored to a variety of needs. The secondary market for these instruments has
also developed greatly, reducing the costs and uncertainties involved in moving
between cash and earning assets, and thereby contributing to the increased demand
for short-term obligations. The dealers in Government securities have played a
key role in this process, partly because the entry of new firms and the general
stability of interest rates in the 1961-65 period intensified competition and
encouraged the search for new business.
The volume of money market instruments outstanding grew rapidly during
the economic expansion of 1961-66, rising almost 80 per cent in the six years
that ended in December 1966 (Table II). The supply of Treasury bills alone increased by $25.3 billion as the Treasury financed most of its cash requirements
in the short end of the market--during much of the period in order to shore up
short-term interest rates for balance-of-payments reasons. Other short-term debt

TABLE III

SELECTED SHORT-TERM DEBT OUTSTANDING
(billions of dollars)

December 31, i960
U.S. Government marketable
securities maturing in less
than one year
Treasury bills
Other

39.4
34.4

Subtotal
Other short-term debts/
U.S. Agency issues
Commercial paper
Bankers1 acceptances

December 31, 1966

64.7
40.$
105.2

73.8
4.4
4.5

13.4
13.3
3-6

2.0

Banks
Negotiable C/D's
Short-term notes

15.7^
N.A.

Subtotal

10.9

46.0

Total

84.7

151.2

a/ Government securities dealers had $2.3 billion in repurchase agreements
with others than banks in December 1966; major banks around the country
also had a large volume in such agreements outstanding with nonfinancial
corporations. Since in both cases these essentially finance dealer positions in Government securities, they do constitute an addition to the
supply of short-term debt outstanding,
b/ Weekly reporting banks.
Source:

Treasury Bulletin and Federal Reserve Bulletin

12
grew at an even more rapid pace, more than quadrupling within the six-year
period. Indeed, a striking characteristic of the money market during the interval was the willingness of short-term investors to reach beyond Treasury bills,
the most widely held and actively traded of liquid assets. The commercial banks
were particularly successful in capturing a major share of the growth in liqquidity reserves through their issuance of negotiable certificates of deposit.
On a much smaller scale, banks also provided corporations with very short-term
investment outlets by selling Government securities to them under repurchase
contracts and for a time by selling short-term notes of their own."1" The nonbank
dealers in Government securities continued to make repurchase agreements available to corporations and other investors as a means of financing dealer positions.
Traditional issuers of short-term paper also shared in the enlarged market for
such debt and the total outstanding of short-term Federal agency securities, commercial paper (including finance company paper), and bankers' acceptances rose
sharply.
The very success of the System and Treasury in holding up short-term
interest rates, even in the early stages of the expansion, provided holders of
liquid balances a significant incentive for employing them in the money market
during the 1961-65 interval. State and local governments greatly increased their
participation in the Treasury bill market, raising their holdings from $2.6 billion at the end of i960 to $4.5 billion on December 31, 1966.

The more sophis-

ticated of such governmental units also added significantly to their holdings of
bank certificates of deposit. The number of commercial banks investing in Federal

1. The Federal funds market continued to provide primarily a mechanism for
inter-bank reserve adjustments. While this grew apace, it did not add to the
investment outlets available to nonbank investors.
2. Treasury Bulletin.

13
agency securities and commercial paper also expanded. Corporate treasurers,
already skilled in cash management and short-term investment, were especially
aggressive in seeking out higher yielding assets. Nonfinancial corporations
are believed to be the primary investors in bank C/Ds and finance company paper,
and also are active in almost every other segment of the money market. Other
new areas of activity have included the purchase of short-term municipal securities, both outright and under repurchase contracts, and at one stage the
placement of funds with Canadian banks and in the Euro-dollar market. Holdings
of Treasury securities by large corporations reporting to the SEC declined by
$4 billion over the five years ended December 31> 1965; "but holdings of other
current assets (excluding cash, receivables and inventories) rose by $13-5 billion to $23o3 billion.
b. The increasing professionalism of customers
of the Government securities market
A notable feature of the Government securities market in the 1960,s
has been the growing professionalism of nondealer participants in the market.
Money managers in banks and other financial institutions, nonfinancial corporations, state and local government instrumentalities, foundations, and trade
unions have both broadened their investment horizons and sharpened the techniques they use in increasing the return on the funds under their care. Increasing customer sophistication in financial matters began much earlier, of
course, but the steadier interest rate environment that developed in the first
half of the 1960's both encouraged the search for better yields and reduced the
risks associated with more venturesome investment behavior. The Government
securities dealers themselves were a major force in the education of their customers to the attractiveness of alternative investment outlets and to the potential profitability of increased trading activity.

14
By mid-1965 the Government securities market functioned in a milieu in
which professional money managers shifted funds in large size among a range of
debt instruments and maturities in response to yield incentives that would have
been thought nominal only a few years earlier.1 While this development was most
pronounced at the short-end of the maturity spectrum where alternative outlets
abound, it was evident as well at the longer end where the yield spreads between
Government securities, corporate bonds and mortgages were considerably narrower
than in earlier years. The reappearance of major cyclical uncertainties in
financial markets after mid-1965 increased both the importance of liquidity
considerations and risks so that most money managers tended to pull back, at
least temporarily, from the trading, arbitraging, and underwriting activities in
which they had become engaged in more tranquil times.
Evidence on the use made by financial officers of the investment alternatives available to them is provided by an analysis of replies to a mail
questionnaire by 397 institutional investors, which held about one-quarter of
the marketable U.S. debt held outside official accounts at the end of 1965.^
The respondents were all holders of Government securities, largely selected
from those covered by the Treasury's survey of ownership. The replies indicated stepped-up use of loans or repurchase agreements with Government securities dealers, commercial paper of all types, bankers1 acceptances, short-term
municipal bonds and negotiable certificates of deposit. Not surprisingly those

1. See Robert W. Stone*"The Changing Structure of the Money Market", Monthly
Review of the Federal Reserve Bank of New York, February 1965*
2. Data drawn from the survey conducted by Joseph Scherer and his report
"Institutional Investors and the Government Securities Market." Included in the
survey were commercial banks, mutual savings banks, savings and loan associations, life insurance companies, fire and casualty insurance companies, and nonfinancial corporations, as well as the general funds and retirement funds of
state and local governments, college foundations, and trade unions.

15
respondents that were most active in Government securities and/or had large total
assets were most active in broadening their investment horizons. Banks and large
nonfinancial corporations were among the most active, but a rise in activity was
observed in all institutional groups. Over half of the respondents, however,
reported no activity in the several types of short-term debt listed above.
About half of the respondents, accounting for three-quarters of the
assets of the group around the end of 1965, reported repurchase contracts outstanding with Government securities dealers at the end of 1965. Somewhat surprisingly, only 30 per cent of respondents, accounting for about half of total
assets, reported ownership of Federal agency securities--about the proportion
owning bankers' acceptances. Almost half of the institutions with three-quarters
of the assets were active in finance company paper in 1965 while two-fifths with
about half of the assets employed funds in other commercial paper. Almost half
of the respondents--with half of the assets--reported activity in short-term
municipal bonds. About one-fourth of the institutions with about that proportion of the assets reported activity in negotiable certificates of deposits
(C/Ds), which did not appear as a market instrument until 1961.
A very large proportion of those institutions reporting activity in
short-term outlets other than Treasury securities indicated that they had stepped
up their activity in the period 196l-mid-1965 as compared to 1955-60. Thus,
three-quarters of the respondents with almost 90 per cent of the assets reported
that their use of finance company paper had increased. Two-thirds of the respondents with 80 per cent of the assets indicated increased use of other commercial paper, and a slightly higher proportion were more active in bankers1
acceptances. Three-fifths of those active in short-term municipal bonds,
accounting for 70 per cent of assets of this group, reported increased activity
in the 196l-mid-1965 interval.

16
Treasurers of nonfinancial corporations have been among the more
aggressive in utilizing all forms of short-term obligations. A survey by the
First Boston Corporation in 1964 provides some insight into the range of investment outlets authorized for 274 large manufacturing, trade, utility, and
transport companies, each of which had $20 million or more in cash and marketable securities at the end of 1963^

Of this group, 83 per cent were authorized

to buy Government securities, 72 per cent could buy C/Ds, 65 per cent finance
paper, 50 per cent Federal agencies, 39 per cent municipals, 32 per cent bankers'
acceptances, and 29 per cent Canadian Treasury bills, C/Ds or finance paper. As
might be expected, the larger companies had the broadest authorizations. Of the
109 companies with $50 million each in cash and marketable securities at the end
of 1963, authorizations ranged down from 100 per cent for Government securities
to 69 per cent for municipals and lesser percentages for bankers' acceptances
and Canadian short-term paper. Moreover, a considerable number of these larger
firms authorized their treasurers to buy longer maturities of Government securities . Of the 109; only 6 were restricted to maturities of under one year,
while 50 could buy Treasury issues maturing in over two years. Indeed, 31 firms
either had no maturity limits or had specifically authorized purchases of issues
maturing in over five years.
The Treasury-Federal Reserve survey of institutional investors revealed
widespread sophistication in the techniques of money management.

Of 397 re-

spondents, three out of five reported that they bid in Treasury bill auctions
with a view to quick resale at a profit. Two-thirds reported that they bought

1. Information furnished through the courtesy of Mr. Carl Cooke, The First
Boston Corporation.
2. See Scherer, op. cit. His study documents the tendency for such investors
to deal with an increasing number of individual dealers in recent years.

17
longer Treasury "bills in the market and sold them before maturity to increase
their return--taking advantage of the fact that longer bills normally yield more
than shorter bills. About two-thirds also indicated activity in trading to take
advantage of changing price relationships between different Treasury coupon
securities. Half or more of the respondents reporting such activities indicated
that their activity in each of these categories was about the same in the 1961mid-1965 period as in 1955-60, "but 25 per cent or more reported greater activity.
Those reporting greater activity in the several categories accounted for about
half of all activity in Government securities in 1965 by those using the three
techniques mentioned above.
4. Changes in the Dealer Community, 1961-66
a. The new dealers
The entry of new dealers into the Government securities market was a
major influence on the changing structure of the industry in the 1961-66 period.
Five new dealers—three bank and two nonbank dealers—came on the scene while
three nonbank firms that dealt with the Desk in i960 either discontinued operations or retired from active participation in the market. Of the two new nonbank dealers, one is involved primarily in Government securities while the other
is a department in a large underwriting firm. The three new bank dealers are
dealer departments of banks in Chicago, New York City, and Los Angeles. Of
these, the first two have their trading operation in New York City while the
other operates essentially from the West Coast. Two of the new dealers began
operations in 1961 and one each began in 1962, 1964 and 1965.
The new dealers added to the industry's already keen competition for
customer business during an interval when most customers were "becoming increasingly sophisticated in their use of the dealer market and of trading techniques.
By 1965 the new dealers had built up trading volume in Government and Federal

18
agency securities to an average of $446 million daily while the old dealers
traded about $1.6 billion daily—about the same pace of trading for them as in
1961 when the entry of new firms began. The new dealers accounted for about
one-fifth of activity in maturities of under one year in 1965, a slightly higher
proportion of activity in 1-10 year maturities and somewhat less of activity in
longer Government securities and Federal agency securities.
The new dealers as a group have apparently not been able to turn over
their inventories of Government securities as rapidly as the old dealers. In
1965, for example, the old firms turned over their portfolios three times every
four days on average while the new firms turned theirs over only twice in the
same interval

Presixnably, building up trading activity with customers is one

of the chief challenges facing a new firm entering this service industry. It is
perhaps not surprising that the old firms as a group maintain an edge despite
the aggressive search of the new firms for business on all fronts.
t> • Changing dealer shares of trading activity
Increased competition exerted a pervasive effect on the industry
during the 1961-65 period. The share of the major dealers in total activity
declined and both the medium-sized and the smaller dealers enlarged their share
of the business. There were also some shifts in the positions of individual
dealers within the industry. The bank dealers incieased in number from five to
eight and their share of total transactions also rose.
Data on dealer activity suggest that competition eroded most the market position of the major dealers in Treasury bill trading, in which the risks
are least, but that their market share of trading in Treasury coupon securities
also declined. The top third of the dealers i:n terms of activity accounted for

1. The trading positions of dealers used in this calculation exclude securities financed under repurchase agreements maturing in over 15 days.

19
67 per cent of gross Treasury "bill transactions totaling about $800 million daily
in the last eight months of i960, when bill rates were dropping back sharply as
the recession deepened (Table III). By the following year, however, when rates
moved much more narrowly, their share had begun to recede and by 1965* the share
of the top six dealers had declined to 54 per cent of the $1.4 billion volume.
Between i960 and 1965 the share of the middle third of the dealers in Treasury
bill trading rose from 26 to 34 per cent and that of the lower third rose from
7 to 12 per cent. The six leading dealers in Treasury coupon securities
accounted for a larger share of activity in such issues than in Treasury bills-73 per cent of the $470 million average daily trading volume in i960. By 1965
their share had declined to 63 per cent of the $440 million daily volume. The
share of the middle third in trading in Treasury coupon issues rose from 24 to
29 per cent and the lower third from 3 to 8 per cent.
The dealers that were in the top third in activity in i960 remained in
the top third in 1965, but there were some shifts in position. Between the two
periods, one dealer within the top third rose two places in Treasury bill trading
and another dealer rose one place while two others fell correspondingly. In
trading in Treasury coupon issues, two dealers among the top third rose two
places each, one fell three and one dealer was displaced by a new dealer. In
the middle third of dealers in Treasury bills in I965, four of the seven were new
dealers; in coupon trading, three of the six middle dealers were new dealers.
(There were only 18 dealers that dealt in coupon issues.)
One of the key changes in the dealer community has been the rising importance of the bank dealers in total activity and a roughly corresponding decline
in the market share of the most active nonbank dealers. In 1965 the eight bank
dealers did one-third more business in Treasury bills than the three leading nonbank firms whereas the nonbank firms had had a small edge in i960. The three
nonbank firms, it is true, did about one-third more business in Treasury coupon

TABLE III
DEALER TRANSACTIONS IN GOVERNMENT SECURITIES
(market share; percentage of total)
Dealers

19 60*

1961

1962

1963

1964

1965

TREASURY BILLS
Upper third

Middle third

_JL5.

_13

_12

100

Lower third

7
100

100

COUPON ISSUES MATURING IN LESS THAN 5 YEARS
Upper third

Middle third

Lower third

100

COUPON ISSUES MATURING IN MORE THAN 5 YEARS
Upper third

Middle third

Lower third

100

Beginning second quarter i960

Source: Market Statistics Division, Federal Reserve Bank of New York

21
securities than the bank dealers in 1965^ but in i960 they had done almost twice
as much business as the bank dealers. In 1965 the eight bank dealers accounted
for 42 per cent of all trading in Treasury bills and 32 per cent of trading in
Treasury coupon securities, a gain in each category of 7 percentage points from
i960 (Table IV). Nonbank dealers other than the top three retained about the
same share of activity in both Treasury bills and coupon securities in 1965 as
i960.
This change in industry composition appears to be rooted not only in
the decision of more banks to add a dealer department to their array of services,
but also in the diminished risks that seemed to be involved in the business in
the period from 1961 to mid-1965. In the beginning most bank dealers tended to
perform better in the short end of the market where risks were small. However,
interest rates in the period fluctuated only narrowly, chiefly as a consequence
of the orderly and sustained pace of the economic expansion, but also because of
official actions to foster domestic growth while avoiding flows of short-term
funds to foreign countries. With risks of loss apparently reduced, the size of
the markets that all dealers would make expanded. The bank dealers as a group
were able to do a rising proportion of both the increasing business in Treasury
bills and the declining volume of activity in Treasury coupon securities. It
may be that the concentration of market activity near times of Treasury advance
refundings worked in the same direction since bank dealer departments may have a
particular edge in trading with their correspondent banks and other customers of
the bank at such times.
c. The broadening of dealer activities
The primary dealers in Government securities took a variety of steps
in trying to cope with the increased competition from within the dealer market
and from trading banks and other active participants in the market. Dealers

TABLE IV
BAM vs. NONBANK DEALER TRANSACTIONS
(daily averages, in millions of dollars)
I960*
Bk. Noribk.
Treasury bills

1961
Bk. Noribk.

1962
Bk. Nonbk.

1963
Bk. Noribk.

1964
Bk. Nonbk.

1965
Bk. Nonbk.

(1st half)
1966
Bk. Nonbk,

277

522

386

650

477

753

475

724

504

797

592

805

694

822

37
64
15

95
191
64

45
56
16

123
208
67

45
50
33

126
175
123

28
47
45

92
168
146

24
56
42

62
162
125

24
65
45

55
129
106

40
84
49

75
149
99

Subtotal

116

350

117

398

128

424

120

406

122

349

134

290

173

323

Total
Government
Securities

393

872

503 1,048

605

1,177

595

1,130

626 1,146

726

1,095

Treasury coupons
under 1 yr.
1 - 5 yrs.
over 5 Yrs•

867 1,145

PERCENTAGE DISTRIBUTION
Treasury bills

Treasury coupons
under 1 yr.
1 - 5 yrs.
over 5 yrs.

28
25
19

72
75
81

27
21
19

73
79
81

26
22
21

74
78
79

23
22
24

77
78
76

28
26
25

72
74
75

30
34
30

70
66
70

35
36
33

65
64
67

Subtotal

£5

§1

Total
Government
Securities

Beginning May "195b

Source:

Market Statistics Division, Federal Reserve Bank of New York

i\)
ro

23
intensified their contacts with old customers and sought out new one through
their sales personnel. Most sought to improve their efforts to inform and
educate their customers concerning both economic and bond market trends and
current money market developments. Several nonbank dealers added economists
and other research-oriented personnel for the contribution that they could
make to internal decision-making and to relations with professional investment
managers. Several of the bank dealers organized special money market desks
that offer corporate treasurers advice on short-term investment outlets and
even place funds for corporations.
As profitable opportunities shrank in the Government securities market
during the long period of interest rate stability, many dealers expanded their
activities in related markets. Nearly all stepped up their activity in Federal
agency securities, the volume of which grew rapidly during the period. The
dealers worked assiduously to win customers for these issues, which were available at higher yields than comparable Treasury issues, and thereby to earn an
increased share of the attractive underwriting concessions allowed to members
of the various Federal agency selling groups. The dealers became increasingly
active in the secondary market for agency securities, greatly broadening that
market. As a consequence, the daily average volume of trading in such issues
rose from $78 million in the last eight months of i960 to $141 million in 19&5Dealers' positions in the issues rose from $138 million to $339 million over the
interval—in part, because the higher yields on Federal agency issues generally
provided a positive carry. At the same time the spread between yields on
Federal agency issues and comparable Treasury securities narrowed considerably
as the secondary market for agencies improved.
The dealers were also quick to foster a secondary market for negotiable
certificates of deposit (c/Ds), which were issued by commercial banks in

24
negotiable form beginning in 1961. Under existing Regulation Q ceilings banks
could not effectively sell C/Ds maturing in less than six months, so that dealers
could position them without any risk that banks could otherwise offer a more
attractive rate on new C/Ds than the dealer could on outstanding ones. Subsequently, however, increases in the Q ceilings in 1964, and 19&5 enabled banks to
sell C/Ds maturing first, in three months or more and then, in 30 days or over.
Thus, when interest rates moved irregularly higher in late 19^5 and 1966, few
dealers were willing to position a sizable volume of C/Ds and trading tended to
move to a negotiated basis. However, once interest rates began to move lower in
late 1966, dealers acquired large amounts of C/Ds in order to profit by the rate
decline that developed. Trading activity also picked up considerably.
Some nonbank dealers also expanded activities into other markets.
Firms already engaged in the corporate and municipal bond markets had every
reason to step up efforts in those areas as competition increased in the
Government securities market. Their multiple-product lines afforded special
advantages in dealing with investors wishing to switch between Government,
corporate, and municipal securities. One or two others entered these markets
in a small way but pulled back later. One major dealer also became a dealer
in bankers1 acceptances during the 1961-65 interval.
The bank dealers, for their part, sought to integrate their operations
with the full range of other services provided by their banks--deposits, loans,
safekeeping, and investment counsel. In close conjunction with their own dealer
and money market operations several bank dealers developed a special facility to
advise corporate treasurers on their short-term investments.

Such money desks

progressed rapidly to the actual placement of money for corporations in repurchase agreements with the bank, commercial and finance paper, bankers' acceptances, and short-term municipals as well as Treasury and Federal agency securities.

25
5. Changes in Dealer Performance as Underwriters
of Treasury Offerings
The Government securities dealers play a key part in the financing
operations of the United States Treasury. They subscribe for a significant share
of nearly all new marketable securities sold by the Treasury, distributing them
subsequently to investors. They maintain the secondary market for Treasury securities, in which supply and demand forces determine the yields on outstanding
issues--yields that provide one yardstick of value to investors appraising any
new securities the Treasury offers. Drawing on their very wide range of customer contacts, the dealers give the Treasury their views in advance concerning
investor interest in different maturity areas that might be suitable for a new
coupon security and of the terms that would be necessary to sell the issue.
More generally, the dealers may put forward their recommendations on how the
Treasury might most expeditiously cover the financing requirements projected in
the budget. Once the terms of a particular offering are announced by the
Treasury, the dealers inform their customers of the offering and help sell them
on the new issue as a desirable investment.
Treasury financings pose a special challenge and opportunity to
dealers. Normally, new offerings have to come to market at yields that are
more attractive than those available on comparable maturities in the secondary
market in order to attract the buying necessary to take up the offering. The
subscribing dealer (or any other subscriber to the new issue) can realize an
underwriting profit if demand for the new securities proves strong enough to
cause the yield on them to drop back in line with yields available on similar
maturities and if nothing intervenes to depress prices of Government securities
generally. In determining his participation each dealer must gauge the attractiveness of the new issue, the potential demand for it, and the likelihood of

26
any significant change in interest rates during the period of distributing the
issue to investors.
The manner in which dealers perform their underwriting role depends in
some degree on the type of Treasury financing. Weekly, monthly, and special
auctions of Treasury bills proceed routinely as a general rule. Offerings of
new Treasury coupon securities for cash involve considerable educational effort
by the dealers and give rise to moderate trading activity in outstanding issues;
a maximum for dealer subscriptions for a new cash issue is usually set by the
Treasury. Offerings of new Treasury coupon securities in exchange for maturing
issues (a regular rights refunding) or for issues maturing in the future (an
advance refunding) usually involve a much heavier volume of secondary market
activity as the eligible "rights" issues, the new issues, and outstanding issues
change hands. In such exchange offerings, each dealer can usually control his
own underwriting commitment by the manner in which he trades and the extent to
which he exchanges the rights acquired in trading. To illuminate the changes
in the underwriting role of dealers that took place in the 196l-mid-1965 period
attention is focussed herein on Treasury bill auctions and on exchange offerings
because the dealer largely controls his net commitment in such financings.
a. Treasury bill offerings
The dealer community is a major subscriber to the Treasury's regular
offerings of three-, six-, nine- and twelve-month bills for cash. The average
amount of Treasury bills taken by the dealers in the weekly auctions of three- and
six-month bills rose from $464 million in i960 to $740 million in 1965. All of
the gain was in takings of six-month bills, which tripled to just over $400 million. However, the outstanding volume of Treasury bills rose quite sharply during
the interval, partly as a result of the Treasury's effort to shore up Treasury
bill rates for balance-of-payments reasons. Accepted dealer bids in the regular

27
weekly auctions were 30 per cent of the total auctioned in i960 and 34 per cent
of the total auctioned in 1965. The dealer share of the nine- and twelve-month
bills auctioned monthly has typically been larger, averaging 44 per cent of the
total auctioned in the six auctions beginning in September 1966 with the introduction of the nine-month bills. Treasury sales of tax anticipation bills
usually allow commercial banks to pay for some portion of their awards by payment to Treasury tax and loan accounts, effectively limiting the nonbank dealer
role to buying the bills from successful bank bidders in the secondary market.
An analysis of the weekly auctions in January and July 19^5 anc^
January and June 1966 gives some evidence of dealer performance of the underwriting role. On average in the sixteen auctions examined, the dealers took
27 per cent of the three-month bills and 44 per cent of the six-month bills
that were awarded. The bank dealers took 11 per cent of the total awards of
three-month bills and 10 per cent of the six-month issues. The nonbank dealers
took l6 per cent of the three-month and 34 per cent of the six-month issues,
the latter reflecting concentrated bidding by a few firms that frequently place
substantial amounts of these bills under long-term repurchase agreements in
hopes of selling them at lower rates when they are closer to maturity.
The performance of individual dealers as underwriters in Treasury bill
auctions seems to be quite variable. Most dealers appear to regard such underwriting a normal part of their function, bidding in nearly every auction to get
some bills. But some appear to be good bidders only spasmodically--presumably
on those occasions when they deem the profit potential to be particularly
attractive.
The bank dealers seem to be consistently good bidders for the threemonth bills as are a small group of nonbank dealers. Thus, in the auctions
noted above, six out of seven bank dealers and five out of twelve nonbank

28
dealers received over $5 million in 3-month "bills in 12 or more of the l6 auctions.
The six bank dealers accounted for 37 per cent of the three-month bills awarded to
all dealers while the five nonbank dealers accounted for 42 per cent of total
awards.
The bank dealers appear less interested in the six-month Treasury bills,
but a small group of nonbank dealers are consistent bidders. Only two of seven
bank dealers received over $5 million in six-month bills in 12 or more of the
16 auctions, while four of twelve nonbank dealers were that successful. The two
bank dealers received only 6 per cent of total dealer awards in the 16 auctions,
while the four nonbank dealers received 45 per cent of total dealer awards.
Dealer participation in the 16 auctions analyzed suggests that dealer
performance as underwriters of Treasury bills changed in 1966, as uncertainties
mounted and dealer financing costs rose above Treasury bill yields. The bank
dealers appear to have been less affected as bidders by the shifting circumstances than the nonbank dealers. Their share of both the three- and six-month
bills auctioned in July 1966 was about the same as the average of the twelve
earlier auctions, perhaps because the banks bid moderately and consistently in
each auction--presumably related to current customer demand. The nonbanK
dealers, too, maintained in July 1966 their relative share of total awards of
the three-month bill, but their participation in tne six-month auction fell to
26 per cent in July 1966 from 37 per cent in the three earlier months analyzed.
The four consistent bidders for the six-month bill among the nonbank dealers
received only slightly less in July 1966 than earlier, but the other nonbank
dealers dropped back sharply.
bo

Regular exchange offerings
Once the Treasury has announced that it is offering one or more issues

(either new or reopened) to holders of maturing Treasury coupon securities, the

29
dealers play an important part in "bringing the terms to the attention of these
holders and other investors. Typically, the dealers buy the rights in considerable volume from holders that do not wish to make the exchange, frequently
because these holders own the maturing issues as short-term investments and do
not want to roll them over into issues maturing in as long as 12 to 18 months.
At the same time dealers sell either the rights or the new securities to investors who want the new securities but do not own the maturing rights.1 In
the six or seven days between the Treasury's announcement and the close of the
subscription books, the dealers acquire a position in the rights that exceeds
by a sizable amount their when-issued sales, establishing the net position with
which they emerge from the refunding. With the books closed the dealers hope,
as noted earlier, that they will be able to sell their stake in the new issues
at rising prices to investors that will be attracted by a yield that would normally be somewhat higher than that available on nearby Treasury maturities.
Dealer participation has been an important, though variable, element
p

in the Treasury's regular exchange offerings in recent years.

Dealers have

participated on average to the extent of about 10 per cent of total public subscriptions for the short options--12 to 18 month issues--in twelve such
offerings over the 1961-65 period, but their share ranged from 2 to 18 per cent
in particular offerings (Table V). The dealer role was considerably more
1. Dealers, of course, also buy when-issued securities from holders of the
rights who wish to remain invested until the payment date for the new issues,
which is usually about two weeks after the books close.
2. This section draws heavily on material prepared by Mr. Donald Hunter of
the Securities Department of the Federal Reserve Bank of New York. There are
many problems with the data, on Treasury financings, but the data presented herein
are comparable for the entire period despite internal imperfections. Dealer participations are taken herein as the sum of rights owned on the day before the
books close, and net long positions on the same day of when-issued securities by
those individual dealers reporting such positions. The aggregate data approximate
those presented in Thomas R. Beard, U.S. Treasury Advance Refunding, June 1960June 1964 (Washington: Board of Governors of the Federal Reserve System, 1965),
pp. 26-27.

TABLE V
DEALER PARTICIPATION IN TREASURY EXCHANGE REFUNDINGS

Refunding
(i)

Total Dealer Participation
Per Cent
of Public
($ millions) Subscription
(2)
(3)

Percentage of
Total Dealer Participation
3 Top
Dlrs.
(4)

6 Top
Dlrs.
(5)

Other Dlrs.
(6)

Percentage of
Total Dealer Participation
Bank
Dlrs.
(7)

Non-Bank
Dealers
(8)

Total
(9)

3H0RT OPTION—
Aug.
Nov.
Feb.
May
Nov.
Feb.
May
July
Feb.
May
May
Aug.

1961
1961
1962
1962
1962
1963
1963
1963
1964
1964
1965
1965

817
892
587
736
344
121
764
284
717
52
137
266

13
15
9
10
8
4
14
13
18
2
8
13

50
50
40
34
32
45
43
33
34
42
31
36

69
67
67
62
59
51
66
66
59
62
45
58

31
33
33
38
41
49
34
34
41
38
55
42

21
22
28
27
30
31
25
39
40
38
61
56

79
78
72
73
70
69
75
61
60
62
39
44

100
100
100
100
100
100
100
100
100
100
100
100

28
27
32
25
30
34
36
35

20
17
17
23
19
25
27
35

80
83
83
77

100
100
100
100
100
100
100
100

—LONG OPTION—
Aug.
Nov.
May
Nov.
Feb.
May
May
Aug.

1961
1961
1962
1962
1963
1964
1965
1965

205
261
471
677
572

818

197

32
54
23
20

27
38
41
24

48
57
48
56
43
43
39
39

72
73
68
75
70
66
64
65

75
73
65

1. Total participation in each exchange offering is equal to:
(a) Total rights held on the day before the books close.
(b) Net long positions in when-issued issues on the day before the books close by individual
dealers reporting such positions.

OJ
o

31
important, however, in the eight offerings of a longer option--ranging from
2 l/2 to 13 years to maturity. Dealer participation in these averaged 32 per
cent of total public subscriptions, with participation ranging from 20 to
54 per cent in individual offerings. Clearly, the dealer community supplies
a very significant amount of support to the Treasury's regular debt lengthening
operations.
Dealer participation in exchange refundings includes subscriptions
tendered to cover sales of when-issued securities made before the books close.
On average, such sales amounted to about one-quarter of dealer participations in
the short option on 12 occasions and to about one-third of dealer participations
in the longer option on 8 occasions. On average, dealers distributed about
another 15 per cent of their participations in both short and long issues by the
day before settlement for the exchange. This left the dealer community with net
long positions averaging about three-fifths of their total participation in the
short options and one-half of their total participation in the longer options.
It seems clear that the underwriting period extended well beyond the settlement
date for these exchanges.
During the 1960's the dealers came increasingly to favor the long
option in regular exchange refundings in which it was available. Thus, dealer
participation in the short option was 2.5 times that in the long in the four
1961-2 offerings in which both options were offered. By 1964-65^ however,
dealer participation in the long option was 3«5 times that in the short in the
three refundings in which both were offered. This marked shift in emphasis was
more acute than a similar shift affecting general public participation. Dealer
participation fell from 11 to 7 per cent of public subscriptions for the short
option, but held steady at around one-third of public participation in the long
option.

32
The shift in dealer interest to the longer option probably reflected
a number of influences at work. Investors came to favor the longer option in
the comparatively stable interest rate environment of the first half of the
decade. In addition, the Treasury was somewhat more aggressive during the
period in buying for Treasury trust accounts portions of new issues that fell
or threatened to fall below issue price, usually the longer option. This
official buying led many dealers to feel that their risk of loss was limited
and that larger commitments were justified even though potential gain per million dollars might be considerably smaller than in earlier years. In the May
1964 and May 1965 refundings dealers took almost 40 per cent of total public
subscriptions. In the event, however, some other market participants seem to
have reached similar conclusions and subscribed as quasi-underwriters. Thus,
despite selling a normal one-third of their total participations before the
books closed, the dealers in these instances made little additional distribution by the settlement date, because of net selling of the new issue by other
market participants.

In the August 1965 refunding, both dealer and other

underwriting interest waned in the wake of stepped-up involvement in Vietnam
and distribution proceeded more rapidly than usual as the dealers sold
aggressively.
Within the dealer community there were significant changes in the participation in the Treasury's exchange refundings. Perhaps the most notable of
these was the increased participation of the bank dealers, whose number rose
from 5 to 8 over the interval (Table V). In the short option their share in
total dealer participation rose from 26 per cent in 1961-62 to 49 per cent in
1964-65. In the long option their share rose from 19 per cent to 29 per cent.
The dealer banks' share of the distribution made of the short option appears
to have kept pace with their higher participation.

In the long option, however,

33
their performance as distributors showed little change in 1964-65 from 1961-62
(Table VI). This suggests that the bank dealers as a group took an increasing
stake in the longer option but were not able to develop outlets to a
corresponding degree.
More generally, the data on the 1961-65 experience suggest that the
major dealers continued to account for an overwhelming share of the distribution
of the longer issues throughout the interval, despite their shrinking share of
the total dealer participation.

In three 1961-62 offerings, the top three

dealers accounted for 58 per cent of the when-issued sales by all dealers in the
period preceding the settlement date. In three 1964-65 offerings the top three
dealers accounted for 63 per cent of such sales although their share in the
initial dealer participation had declined to 40 per cent from 52 per cent in
1961-62. Taking the top six dealers in both intervals--equivalent to the top
third, their average share of distribution rose from 76 to 86 per cent between
the three 1961-62 financings and the three in 1964-65, while their share in
initial dealer participation declined from 72 per cent to 65 per cent.
These relationships indicate that the growth in dealer participation
in the long option between 1961-62 and 1964-65 was not accompanied by a commensurate growth in the ability of most dealers to distribute such securities.
The top six dealers, a group that included one or two bank dealers on each
occasion, continued to account for the bulk of the distribution carried on.
The increased weight of securities in the hands of other dealers, as well as
in the hands of other short-term holders, would appear to have prolonged the
period needed to distribute the new issues and increased the likelihood that
the Treasury would find it necessary to relieve market congestion.

TABLE VI
DEALER DISTRIBUTION OF THE LONG OPTION IN TREASURY EXCHANGE REFUNDINGS

Net Position
on Day Books Close
Per Cent of
($ mil.
Public Exchange

Refunding

When-Issued
Sales to Day
Before
Settle. Date
($ mil.)

Percentage
of Sales by
Bank
Non-Bank

Total

Percentage
of Sales by
6 Top
3 Top
Dealers
Dealers

Othe

Aug. 1961

181

n.a.

n. a.

n.a.

100

n.a.

Nov. 1961

114

100

May

1962

170

155

100

Nov. 1962

363

234

100

Feb. 1963

345

434

100

May

1964

417

196

100

May

1965

536

283

100

Aug. 1965

126

104

100

n.a.

Not available.

35
c. Advance refundings
One of the major innovations of the past decade in Treasury finance
has been the introduction of the advance refunding in which holders of issues
maturing as long as several years in the future are offered an opportunity to
exchange into new or reopened securities maturing even further in the future.
The new techniques enabled the Treasury to increase the average maturity of
the marketable debt over the 1961-65 period even though four-fifths of the
$25.6 billion increase in marketable debt during the interval was in the form
of Treasury bills.-1The primary dealers in Government securities have become an important
factor in the distribution of securities maturing in about 5 years or longer
through this technique.2 in 1960-61 they were responsible for only 4 to 7 per
cent of the total public exchange into very long-term issues, but their participation expanded rapidly until they accounted for 26 to 40 per cent of the
issues exchanged in 1963-65 (Table VII). This increase paralleled a general
expansion of public interest, which proceeded to the point that over $9 billion
of securities were exchanged in advance of maturity in both July 1964 and
January 1965- As in the case of regular exchange refundings, the dealers also
were willing to build up their stake--in part because of expectations that
official buying would be likely to limit the risk of loss.
Dealer participation in the advance refundings tended to be considerably higher in the longer maturities offered by the Treasury. Thus, in
1963-65 dealer conversions ranged from 62 to 73 per cent of total public

1. E. Ettin, The Financial and Economic Environment of the i9601s in
Relation to the U.S. Government Securities Market. See also Thomas R. Beard,
op. cit. which analyzes the advance refundings in detail.
2. This section draws heavily on material prepared by Mr. Donald Hunter
of the Securities Department of the Federal Reserve Bank of New York.

36
conversions into issues maturing in over 10 years. The dealer share of exchanges
into 5-to-10 year maturities was considerably lower, ranging from 12 to 31 per
cent.
Advance refundings typically touched off a substantial volume of trading
in the secondary market as investors used that market to acquire or sell the
issues eligible to the exchange or the new issues. A larger share of the conversion apparently took place through the market than in regular exchange refundings,
when many of the holders have presumably acquired the maturing coupon securities
with a view to the possibility of exchange. Thus, dealers placed from 11 to 20 per
cent of the final exchange with investors in the week to ten days from the time the
Treasury announced the terms until the books closed. This distribution compared
with a range of 2 to 9 per cent in regular refundings. Even so, advance refundings
were normally so much larger in magnitude than regular refundings that the net
underwriting commitment of the dealer community was considerably larger. Dealers*
net positions on the day the books closed totaled almost $2.5 billion in the three
1964-65 advance refundings compared with $1.3 billion in the long option of regular
refundings in February 1963; May 1964 and May 1965*
Dealer distribution of the new issues seems to have become somewhat more
sluggish in the later advance refundings. In the three 1962-63 refundings on
which data are available, dealers were able to distribute two-thirds of their
total exchange by the day before settlement for the new issues (Table VII). In
the three 1964-65 operations, their distribution fell back to 56 per cent of the
amounts exchanged for by the dealers. One suspects that in advance refundings,
as in regular refundings, a large volume of speculative subscriptions was
attracted over time from dealers, banks and others, who have limited capacity
to distribute securities to investors.

TABLE VII
DEALER PARTICIPATION IN ADVANCE REFUNDINGS

Occasion

Dealer Conversions
Per cent of
public
$ million conversion

Net dealer positions
in new
issues after conversion
Per cent of
public
$ million conversion

Net dealer sales to
day before settlement1
Per cent of
dealer
$ million
conversions

1962

400

271

n.a.

Sept. 1962

1,515

661

1,015

Feb. 1963

2,288

886

1,683

Sept. 1963

2,210

932

1,315

Jan. 1964

1,052

492

552

July

1964

2,433

995

1,553

Jan. 1965

2,447

985

1,265

Feb.

n.a.

Not available.

1. Excluding sales to Treasury investment accounts.

38
6. Dealer Financing^The interest costs that Government securities dealers incur in
financing their portfolios bear on dealer profitability and on the size and composition of their portfolios. What matters is not so much the particular level
of rates at which financing is available as the spread between the interest rates
dealers earn as owners of Government securities and the rates they pay for carrying the securities. A sizable positive spread, or "carry," adds to profits
while a negative carry imposes an additional charge against profits earned in
trading. As noted earlier, the nonbank dealers normally finance positions to the
extent of 95 per cent or so with borrowed money. Accordingly, they have a powerful incentive to seek out the cheapest source of financing available, provided
this does not impair the availability of securities for trading purposes. Aside
from expectations of potential trading profits, dealers have a natural tendency
to weight their portfolios with securities that will carry themselves—that is,
provide an interest return at least as great as current financing costs.
Accordingly, dealers tend to have net long positions in high coupon securities
and to have net short positions in low coupon securities--although other considerations may outweigh interest calculations at times. Bank dealer departments are likewise conditioned in their operations by the rate at which their
bank charges the dealer department for the use of bank funds, if such a charge
is made.
a. The nonbank dealers
The nonbank dealers tap a variety of sources in financing their positions. Nonfinancial corporations are a major source, financing about half of
nonbank dealer positions in recent years.

(See Table VIII.) Dealers normally

make repurchase agreements with a corporation, selling securities to them with

1. This section draws on the excellent Ph. D. dissertation by Louise Freeman
Ahearn, The Financing of U.S. Government Securities Dealers, 1960-63 (New York,
1965).

TABLE VIII
SOURCES OF FINANCING FOR THE NONBANK DEALERS IN GOVERNMENT SECURITIES'1
(dollar volume in millions of dollars)

I960
Vol.

Per
Cent

$
Vol.

1961
Per
Cent

1962

$
Vol.

Per
Cent

$
Vol.

1963
Per"
Cent

~f
Vol.

1964
Per
Cent

1965
Per
Vol.
Cent

1966 (1st half)
Per
Cent
Vol.

Corporations

1,024

1,132

1,408

1,392

1,255

1,282

934

Com. Banks
N. Y. City
Other

292
331

14
_l6

394
428

18
19

530
467

19
17

498
572

512
601

19
22

494
490

18
18

418
330

21
17

Subtotal

623

822

997

1,070

1,113

984

748

Fed. Reserve

130

114

102

159

Other

250

206

295

267

265

296

179

Total

2,028

100

2,210

100

2,759

100

2,843

100

2,734

100

2,722

100

1,957

100

1. Financing of positions in Government and Federal agency securities including securities held under
repurchase agreements maturing in 16 days or more.
Source: Market

Statistics

Division, Federal Reserve Bank of New York

40
a contract to repurchase them on a specified date one or more days hence at a
price which will compensate the corporation at an agreed-upon rate for the period.
Most dealers cultivate corporate lenders since the rate the dealer pays on corporate repurchase agreements is usually somewhat lower than the rate he will have
to pay on bank loans. Banks outside New York City are another major source,
accounting for a shade under 20 per cent of dealer financing at rates that are
usually quite close to the Federal funds rate. The New York City banks supply a
similar proportion of dealer financing needs but at a rate fractionally higher
than the Federal funds rate so that the City banks tend to finance the residual
needs of the dealers. The Federal Reserve System has met between 2 and 6 per
cent of nonbank dealer financing needs in recent years—usually at the discount
rate—in the course of supplying reserves temporarily to the banking system.
Assorted other lenders--Federal agencies, savings banks, foreign agency banks,
state and local governments--financed 9 to 12 per cent of dealer positions.
There have been no major shifts among the sources of nonbank dealer
financing over the last five years, or even over the past decade. The nonbank
dealers have continued to rely heavily on the corporate lenders that they introduced to repurchase agreements in the first postwar decade. In recent years
the share of corporate lenders in nonbank dealer financing has receded slightly,
but the dollar volume of corporate lending has risen despite the availability of
alternative outlets in the form of rapidly expanding volume of bank C/Ds,
Treasury bills, finance paper, and corporate R/Ps with banks during the period.
The share of dealer financing supplied by commercial banks tended to creep up a
bit through 1964, but fell back in 1965 and the first half of 1966. This decline
apparently reflects a tendency for bank lending rates to rise faster than the
rates available from other sources as monetary restraint increased and Federal
funds traded at an increasing premium above the discount rate. The situation reversed in early 1967 when monetary policy was expansive.

41
The nonbank dealers pay careful attention to the spread between
interest earned and interest paid as well as the outlook for rate movements in
managing their total positions. Indeed, a number of these dealers have made a
large business of entering into repurchase agreements, chiefly with corporations, for a period of several weeks or even months in order to take advantage
of an attractive spread between the interest rate earned on securities bought
for the purpose and the rate paid to the corporation. These securities obviously do not become a part of the firm's trading account until the repurchase
agreements mature, although dealers often have the right to substitute one
issue for another under the agreement. In 1965,

example, the nonbank

dealers held $846 million on average of Government securities financed under
repurchase agreements maturing in 16 days or more--equal to almost one-third of
their total positions. Nonfinancial corporations accounted for $800 million of
these long-term repurchase agreements. If one excludes securities held under
such agreements, the corporate share falls from about one-half of dealer
financing to one-quarter while the bank share rises from 35-40 per cent to
50-60 per cent.
Four dealers have accounted for about nine-tenths of the securities
held by the nonbank dealers under long-term repurchase agreements. Dealers who
use long-term repurchase agreements extensively must weigh the market risks of
owning securities for an extended period against the net earnings accruing to
them from an advantageous rate spread and the potential for trading profits.
Typically, such dealers have bought six-month Treasury bills in the weekly
auction and placed them with corporations at a rate lower than that on the
Treasury bill. If interest rates remain reasonably steady or decline, the market rate on the repurchased Treasury bills--by then an issue with 4 or 5 months
to maturity—should be lower than the rate at which the dealer originally

42
purchased the issue.

Obviously, dealers must be quite astute in their assessment

of the balance of risk and advantage.

If Treasury bill rates should rise appre-

ciably in the interval of the repurchase contract, the dealer can easily suffer
a capital loss that will more than offset the net interest earned. Dealers conducting such operations have, in fact, suffered sizable losses on several occasions in recent years—for example, at the time of both the 1964 and 1965
increases in the Federal Reserve discount rate. The persistence of the practice
suggests, however, that at least a few have been able to turn it to long-run
advantage.
Dealer financing rates--and their relation to yields on Government
securities—exert a shifting influence on dealers1 portfolios over the cycle.
As Chart I makes clear, dealer financing rates at the New York City banks tend
to fall below Treasury bill rates and yields on other Government securities
during periods when monetary policy is seeking aggressively to stimulate economic activity—for example in the first half of 1958 and in 1961. However, as
economic expansion continues and interest rates rise, the interest rate spread
tends to become unfavorable to the dealer first on three-month Treasury bills,
then on longer Treasury bills, and finally on longer term Government securities
as short-term interest rates rise more rapidly than longer rates.

Increasingly,

longer and longer maturities are required to cover financing costs until at some
point—most recently, in 1966--the nonbank dealer cannot finance any Government
security at the New York City banks except at a negative carry.
Once a booming economy and monetary restraint generate high interest
rates, dealer financing tends to become a problem that interferes with the smooth
and orderly functioning of the market.

In addition to the risks of capital loss,

dealers have every incentive to keep their portfolios low when their residual
financing at the New York City banks involves a sizable interest rate penalty.

Chart I

COST OF NONBANK DEALER FINANCING AT NEW YORK CITY BANKS COMPARED TO YIELDS ON U. S. GOVERNMENT SECURITIES
DECEMBER 1958 TO JUNE 1967
Per cent

7.00 I

6.00
5.00
4.00
3.00

J
/

Bank rates to dealers-n ew loan rates
y Mean ofthe range on last Ts
hd
ua
ry: of each month

Per cent

i
AV- h

I 7.00
6.00
5.00
4.00
3.00

2.00

2.00
I l11 111111
1 II
1 1 1 1 ! 1 1I1111l1I1 1 1IIl11II1 1 1 ii!
111111 111 ii 11111! M 11111111111111 ! 1 1 1 1 1 111111111 1 1 1 1 1 II

1959

* Board of Governors of the Federal Reserve System.

44
Moreover, the banks become less reliable as a source of financing, diverting
bank resources to business and other loans. The portfolios of the nonbank
dealers fell sharply in 1966--to $2.1 billion of Government and Federal agency
securities in the first half from $3-0 billion in the year earlier period.
Their average borrowing fell even further as dealers sought aggressively to
sell out Treasury bills and other securities acquired from the Treasury before
payment for them was required,
b. The bank dealers
Financing a position poses different kinds of problems for most dealer
departments of commercial banks than for the nonbank dealer. Basically, the
banks must find the resources employed in dealer operations as well as those
employed in other bank activities. Early in the economic upswing most dealer
departments had no financing problems as long as they stayed within the limits
imposed by top management on the scope of their operations. The dealer department had only to be concerned about the rate it was charged internally for the
use of bank funds--frequently the Federal funds rate or an internal cost-ofmoney rate. This internal accounting rate was very important, of course, to the
departments profitability and hence, a significant influence on operations, but
the bank dealer did not have to search out funds daily like the nonbank dealer.
The bank's money desk had the day-to-day job of dealing with shifts in the bank's
reserve position whether the change came from dealer operations, other bank
activities, or external factors.
In recent years, however, financing has come to play a much more important part in determining dealer department operations than the foregoing
would suggest. As credit demands pressed increasingly on available bank resources, top management increasingly tended to regard dealer operations in the
light of the bank's over-all resource allocation and liquidity reserves. The

45
scope allowed dealer departments for varying the size of their portfolios on the
basis of market judgements was curtailed and the departments have become much more
intimately involved in day-to-day financing.
The bank dealers followed in the footsteps of their nonbank colleagues
in promoting repurchase agreements with nonfinancial corporations. Initially
banks provided a short-term investment outlet to corporate customers as an
accommodation--one that was facilitated by the establishment in a number of banks
of facilities for advising on the placement of corporate funds in money market
instruments. As time passed, corporate repurchase agreements were gradually used
on an expanding scale for augmenting bank resources. The dealer banks appear to
have been most active in this development but other banks have also resorted to
repurchase agreements on a sizable scale. Unfortunately, several dealer departments reporting to the Federal Reserve Bank of New York do not report their use
of repurchase agreements as some banks do not relate their use of such agreements
directly to their dealer departments. Other data, however, show

that the four

dealer banks in New York City in December 1965 had $465 million on a daily average basis in repurchase agreements from corporations for more than one day.-1- At
the time, the funds used by the four dealer departments averaged $532 million.
A few dealer departments went beyond the use of repurchase agreements
to cover their financing needs and used due bills to raise money for their banks.^
Due bills arise when a dealer sells short a particular security to a customer and

1. What portion of these contracts is related directly to the Government
securities operation is unknown.
2. Effective September 1, 1966, the Board of Governors of the Federal Reserve
System amended its regulations to provide in effect that due bills issued by a
bank "...principally as a means of obtaining funds to be used in its banking
business..." (as opposed to simply facilitating a security transaction) were to be
classified as deposits, subject to reserve requirements and the rules governing
payment of interest.

46
the customer makes payment and accepts a written obligation to deliver—a due
bill—in lieu of the security itself.1

Legitimately used, a due bill enables a

dealer to meet a customer's need for a temporarily unavailable issue until the
dealer can make delivery, usually within a few days.

Prior to September 1966,

a few dealer departments issued unsecured due bills in considerable volume for
short-dated Treasury bills selling at low rates--presumably as a means of
raising cheap money for their banks.

The actual bills were often never bought

in to make delivery prior to the expiration of the contract.

Such a practice

would appear to represent an undesirable distortion of normal market practice,
involving a net addition to the effective market supply of Treasury bills outstanding to the benefit of the issuer of due bills rather than to the benefit
of the Treasury.
c. Dealer financing and market performance
The changes that have occurred in dealer financing patterns from 1961
to date appear related chiefly to the general growth of credit demands in the
course of the present expansion. As in the past business expansions, the nonbank dealers experienced progressive difficulty in financing their positions at
a positive carry as the economy approached full employment levels. The problem
became acute in 1966 when the nonbank dealers could not finance any securities
at a positive carry. Moreover they frequently encountered reluctance on the
part of New York City banks to handle their residual financing at even the high
posted rates. The bank dealers were all exposed to great pressure to hold inventories down and/or to expand the use of R/Ps and due bills in order to free
the bank .resources employed in dealer operations for commercial loans and other
bank uses.

1. Some customers will accept due bills secured by Government securities
from a nonbank dealer, but more will take unsecured due bills from banks, deeming
the bank itself a sufficient guarantor„

47
The gradual effect of credit restraint on the dealer financing
mechanism contributed to a deterioration in the capacity of the dealer market
to buy and sell Government securities in volume at prices that respond in an
orderly fashion to supply-demand forces. Dealers found their market judgements
overruled by the necessity of avoiding losses in carrying securities. Not only
did dealer portfolios in 1966 shrink to the point of not being large enough in
many issues of Treasury bills and coupon securities to serve as effective buffers to the movement of interest rates. The dealers also became a potent force
for short-term rate instability as the negative carry caused them to press sales
aggressively of securities acquired from customers or the Treasury to avoid
carrying inventory.

The financing problem added to the basic market difficul-

ties caused by the burgeoning credit demands of a boom economy and the uncertainties stemming from the mix between monetary and fiscal policies.

Structural Change and Market Performance
The interaction of intensified dealer competition and an environment

of comparatively steady economic growth from 1961 through mid-1965 fostered a
Government securities market that accommodated increasingly large transactions
in that period with only modest movements in interest rates.

Investors and the

Federal Reserve System found the dealer market an increasingly efficient mechanism for carrying out investment decisions and management responsibilities with
distinction.

It drew heavily on the intelligence supplied by the competitive

dealer community as to the investment climate and relied to an important degree
on the expanding capacity of that community to underwrite new Treasury issues.
In mid-1965 it almost appeared that no one had serious cause for complaint about
the functioning of the market—no one, that is, except the dealers who complained that their poor profit experience in the 1960's would lead to a withdrawal of capital and personnel from the indsutry.

48
The performance of the Government securities market in the year or so
after mid-1965 brought into question whether the structural changes at work in
earlier years had really added as much to the market's ability to function well
as surface appearances had previously suggested. In an economy becoming overheated, interest rates not only rose sharply but also fluctuated widely as expectations swung back and forth. Investors and the Federal Reserve alike
encountered a marked shrinkage in the size of transactions dealers were willing
to undertake--even at prices far away from those currently quoted. The capacity
of even the Treasury bill market to effect liquidity adjustments was impaired by
the penalty costs of carrying first, short-dated Treasury bills and then longer
maturities. At times the bond market was so unsettled as to make it difficult
for investors to execute sales of any magnitude. In this environment the
Treasury found market prices a less reliable guide to pricing its new issues,
and the dealers found a much less receptive market for such issues.
The lessons of this experience lie in the structural characteristics
of the market's response to the challenge of rapid change, not in the direction
of the response. One should not be surprised after all that a marked increase
in uncertainty and risk--and a preponderance of customers wishing to sell--would
bring retrenchment and caution in a group as sensitive to risk as the primary
dealers are. What is important is that at best only a half-dozen of the 20 primary dealers continued to make effective markets throughout the Treasury list-even on a reduced scale—from mid-1965 through most of 1966. Frequently, no
more than two or three dealers were willing to make firm bids in any size to
customers at any price near quoted market levels for intermediate- and long-term
Treasury bonds.
The behavior of the market in 1965-66 has made clear that an orderly
secondary market depends very heavily on the performance of a small core of key

49
dealers. Other dealers withdraw from making real markets when uncertainties in
the economy or market environment, reach the point that they cannot depend on unwinding customer transactions quickly with the core dealers. The inner core of
the dealer community included from three to five nonbank dealer firms at any one
time and one or two bank dealers. A few other dealers--chiefly bank dealersmade reasonably good markets in Treasury bills throughout the list, and most
dealers continued to be active in the latest issues. A large number of banks
and corporations, which tended to give the market resiliency in better times
through their trading activity, largely withdrew.
Further insight into the structure of the market and the change in its
functioning between 1965 and the first half of 1966 can be gained by a review of
dealer transactions with customers during the two periods. In the Treasury bill
market the top six dealers (the top third) play a key market role, but all
dealers do a fairly broad business. Thus, in 1965 the top six--three bank and
three nonbank--accounted for 59 per cent of all dealer activity in Treasury
bills with customers. Even more indicative of their role as makers of markets
throughout the full Treasury bill list was the fact that three-quarters of their
total trading was with customers and only one-quarter with other primary dealers
in Government securities.

(See Table IX, column 3-) In other words, the trading

of these dealers with customers in Treasury bills was about three times as large
as trading with other dealers. The middle third of dealers traded with customers
about twice as actively as with other dealers and in 1965 the lower third relied
almost as much on the dealer market as a whole to unwind or consummate their
transactions as on customers or on their own positioning of securities. Nonetheless, the large participation of all dealers in the market for Treasury bills is
evident.

TABLE IX
DEALER TRANSACTIONS WITH CUSTOMERS IN TREASURY BILLS
(i.e. excluding Inter-Dealer Trading)

millions

~ m —
Top three

1965
As per cent
total dealer
activity
with customers

375

m
38

As per cent
gross
activity^

1st half 1966
As per cent
total dealer
activity
with customers

As per cent
gross
activity^

(T)

$ millions
(4)

78
74

434

243

.22

Next three

210

Upper third1

585

677

Middle third

335

69
45

330

Lower third

995

100

1,098

100

1. Six, including top three.
2. Activity of group with customers as per cent of total activity (including inter-dealer trading).
Source: Market Statistics Division, Federal Reserve Bank of New York

51
The first half of 1966 brought a considerable pickup in activity with
customers amidst a background of bill rate swings that were considerably more
pronounced and abrupt than in earlier years. All dealer groups shared to some
extent in this increase, but the top six dealers increased their share of customer activity to 62 per cent of the total while the lower two-thirds lost
ground. Even so, the share of the top six remained well below the 70 per cent
level that had prevailed in i960.
In the market for Treasury coupon securities maturing in less than
five years, the share of the top six dealers in activity with customers rises
appreciably. These dealers--two bank and four nonbank--accounted for 68 per
cent of such activity in 1965. The role of the top three--all nonbank
dealers--becomes much more important.

(See Table X, column 3 0

Three-quarters

of their total business was with customers, indicating their very important
role as market makers. The remaining group of dealers traded with customers
only slightly more, or slightly less, than with other dealers.
In the first half of 1966, trading activity with customers picked up
by more than 20 per cent. The top three dealers increased their share of activity somewhat, although trading by all dealer groups rose. The top six dealers-five nonbank and one bank—increased the proportion of their total activity that
was carried on with customers. In contrast both the middle and lower thirds of
the dealer community became more dependent on other dealers in the execution of
transactions. Despite the first half gain in their share of activity with customers, the top three and the top six in total customer activity remained below
the i960 level.
In the market for Treasury coupon issues maturing in over 5 years, the
importance of the top three dealers is even more pronounced. This group--all
nonbank dealers--accounted for 52 per cent of all activity with customers in 1965.

TABLE IX
DEALER TRANSACTIONS WITH CUSTOMERS IN TREASURY COUPON SECURITIES
MATURING WITHIN 5 YEARS
(i.e. excluding Inter-Dealer Trading)

1965

millions
~(T)
Top three

As per cent
total dealer
activity
with customers

[2]

As per cent
gross
activity
U)

$ millions

(4)

1st half 1966
As per cent
total dealer
activity
with customers
(57

76
55

105

As per cent
gross
activity^

(5J

Next three

_38

Top third1

121

152

Middle third

Lower third

178

100

216

100

Six, including top three.

Activity of group with customers as per cent of total activity (including inter-dealer trading).

Source:

Market Statistics Division, Federal Reserve Bank of New York

53
In this maturity category the second three—one bank and two nonbank--account for
an additional 18 per cent of customer activity. However, only the dealings of
the top three with customers approached three times that with other dealers. For
the other dealer groupings, activity with customers was about equal to that with
other dealers.
In the first half of 1966 trading with customers by the top three firms
rose 30 per cent and their share in such trading rose to 63 per cent. (See
Table XI.) Indeed, two dealers accounted for about half of such activity. The
share of the top six dealers—one bank and five nonbank--rose from 70 to 8l per
cent, and activity with customers dropped back sharply for the middle and lower
third of the dealers. The share of the top three dealers—and the top six—
exceeded in the first half of 1966 the share achieved in any year in the 1960-65
interval. Hence, it would appear that the growth in the number of dealers over
1960-65 did not add to the basic strength of the market in this area or its
capacity to function under stress.
As noted earlier, major Treasury financings also depend importantly on
the distribution and underwriting activity of a small group of dealers. The top
six--typically five nonbank dealers and one bank dealer--accounted for two-thirds
or more of all subscriptions for the long option in the 1961-65 exchange refundings. The top three and top six accounted for an even larger share of the
net sales of when-issued securities before the close of the books on the refunding, the crucial period in determining the degree of success of the operation.
Dealer activity was particularly important in the advance refundings, in which
dealers turned in from 16 to 40 per cent of the issues exchanged after mid-1962.
Over the interval from 1961 to mid-1965 the non-core dealers did increase appreciably the size of the net positions they were willing to take in Treasury
financings but their distributive potential did not appear to keep pace. After

TABLE IX

DEALER TRANSACTIONS WITH CUSTOMERS IN TREASURY COUPON SECURITIES
MATURING -IN OVER 5 YEARS
(i.e. excluding Inter-Dealer Trading)

1st half 1966
As per cent
total dealer
activity
with customers
U)

(I)

1965
As per cent
total dealer
activity
with customers
(2)

As per cent
gross
activity
(3)

Top three

Next three

Upper third3

$ millions

millions
"741

As per cent
gross
activity

72
Middle third

Lower third

J+7

100

103

100

Six, including top three.

Activity of group with customers as per cent of total activity (including inter-dealer trading).

Source:

Market Statistics Division, Federal Reserve Bank of New York

55
mid-1965 the willingness of all dealers to take on an underwriting commitment
diminished but several of the major dealers continued to underwrite Treasury
offerings on a sizable scale.
The 1961-66 behavior of the dealer market reaffirms the importance of
a small number of key dealers to the performance of that market. The bank
dealers performed reasonably well throughout as dealers in Treasury bills .
However, the larger nonbank dealers continued to be the dominant factor in the
market for Treasury coupon securities. Thus, a legitimate concern exists
whether the more rapid growth of bank dealer activity over the 1961-66 period
poses a danger to the future performance of the dealer market.

One cannot come

to grips with that concern without a careful appraisal of the extent to which
the nonbank dealers find profitability over the entire cycle adequate to justify their investment of capital and personnel. The evidence of the first half
of 1966 suggests that those firms that really performed as dealers have increased their market shares and probably their long-run profit potential. Customer loyalty is built on the basis of experiences in just such a period.
Trading profits appear to have expanded greatly in the 1966-67 interval when
interest rates moved lower and there is some presumption that the major firms
have benefited therefrom.

Full text of The Changing Structure of the Dealer Market in Government Securities : Staff Study

FRASER