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TRSASiifiVi^^^*'-''*"""
April
1969
r.it
Library of Congress Catalogue Card
Copies of
this report
may
Number 72-601957
be obtained from Publica-
Services, Division of Administrative Services,
Board of Governors of the Federal Reserve System,
Washington, D. C, 20551. The price is 25 cents per
copy; in quantities of 10 or more sent to one address,
20 cents each. Remittances should be made payable
to the Board of Governors of the Federal Reserve
System in a form collectible at par in U.S. currency.
tions
(Stamps and coupons not accepted.)
PREFACE
Government securities market was
initiated in early 1966 in order to evaluate
how the U.S. Government securities market
was functioning in light of the institutional and
and the staff. Because of this, the study was
approached in phases, and the recommendations and staff analyses of the study were, for
the most part, forwarded to the Treasury and
Federal Open Market Committee as completed.
public policy changes that took place in the
This
This joint Treasury-Federal Reserve study of
the
U.S.
first
half of the 1960's.
That was a period, by
and large, of relative stability in interest rates
and during which there were several innovations in Treasury and Federal Reserve operating policies in the market, such as the Treasury's increased use of advance refundings
and
the System's undertaking of open market operations in
ment
all
maturity sectors of the Govern-
In the course of the
securities market.
study economic
and financial conditions
changed rapidly, as inflationary pressures developed, monetary policy was more actively
used, and interest rates fluctuated widely. These
conditions gave rise to a
that
were encompassed
number
in
of problems
the study, such as
final report brings
together
all
of the rec-
ommendations, with supporting analyses, and
summarizes much of the staff research.
The study was carried out under a Steering
Committee chaired by William McC. Martin,
Jr., Chairman of the Board of Governors of
the Federal Reserve System, and including
Joseph W. Barr, then Undersecretary of the
Treasury; Frederick L. Deming, then Under-
Monetary Affairs;
George W. Mitchell and J. Dewey Daane,
members of the Board of Governors of the
secretary of the Treasury for
Federal Reserve System; Alfred Hayes, Presi-
dent of the Federal Reserve
Bank
of
New
York; and George H. Ellis, President of the
Federal Reserve Bank of Boston until June 30,
the availability of financing to the dealer market
1968. Henry H. Fowler, then Secretary of the
and the potential for Federal Reserve open
market operations in Federal agency issues. In
Treasury, participated as a
addition, issues involved in the continuing eval-
member
ex-officio
of the Steering Committee.
A
number
of individuals participated in the
which was im-
uation of market performance and practices
work
were appraised.
mediately responsible for direction of the study.
The study was
carried out in a period in
which many other pressing domestic and international monetary problems urgently required
the attention of Steering
Committee members
of the staff Secretariat,
Participating for the U.S. Treasury were Peter
Deputy Undersecretary for Monefrom November 1965 to October
1967; Frank Schiff, Deputy Undersecretary in
Sternlight,
tary Affairs
the latter phases of the study; and R.
Duane
in nature.
An
effort
was made
to evaluate the
Saunders, Special Assistant to the Secretary for
performance of the market as a vehicle for
Debt Management. Participating from the
Board of Governors of the Federal Reserve
System were Ralph A. Young, Senior Adviser
to the Board until March 1967; Daniel H.
Brill, Senior Adviser to the Board and Director
of the Division of Research and Statistics; Albert R. Koch, Deputy Director of the Division
of Research and Statistics until August 1968;
and Stephen H. Axilrod, Adviser in the Division of Research and Statistics. Participating
from the Federal Reserve Bank of New York
was Alan R. Holmes, Senior Vice President
and Manager of the System Open Market Ac-
carrying out the transactions of the Treasury
tion of the extensive daily data
on
transactions and positions collected
securities
on a con-
from Government securities deal1960 and of the annual data on
income and expenses that have also been developed. The staff members who undertook
sistent basis
ers since
May
individual
studies
are noted,
along with the
topics, in the final section of the report.
These
individual staff studies are available for distri-
count.
Much
and Federal Reserve as well as private instituand businesses. This was accomplished
not only through interviews with dealers and
investors but also through statistical examinations
of the analytic
work was exploratory
bution,
and many of them
Wm. McC.
will
Martin,
Jr.,
be pubhshed.
Chairman,
Joint Treasury-Federal Reserve Study
of the U.S.
Government
Securities Market.
CONTENTS
INTRODUCTION
1
SUMMARY OF FINDINGS AND POLICY CONCLUSIONS
2
III.
FINANCIAL AND ECONOMIC ENVIRONMENT
6
IV.
STRUCTURE OF THE DEALER MARKET
I.
II.
IN U.S.
GOVERNMENT
SECURITIES
V.
VI.
VII.
VIM.
IX.
X.
14
VIEWS OF MARKET PARTICIPANTS
16
OVER-ALL PERFORMANCE OF THE MARKET
20
MARKET ACTIVITY BY TYPE OF DEALER
26
DEALER PROFITS AND CAPITAL AVAILABILITY
28
MARKET
CONSIDERATIONS, AND CONCLUSIONS
OFFICIAL RELATIONSHIP TO THE
30
POLICY ISSUES,
31
A.
Treasury Debt Management Operations
ADVANCE REFUNDINGS
CERTAIN OTHER DEBT MANAGEMENT TECHNIQUES
B.
Federal Reserve
Techniques
XI.
35
Availability of Financing to tlie Dealer
Market
D.
Improvement
E.
Continuing Evaluation of Market Performance
STAFF STUDIES
32
Open Market Operations and
OPEN MARKET OPERATIONS IN COUPON ISSUES
MODIFICATIONS OF TRADING DESK TECHNIQUES
FEDERAL RESERVE OUTRIGHT TRANSACTIONS IN
FEDERAL AGENCY ISSUES
C.
31
31
of Technical
Market Performance
35
37
40
43
44
45
48
INTRODUCTION
I.
Prior to the current U.S.
Government
securities
market study, the functioning of the market
had been studied in the early 1950's and then
again at the end of that decade.^
these
studies
The
first
was carried out following
Treasury— Federal
Reserve
accord
of
of
for the purpose
in the
on
and price changes
of obtaining information
factors influencing activity
Government
Analyses
securities market.
were also undertaken of certain aspects of the
the
market, including a
statistical
1951,
Treasury's financing
in
review of the
June 1958 and asso-
which permitted the Federal Reserve to withdraw from the wartime and early post-World-
ciated price and yield movements, the adequacy
War-II policy of pegging
ments, and the possibilities and potential func-
interest rates in the
U.S. Government securities market and which
made
of dealer statistics, the use of repurchase agree-
tions of a dealer association.
it
possible for monetary policy to be
the study,
used flexibly
in the interest of sustainable eco-
established to obtain
thus
As one
was
from U.S. Government
nomic growth. Federal Reserve open market
securities dealers daily statistics
operations during the 1950's normally
rowings,
in cases of disorderly
Government
—except
market conditions —came
result of
a formal reporting procedure
on
their bor-
and transactions
positions,
securities,
U.S.
in
Federal agency issues,
issues involved in or related to Treasury financ-
and certain other securities. These statistics
form the basis of several of the current staff
studies, which, because of the new ground they
This period saw the development of a
break, should be of special interest to students
conducted almost wholly
to be
securities, preferably
ings.
Treasury
short-term
in
bills,
and avoided
broad, active, and self-reliant U.S. Government
of
market that would readily accommodate Treasury debt management operations
statements, measured
securities
without
official
support and could
accommo-
date Federal Reserve buy-and-sell transactions
volume consistent with
in the
mone-
a flexible
tary policy.
In
now being obtained
addition,
on
dealer financial
a consistent basis, are
annually.
In the 1960's public policies, including monetary
and debt management
policies,
cope with domestic conditions which
had
in
Government
securities
in price in the
market
around
mid- 195 8 in connection with the shift in the
economy from recession to revival, and in view
of indications that price
movements were
partly
accentuated by undue speculative activity, a
further study of the U.S.
Government
market was undertaken under
joint
securities
Treasury-
Federal Reserve auspices. This study included
consultations with active market participants
slow rate of economic growth and in the middle
showed mostly an excesgrowth. Under
one aim of policy was to keep
years of the decade
rapid
sively
both
inflationary-type
settings,
interest-rate
foreign
relationships
centers
financial
worsening
in the
between U.S.
from leading
and
to
See
Open
the
following
published studies: "Federal
Market Committee Report of Ad Hoc Subcom-
on the Government Securities Market, November 12, 1952," in U.S. Monetary Policy: Recent
Thinking and Experience, Hearing.';, 83rd Cong. 2nd
mittee
Treasury-Federal Reserve Study of the
Government Securities Market. Parts I-III, 1959-60,
Wash., D.C. Also see U.S. Congress, Joint Economic
Committee, A Study of the Dealer Market for Federal
Government Securities, 86th Cong., 2nd Sess. 1960.
Sess.,
1954;
a
U.S. balance of payments. In
its policies to these conditions, and
inasmuch as the U.S. Government securities
market had broadened and become more self-
adapting
reliant during the previous several years,
1
to
the
early 1960's were characterized by a relatively
Following the sharp changes
U.S.
market.
the
the
Federal Reserve began to undertake open market transactions in
ernment
all
sectors of the U.S.
securities market,
ing operations almost entirely to Treasury
At the same
time, the Treasury
use of advance
Gov-
instead of confin-
made
bills.
increasing
refundings to refinance out-
standing debt and
made
several innovations in
the marketing of Treasury
bills,
coming
to rely
heavily on
bills in raising
new
cash.
These de-
velopments in Treasury and Federal Reserve
policy represented an effort during the early
1960's to exert upward pressure on short-term
rates while also
ture
of
the
improving the maturity struc-
Federal debt and providing the
bank reserves necessary to encouragement of
economic growth and moderation of upward
pressures on long-term rates.
In this period the U.S. Government securities
market was affected not only by innovation and
adaptation in Treasury and Federal Reserve
without
transactions
unreasonable
delay
or
price change. In addition, the development
and
performance of the secondary market for Federal agency issues were investigated. The ultimate objective of the study was to determine
what,
if
any, adaptations might be
made
in the
conduct of Treasury and Federal Reserve mar-
promote public policy obemerging conditions in the
Government securities market and in
ket operations to
jectives in light of
U.S.
related markets.
In assessing the U.S. Government securities
ting in private financial markets, such as the
market performance and factors affecting it,
staff analyses were undertaken on a wide vari-
evolution of negotiable certificates of deposit
ety of topics including changes in the financial
operations but also by developments origina-
issued in large denominations by major banks.
and economic environment; the structure of the
Moreover, there were changes in the dealer
dealer market; the behavior of various market
structure
market:
of the
new
some dealer
U.S.
Government
securities
dealer firms entered the market;
firms withdrew or
combined with
such
indicators
as
activity,
and
positions,
spreads between bid and asked prices; changes
System open market operaand new techniques of Treasury debt
management. Moreover, market opinion was
in the techniques of
other firms; and in general, bank dealers be-
tions;
came relatively more important.
The current study of the U.S. Government
obtained through individual consultations with
market has focused mainly on the
relation between the economic, financial, and
policy developments of the 1960's and the market's over-all performance
that is, the ability
of the market to accommodate and reflect Federal Reserve, Treasury, and private investor
securities
—
II.
and other active market participants. These
background studies and analyses (see list of
studies in Section XI on page 48) provide the
detailed analyses and findings on which this
report
is
D
based.
SUMMARY OF FINDINGS AND POLICY CONCLUSIONS
The U.S. Government securities market during
1960's was affected by adaptations made
the
in
dealers and questionnaire responses of dealers
Treasury
policies
in
and Federal Reserve operating
the
U.S.
Government
securities
In the early 1960's, the various economic,
financial,
in quite
and policy influences were reflected
moderate and gradual movements in
interest rates,
which both reduced opportunities
risks for active market
market that contributed to the attainment of
for gain
public policy objectives. In addition, the market
participants.
had
compete more
to adjust to innovations in private financial
and lessened
In
those
years
actively
for
banks began to
short-term
funds
markets, and to a shift in economic and finan-
through issuance in volume of negotiable time
cial conditions
from a period of considerable
to one of relatively sharp
variations in market expectations and in fundamental factors affecting economic and credit
certificates
over-all
steady, but the
expansion.
a generally steady, expansive posture while
stability
was
most part was
below its potential; price indices were relatively
stable; and monetary poHcy was able to hold to
of deposit; economic growth
economy
for the
at-
tempting, along with Treasury debt manage-
ment
policies,
keep upward pressures on
to
and long-
Later, after mid-1965, both short-
much more
term interest rates became
volatile
on balance, rose considerably.
Economic expansion became more vigorous and
and,
price inflation
ing,
more of
ticularly evident in periods of tight
money when
the reduced availability and high cost of dealer
short-term interest rates.
—
time to time. This problem, too, has been par-
a threat; Federal spend-
spurred by needs for defense in connection
an unavoidable
financing
is
restraint.
The market has
aspect of credit
generally
adjusted
well to such changes, but shortages of day-to-
day financing
—sometimes
as a result of unfore-
seen defXDsit outflows from large lending banks
—have
occasionally threatened to cause unduly
with the conflict in Vietnam, accelerated; and
sharp market pressures, which, though tempo-
posture with more
rary, are potentially disruptive of the market's
monetary policy
shifted
its
frequency. In these circumstances dealers were
confronted with very costly and
at times
were
readily available financing; but there
less
inter-
vals of declines in interest rates, and, over-all,
the dealer market
was able
to remain actively
functioning while experiencing a reasonable return
on
capital over the longer run.
Although
difficult to
measure and evaluate,
with evidence sometimes conflicting, the over-all
performance of the U.S. Government
market appears
in the 1960's as
all
have been
to
compared with the
securities
maintained
at least
1950's.
Not
aspects of market functioning in the 1960's
have been completely satisfactory to all participants, however. A number of dealers felt
that the market did not show sufficient price
and yield
flexibility in the early 1960's.
vestors found
transactions,
it
difficult
particularly
Government
U.S.
to
And
in-
undertake sizable
sales
securities.
of longer-term
The
latter
has
ability to
underwrite Treasury financings and
accommodate Federal Reserve operations or
to
the investment needs of customers.
The
structure of the U.S.
Government
securi-
market has undergone certain changes over
the past several years. The most important of
these changes has been an increase in the relative importance of bank dealers, although nonbank dealers still accounted for somewhat more
ties
than half of the activity
Little difference in
in
the
mid- 1960's.
behavior was found between
bank and nonbank
dealers,
except
that
the
appear to account for a relatively large
latter
portion of the activity in the bond area, where
bulk
the
of trading in
any event has been
limited to comparatively few dealers.
Given the changes
dealer market,
the
in
the structure of the
availability of capital
ap-
pears to have been well maintained relative to
the
volume of
activity
and to the need for
been most evident, of course, during periods of
monetary restraint, when the threat of price declines Hmited the willingness of U.S. Govern-
of the U.S. Treasury and the Federal Reserve.
ment
It is,
securities dealers to position longer-term
issues.
But
number of dealers
be making adequate pri-
in addition, the
that can be said to
mary markets
dealers to position securities in order to accom-
modate
their customers' needs, including those
of course, difficult to
ability
of capital,
measure the
diversified dealer firms
avail-
and
and banks, where man-
particularly
for
large
in longer-term securities
has been
agement decisions on the allocation of
small relative to the approximately 20
nonbank
take account of competing uses such as bank
and bank dealers who make up the dealer market for U.S.
number
ited
Government
securities.
reflects in part the
profit
risks in the
opportunities
bond
This small
comparatively lim-
and the substantial
area, given the rising trend of
The
availability of financing to dealers
in the
lending or corporate bond underwriting.
The
return on capital in the dealer industry
normally ffuctuates widely and roughly in
line
with economic and interest-rate cycles. In the
first
half of the 1960's the return
was
relatively
low, reflecting primarily reduced opportunities
interest rates since the early 1950's.
been another problem area
capital
has
market from
for capital gains in view of the tendency for
prices of long-
and
also short-term securities to
show an unusual degree
in
a period of gradual
of day-to-day stability
upward
yield drift
and
some
rise in financing costs relative to the in-
terest
return on intermediate- and long-term
securities.
prices in
The increased volatility of security
more recent years, including a brief
WITH RESPECT TO TREASURY DEBT
MANAGEMENT OPERATIONS:
1
—Advance
refundings as a technique of
management should be
debt
when
feasible in
and
Treasury
view of
its
its
retained and used
advantages to the
attractiveness
investors,
to
period of relatively sharp price gains in late
while giving consideration to the impact on the
1966 and early 1967, tended
market of unduly large and/or frequent ad-
to increase the
return on capital.
would appear
It
terms
of
vance refundings.
2
Consideration
—
should
to
be
given to the reopening, whenever appropriate,
Treasury and Federal Reserve
of outstanding issues in order to avoid relatively
performance, has
policy changes of the 1960's and to the increas-
small-sized issues that
competition of other market instruments
the secondary market.
ing
continue
adapted
over-all
fairly well to the
that the dealer market, in
with U.S. Government securities. In addition
3
—A
number
may be
less tradable in
of other suggestions with re-
banks, there has been a considerable growth in
Treasury debt management operasuch as
tions and practices were considered
commercial paper and
changes in the monthly
expansion in negotiable CD's issued by
to the
in
Federal agency issues
outstanding. In adapting to changes in the U.S.
Government
securities
and
related
markets,
dealers have in part broadened their operations
to
encompass other debt instruments, including
Federal agency issues and negotiable CD's. At
the
same
time, the structure of the dealer in-
dustry has changed, with bank dealers and nonbank dealers who are part of large diversified
securities firms assuming more importance. And
the longer-run outlook remained satis-
finally,
enough for dealers to maintain their
though not without some erosion at
activity
through years
times in certain market areas
when there was little or no return on capital.
In light of the flexible adaptation demonstrated by the U.S. Government securities
market to changes in the economic and financial
environment during the 1960's, and to help
factory
—
—
further an effective functioning of the market,
spect
to
—
1-year
auction,
bill
elimination of cash refundings, alterations in
the
tax-and-loan-account
payment
privilege,
exposure to information leaks.
In some cases adjustments in practices have
and the
risk of
been made during the course of
this
study,
while in others the advantages of current practice
appeared to outweigh possible disadvan-
tages.
The various debt management operations
should be, and are, continuously reviewed with
respect to their suitabiUty to emerging market
conditions.
WITH RESPECT TO FEDERAL RESERVE
OPEN MARKET OPERATING
TECHNIQUES:
4
—System
long-term
purchases of intermediate- and
U.S.
Government
should be continued
—even
coupon
issues
apart from use in
correcting or forestalling disorderly market con-
the principal recommendations with respect to
ditions
operating policies and procedures vis-a-vis the
chases
—
as
in
a useful
supplement to
providing reserves
to
bill
the
pur-
banking
Steering
system and, when compelling reasons exist, for
affecting, to the extent consistent with reserve
warded, as appropriate, to the Treasury and/or
objectives,
U.S.
Government securities market made by the
Committee for this study and for-
Open Market Committee (FOMC) are
below. The various policy conclusions
Federal
listed
and considerations
affecting
them are discussed
in considerable detail in Section
port.
Many
X
of this re-
of the recommendations have al-
ready been, or are in the process of being,
implemented.
interest-rate
pressures
on
specific
short- or long-term maturity sectors of the debt
market.
5
—Consideration should be
ing reserves through limited
issues
as might be
given to absorbsales
of
coupon
appropriate from time to
time in light of market conditions.
6
Under current market circumstances,
—
outright operations in Federal agency securities
would not
ability
facilitate,
of the
in
any material way, the
System to
reserves in the market.
the supply of
alter
While market condi-
make it more feasible to undertake System transactions in Federal agency issues by
means of repurchase agreements (as has been
done since late 1966), it is recognized that
market conditions may develop for example,
as a result of further growth in the agency
market or the availability of a large floating
supply of agency securities
that would make
System outright operations more practicable.
Moreover, the Federal Reserve should keep
under review the desirability and feasibility
tions
—
—
conducting outright operations in
of
issues
System
in
light
the
of
over-all
of
policy.
the large
number
of small individual financ-
ings could be consolidated into fewer but larger
offerings, possibly
all
—
9
Continued progress should be sought in
expanding clearing arrangements for U.S. Government securities, including the active participation of the Federal Reserve in these arrange-
ments, in an effort to avoid the necessity for
physical deliveries of securities to the extent
practicable; clearing arrangements might ulti-
mately look forward to a general book-entry
system, not only for those U.S.
securities held in custody
Banks but also
more generally.
for U.S.
Government
at Federal
Government
Reserve
securities
agency
objectives
System outright purchases and
sales of agency issues would be more feasible
if
WITH RESPECT TO IMPROVING
TECHNICAL MARKET PERFORMANCE:
under the aegis of an over-
marketing unit.
7
To the extent consistent with policy ob-
—
WITH RESPECT TO THE CONTINUING
EVALUATION OF MARKET
PERFORMANCE:
10
—The
and continuing interest of
and the FOMC in the performance of the U.S. Government securities
market is self-evident. Recent evidences of
inappropriate market behavior by a few pardirect
the U.S. Treasury
jectives, certain modifications in the details of
ticipants
the operating techniques of the Trading Desk-
surveillance
might be made, including, on occasion, provi-
vailed in the past.
sion of a rough indication to dealers of the
and making even more
use of "go-arounds" of the whole dealer market
in effecting purchase and sale orders for customer accounts as well as in System operations.
size of the operation,
suggest that
is
—Day-to-day
1 1
a
stronger element
of
probably needed than has preoperating
responsibilities
with respect to market performance
—
includ-
ing reporting of undesirable market practices
—should
to the Manager of
Open Market Account, in consul-
remain entrusted
the System
tation with appropriate senior staff officials at
the Treasury and the
WITH RESPECT TO THE AVAILABILITY
OF FINANCING TO THE DEALER
MARKET:
8
—Some
use of Federal Reserve resources
Board of Governors of
the Federal Reserve System. In order to under-
score the interest of the Treasury and the Federal
Reserve in the functioning of the Govern-
ment
securities market, the Secretariat of the
under carefully controlled terms and conditions, and for relatively limited periods, to
study should be maintained on a permanent
help finance the dealer market can contribute
basis to provide for continuing study of the op-
to
assuring the continuous,
satisfactory
per-
formance of the U.S. Government securities
market as it adapts to sharp shifts, and at
present
erations
curities
lenders.
Government
12
of
its
—
market
and functioning of the Government
se-
market; the group would submit periIn
order
to
facilitate
FOMC.
implementation
responsibilities with respect to evaluation
market developments, the System Account
Management should be granted daily access to
of
- All transactions for System Open Market Account
are conducted through the so-called Trading Desk of
the Federal Reserve Bank of New York.
securities
odic reports to the Treasury and the
times erosion, in the availability of financing
from commercial banks and other
U.S.
individual dealer statistics.
—Over
13
longer
the
function, provided that
full
some form
run,
might perform
organization
dealer
it
a
of
useful
could be organized in
conformity with antitrust laws. Such an
organization
could
concern
itself
with
such
matters as a code of dealer conduct, trading
trading,
arrangements,
clearing
and the
like. It
The U.S.
Government
highly sensitive
financial
to
securities
changes
in
the
market is
economic
environment and to adaptations
The market is a focal point for
in public policy.
adjustments
liquidity
principal source of contact between
the market and the Treasury and Federal Re-
serve regarding matters of market practices.
of
such key
appeared to be desirable
rates
terest rates
were needed to reduce incentives
economic
In an effort to resolve this dilemma, a stimu-
and it is also the principal channel through
which monetary and debt management policies
to
pattern
of Federal
are carried out. In addition, the fiscal policies
actions
and
was
Government
strongly influence over-all
order to raise
for capital to flow abroad.
lative
of the
in
aggregate demand, whereas relatively high in-
groups as banks and nonfinancial businesses,
monetary policy was maintained so as
enhance credit
policies
of
availability,
but the maturity
Reserve securities trans-
Treasury
debt
management
altered so as to minimize conse-
demand and supply
quent downward pressures on short-term
ket.
terest rates
relationships in the marDuring the first part of the 1960's, the
market had to adjust to a number of changes
and innovations in public and private institutional policies in an economic and financial environment that was characterized at first
by an economy growing at a moderate rate
with relative stability in prices and interest
rates,
later by considerably
more volatile
movements in economic and financial variables, and persistently by a deficit in the U.S.
balance of international payments.
OVERVIEW OF THE
IN THE 1960's
The two
U.S.
ECONOMY
basic economic problems that con-
fronted public policy in the early years of the
1960's
its
were
potential
to
money markets abroad. As
gressed,
the 1960's pro-
other actions were taken to reduce
These included a voluntary
program (VFCR) to
limit capital outflows from banks, nonbank
financial institutions, and businesses and an
capital
outflows.
foreign credit
restraint
interest equalization tax designed to reduce the
attractiveness of investment in foreign securi-
on an after-tax basis.
Monetary and fiscal policies, including
ties
decrease in early
1964,
contributed to
a tax
sus-
tained economic expansion following the brief
recession at the beginning of the decade.
expansion,
which
proceeded
at
a
The
relatively
moderate pace through 1964, was accompa-
unemployment rates
balance of payments def-
nied by unusual stability in financial markets
high
large
associated with an accelerating rate of gold
outflow. These problems required public poli-
on the one hand, to increase
demand and, on the other,
to restrain capital outflows from this country.
This posed a dilemma for policy with respect
to interest rates because relatively low interest
cies
in-
and thereby avoid encouraging outflows of liquid funds from the United States
an economy performing below
with
and a continued
icit
of
industry and could
for self-regulation in the
become a
hours
could provide a basis
FINANCIAL AND ECONOMIC ENVIRONMENT
III.
and
practices,
designed,
aggregate domestic
and
over-all prices
and led to a gradual decline
unemployment rate. With prices relatively stable, demands for goods and services
moderate, and monetary policy changing relain
the
tively
little,
expectations in financial markets
also tended to stabilize,
and the willingness of
investors to acquire longer-term securities in-
creased. This tended to moderate
upward
pres-
on long-term
sures
interest
did the
as
rates,
banks
in
obtaining funds. Banks sought inter-
increased purchases of longer-term securities
est-bearing
by banks resulting from their enhanced abiUty
to obtain time and savings deposits from the
actively
public.
positions,
Demand
pressures in both nonfinancial and
became
economy
from
deposits
than
in
the
more
public
any other period since the
1920's. In addition, in adjusting their reserve
banks made increasing use of the
the market in which
Federal funds market
—
stronger after mid- 1965 because of the sharp
banks with excess reserves make them available to banks with reserve deficiencies. The
Government expenditures
Vietnam and an acceleration in
business capital outlays. Price stability began
to break down, and there was increasing con-
volume of Federal funds transactions more
than doubled from 1961 through 1966.
Efforts by commercial banks to obtain time
and savings deposits reflected an attempt to
sectors
financial
of
the
increase in Federal
associated with
cern about inflationary pressures.
of payments continued in
The balance
as
deficit,
an im-
provement on capital account resulting from
the VFCR program and from the interest
equalization tax began to be offset by erosion
in the U.S. surplus on goods and services
transactions with foreigners. Mounting credit
demands and a tightening of monetary policy
led to a sharp run-up in interest rates through-
out the maturity spectrum
that
began
—
a rise
yields
in
1965 and ac-
in the latter half of
celerated in 1966.
Thus, participants in the U.S. Government
market were confronted with much
market conditions after mid- 1965
than they had been in the earlier years of the
securities
more
volatile
decade.
The
part to changes in
ditions
as
monetary
was traceable in large
underlying economic con-
diff'erence
they
policy,
influenced
and
demands,
credit
market
about the likely course of interest
expectations
rates.
regain
previous
their
Especially
the
in
competitive
1950's
increasingly substituted
position.
had
corporations
money market
assets,
chiefly Treasury bills, for bank deposits, and
consumers had shifted an even larger share
of their financial asset holdings to claims on
nonbank financial institutions, where yields
exceeded those on bank time and savings
deposits by a wide margin. In the 1960"s the
Board of Governors of the Federal Reserve
System increased the ceiling rate banks could
pay on time and savings deposits four times,
and this enabled banks not only to issue largedenomination negotiable CD's to corporations
and other investors but also to offer more
attractive
yields
on consumer-type time and
savings deposits.
As
a
the
result,
average
annual
rate
of
increase in outstanding time deposits at banks
rose from
per cent
6.5
in
1954-60
than 15 per cent in 1961-65.
By
to
more
the end of
1965, such deposits represented about 45 per
CHANGING ENVIRONMENT
FINANCIAL MARKETS
IN
PRIVATE
During the 1960's two major changes occurred
Commercial banks
aggressive
in
of
commercial bank deposits,
total
seeking lendable
a
little
doubled to an annual rate of about 9 per cent
1961-65,
and the banks' share of
funds; this change affected not only the port-
in
banks but also the financial
behavior of other borrowers and lenders. In
credit flows rose to
folio
policies of
addition,
the
was increased
international
mobility
as a result of the return to con-
vertibility of the currencies of the
pean countries
of funds
major Euro-
the average of
total
more than one-third from
about one-fifth for the 1954—60
period.
With
credit
readily
available
at
banks,
business firms relied relatively less on security
market as a means of financing.
Moreover, increased bank acquisitions of State
and local government bonds and greater will-
issues in the
in the late 1950's.
Commercial bank behavior.
as
more than 25 per cent
at the end of 1954. With greater deposit inflows, the rate of increase of bank credit
compared with
in private financial markets.
became more
cent
One
of
the
most dramatic shifts in financial markets in the
1960's was the increased aggressiveness of
ingness of banks to
make
real estate loans-
—
associated
mainly with the rapid growth of
—
smaller total took the form of very short-term
The
bank time deposits also tended to reduce
pressures on capital markets. At the same time,
may have
the very large increase in short-term financial
attractiveness of bill yields
banks
by
issued
assets
—
especially
CD's
added upward pressure on short-term rates.
Increased use by banks of markets for Federal funds and time deposits also tended to
lend a day-to-day stability to short-term market
yields. With the increased number of participants in financial markets and the greater variety of
money market
of both investors
and
instruments, the ability
issuers to arbitrage be-
issues.
banks
relative
increase in
holdings
bill
reflected both the increased relative
to ensure
and the
efforts of
adequate liquidity given their
increased long-term assets in other than Treas-
and
ury securities
greater reliance
their
on
interest-sensitive deposits.
Insofar as the over-all market for Treasury
was concerned, banks' purchases partially
compensated for reduced acquisitions by corbills
porations. Business firms invested an increasing
amount
of their short-term funds instead in
A
tween markets increased sharply. In particular,
negotiable CD's issued by banks.
the ability of banks to increase or decrease the
market for these CD's developed, made for
the most part by U.S. Government securities
dealers, and so the instruments achieved a
degree of market liquidity. Still, negotiable
CD's were not so Uquid as Treasury bills, and
therefore they generally yielded about 20 to 40
supply of time deposits by small shadings in
rates increased the flexibility with
aggregate stock of
money market
which the
instruments
could expand and contract.
Bank
ments
activity
in
the
growing out of these developfew years of the 1960's
first
basis points
instruments at that time.
of banks
in
The
longer-term
increased interest
assets,
including in
the
return to convertibility of major foreign
currencies in the late 1950's, funds could flow
between
and local government securities,
tended to keep long-term rates from rising
very much in that period, and banks' increased
ability and willingness to offer competitive
yields on time deposits exerted upward pressure on short-term rates.
Aside from affecting security markets generally, and therefore the market for Treasury
securities, greater bank use of Federal funds
and time deposits also influenced U.S. Govern-
more
ment
diverted
particular State
securities
more
With the greater
Federal funds market as
directly.
States, foreign
ties
became even more
sensitively attuned to
the costs to banks of reserve adjustments.
In their
own
banks continued to
reduce the share of their assets devoted to
Treasury issues. However, within their holdings
of
portfolios
Treasury issues,
a
greater
share
of
the
centers
demand
for U.S. financial assets
with liquid funds to invest, became more interested in foreign assets.
increasing
number
And
in
view of the
of attractive alternative in-
vestments, such as CD's and Euro-dollar deposits,
of
dealers of financing their inventories of securi-
financial
slowed, while U.S. investors, including those
Government seclosely matched
to the yields on alternative uses of bank funds.
Thus, the costs to U.S. Government securities
became more
foreign
with interest rates relatively low in the United
issues.
curities dealers
and
U.S.
freely in response to interest-rate differ-
entials. In the first several years of the 1960's,
development of the
an alternative use or source of overnight funds
to banks, loan rates to U.S.
bills.
International financial environment. With
contributed importantly to a narrowing of yield
spreads between short- and long-term market
more than
secondary
demand for dollar assets was
away from short-term U.S. Treasury
foreign
Indeed,
authorities,
except
foreigners
short-term
U.S.
for
foreign
monetary
reduced their holdings
Treasury
balance after 1959. Not
many
securities
on
long-term mar-
issues were acquired by
from 1962 through 1965 foreign central banks and governments acquired
over $1.5 billion of special nonmarketable
ketable
Treasury
foreigners, but
bonds and notes that were issued by the U.S.
Treasury to relieve pressure on the U.S. gold
stock.
The
among
greater ability of liquid funds to flow
leading financial centers, and the devel-
opment of instruments
—such
deposits
reflected
of
Maturity structure of new issues.
From
1961 to 1966 the supply of marketable Treasury issues increased by $29 billion. In order
States
to place
—
readily
that
Euro-dollar
as
interplay
the
supply-demand conditions in the United
and abroad, meant that domestic money
markets became more sensitive to foreign
developments, and vice versa. Thus, financing
costs of dealers and attitudes of investors toward U.S. Government securities began to reflect
not only the outlook for the domestic
economy but
also the likely course of credit
upward pressure on short-term
interest rates, the
OPERATIONS
from
policy
1961
mid- 1965
to
was
designed to increase aggregate demand, while
Treasury debt management operations sought
avoid
to
downward
on short-term
pressures
Treasury sought
to lengthen the average maturity of the Federal
interest rates. In addition, the
debt without exerting undue upward pressures
on longer-term
interest rates.
Fiscal policy. In the
fiscal
first
half of the 1960's,
policy was used aggressively as a vehicle
demand. Cash expendiby the U.S. Government expanded by
more than $33 billion from 1961 to 1965, and
to stimulate aggregate
tures
reductions in tax rates in
1965
lowered
$23.5 billion
1962,
by
inflows
tax
in the years the
came effective. As
amount by which
1964,
a
and
of
total
adjustments be-
a result, "fiscal drag"
—
the
would exceed
expenditures at full employment
declined
from almost $14 billion in 1960 to about
$5 billion in 1965. With increased outlays related to the war in Vietnam, the full employment surplus was reduced to zero in 1966.
The larger cash deficit of the 1960's was
tax revenues
—
translated into an average increase in market-
able debt of about the
1950's.
same
The major reason
marketable issues were used
ment of nonmarketable debt
that Federal agency
issues
—
were
relied
size
for this
on more heavily
As
the
was
that
to finance retirein the
1950's and
and participation
especially in 1966.
as in
certificate
in the
1960's
was an
assets com-
a result there
increase in the stock of financial
peting with direct marketable Treasury issues
for the funds of investors.
bills to
finance
of the increase over the
TABLE 1: MATURITY CHANGE IN OUTSTANDING
MARKETABLE U.S. GOVERNMENT SECURITIES
Type or
maturity of issue
Fiscal
Treasury used
more than 85 per cent
developments abroad.
FISCAL POLICY AND TREASURY
yields
while minimizing such pressure on long-term
issues attractive securities to replace those that
maturing after 20 years. The maturity distribution of Treasury official-account purchases in
might otherwise pass into the hands of inves-
the
available to investors interested in longer-term
tors attracted to shorter maturities. In this
way
the market and rate impact of exchanges to
1961-66 period thereby helped moderate
upward interest-rate pressures in longer-term
markets.
mod-
lengthen average maturities tends to be
erated.
Mainly through the advance refunding technique, almost $70 billion of bonds were sold
TABLE 2: CHANGES IN MATURITIES OF
MARKETABLE U.S. GOVERNMENT SECURITIES
HELD BY TREASURY OFFICIAL ACCOUNTS
(gross) from 1961 through 1966. These sales
shifted 1- to 5-year
coupon
issues primarily into
the 5- to 10-year area and 5- to 12-year maturities
mainly into the over- 15-year area, length-
ening the average maturity despite the net
new coupon
crease of only $4 billion in
in-
issues
and the shortening of the maturity structure
with the passage of
time.''
Treasury investment accounts. During the
1960's the Treasury also used
powers
—
Federal agencies and trust funds
to the
investment
its
in administering the portfolios of
—
some
to contribute
smooth functioning of the market and,
market absorption of new
at times, to assist in
issues.
Acquisitions by Treasury official accounts in
the
1960's rose to about 23 per cent of net
new Treasury
issues,
in the 1950's.
More
up from about
importantly, a
1
3 per cent
much
larger
share of these acquisitions took the form of
long-term securities; holdings of issues maturing in less than
1
year actually declined prior
Almost 60 per cent of net acquisitions
were in bonds maturing after 5 years, and
about 35 per cent had maturities in excess
of 20 years
both much larger than in the
1950's. These acquisitions, obtained through
exchanges and some in the market, accounted
to 1966.
—
for a large share of
securities
— about
new
issues of long-term
one-third of
ing after 5 years and about
all
bonds matur-
40 per cent
—
of those
Senior advance refundings that is, those in which
holders of 5- to 12-year maturities are offered longerterm issues have not been used since 1962 because
the previous exchanges sharply reduced public holdings of issues which could be used in such refundings
and because the core of the refunding problem is the
large amount of 1- to 5-year issues that require the
use of junior and pre-refundings. From mid-1965
through 1966, no new bond issues were used since the
4Vi per cent rate ceiling on bonds made it impossible
for the Treasury to sell longer-term issues.
*
—
Type or
maturity of issue
—
open market operations were conducted
in
System
tions as the
in
from
and purchased other
the early 1960's
such a way as to minimize the downward pressures on short-term rates from the day-to-day
time to time sold
provision of reserves to the banking system.
Federal Reserve open market operations:
maturity structure. As in the 1950's, most
Beginning
in late
1965, monetary policy be-
came increasingly restrictive as aggregate demands on resources rose sharply and pressed
on the available resources of the economy.
Reserves were supplied less rapidly, the discount rate was increased, reserve requirements
were raised on time deposits, and the ceiling
rates on time deposits became increasingly
restrictive on banks as market interest rates
rose during most of 1966.
Federal Reserve open market operations:
of activity. From 1961 to 1966, the
volume
Federal Reserve became a
much
larger factor
Government securities marhad been in earlier years. Not only
volume of gross transactions more than
Government
U.S.
of
the
but
its
net
System
absorbed
an
able securities,
this
period the
amount equal
over one-half of the net
new
of
acquisition
portfolio
Treasury issues rose sharply. In
less
Open
of
transactions
the
—
a greater pro-
involved
net purchases had involved
maturities of
more than
1
coupon
year.
issues with
From 1961
to
1966, the ratio averaged about 30 per cent;
was 85 per cent
No
in
1961 and almost 60 per
maturing after 5
by the System during the
1960's period, and sales of issues maturing in
1 to 5 years were infrequent.
years
1962.
was
security
sold
well
to
issues of market-
compared with
System
the
issues as the
cent in
double,
for
coupon
System attempted to avoid downward pressures on bill yields resulting from
reserve injections by the System. In the 195460 period, less than I per cent of the System's
portion
it
its
transactions
especially in the earlier years
ket than
did
securities.
Market Account in the 1960's involved Treasury bills. However, from 1961 to 1966
over-all in the U.S.
it
bills
than 5 per
cent from 1954 to 1960.
TABLE 4: MATURITY DISTRIBUTION OF FEDERAL
RESERVE SYSTEM TRANSACTIONS IN
U.S.
GOVERNMENT SECURITIES
Percentage distribution
TABLE 3: FEDERAL RESERVE SYSTEM
TRANSACTIONS IN U.S. GOVERNMENT
Total sales
SECURITIES
Annual averages
in billions of dollars, unless otherwise noted
Total
1954-60
Bills
Total transactions
Outright
Repurchase agreements
Coupon
34.7
14.9
5.6
9.4
of net
.2
2.8
4.4
58.3
new
marketable securities
While the increased scale of operations
flected the generally expansive stance of
tary policy
and the rapid increase
posits over the period,
in
in
re-
mone-
time de-
increased fluctuations
technical market factors
affecting reserves
required greater offsetting operations by the
System. Both float and currency in circulation
showed wider swings, and
the
gold
outflow
downward pressures on short-term yields influenced
the volume and types of open market transacaccelerated. In addition, efforts to avert
issues
maturing
16.8
17.8
Net purchases:
Volume
As percentage
100.0
100.0
100.0
100.0
lOO.O
100.0
93.0
83.9
97.3
94.1
87.3
69.5
1961-66
by
official
accounts in the 1961-66 period ab-
sorbed an amount equal to more than 80 per
cent of the rise in marketable Treasury securities
and so the public, on average, accounted
for less than
of the increase.
5: CHANGES IN OWNERSHIP OF
GOVERNMENT MARKETABLE SECURITIES
TABLE
U.S.
20 per cent
Owner
term assets than did Treasury and Federal Reserve
debt
management
combined.
activities
the rapid inflow of time
added to the
relative
and savings deposits,
stability
of
Moreover, the increased demand by banks for
yields in the
longer-term financial assets, which accompanied
short-term issues were drifting up.
1961-65 period when
long-term
yields
on
D
1| INTEREST RATES, 1954-66
I
I
I
TREASURY
BILLS
FEDERHL FUNDS
Monthly averages of daily or weekly figures except for mort(based on quotations for 1 day each month). Yields:
FHA-insured mortgages, weighted averages of private secondary
market prices of certain new-house mortgages converted to
annual yield; State and local Aaa-tax-equivalent, from Moody's
Investors Service, adjusted to a tax-equivalent basis assuming
gages
36 per cent individual income
calculated from bonds
Investors Service and
U.S. Govt, bonds, market yields
(20 years) by U.S. Treasury;
a
issues,
Moody's
rates
on 3-month
issues.
tax rate; corporate Aaa new
rated Aaa, Aa, and
by
adjusted to an Aaa basis;
adjusted to constant maturity
A
U.S.
Treasury
bills,
market
IV.
STRUCTURE OF THE DEALER MARKET
IN U.S.
GOVERNMENT SECURITIES
Not only were
there substantial changes in the
broad economic and
ing the
change
1960's,
in
environment dur-
financial
but these were also years of
narrower segments of markets and in
securities.
At
New York on
volume of trading, and borrowings. Five new dealers
two nonbank firms and
three bank dealer departments
entered the
industry during the interval, and three nonbank
firms withdrew. The net effect was to increase
—
—
competition in an already highly competitive
banks and other investors
apparently became more active in trading Gov-
ernment
securities for short-term gains
taking positions in
new Treasury
and
in
issues.
enlarged their shares.
dealers
Over
declined.
ers
The
erosion in
gate volume of transactions in U.S. Government
and Federal agency securities, the dealers became increasingly concerned during the 196165 interval as to 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.
Increased competition exerted a pervasive
on the dealer market during the balanced phase of the economic expansion that
lasted from 1961 to mid- 1965. The five new
influence
accounted for over one-fifth of
total
Government and Federal agency
1965 while the trading volume of
1961-65
the
interval
bank
deal-
accounted for a rising share of market acwhile the three leading nonbank firms
tivity,
experienced a roughly corresponding decline in
their
market share.
The primary
dealers provided important and
growing support to the Treasury's debt-lengthening operations from 1961 to mid-1965. In
the comparatively stable interest-rate environ-
ment of
the period, the dealers accounted for
about a third of
total public subscriptions
to
the longer-term option in regular exchange re-
fundings.
Despite a substantial increase in the aggre-
dealers
declined,
of trading in Treasury coupon securities also
Gov-
Reserve Bank of
industry. In addition,
activity
commercial banks
eight dealer departments of
their positions,
total
in
the end of the period
and 12 nonbank firms were making primary
markets in Government securities and reporting
to the Federal
—
market share of the top third of the dealers was
most pronounced in Treasury bill trading, in
which the risks are least, but their market share
particular in the dealer market for U.S.
ernment
nonbank
and
whereas both the medium-sized and smaller
Over the
interval the top third of the
dealers continued to account for an overwhelming share of the distribution to the public of the
longer issues. Other dealers
nonbank
more to
—appear
to
—both
bank and
have added considerably
their underwriting participation than
to their distributive capacity. In the Treasury's
advance refundings, too, the dealers were a
major source of support.
As was to be expected, once imbalances
began to develop in the economy and in financial markets in the second half of 1965, the
dealers experienced growing difficulty in maintaining orderly and smoothly functioning markets, particularly in intermediate- and longerterm securities. Expectations in 1966 became
more
and then progressively more ap-
volatile
prehensive about the impact of current and
prospective
Many
demands on financial markets.
and other active traders who had
dealers
contributed to the resiUency of the market ear-
withdrew from participating exbills, and even here their par-
activity in U.S.
lier practically
securities in
cept in Treasury
old dealers remained at about the 1961 level.
ticipation dropped. Thus, the functioning of the
The
Government
share of the top third of
all
dealers
—bank
securities
market outside the short-
term area came
a few
only
to
depend increasingly upon
borrowings and the fact that a large part of
make
the borrowings are overnight loans, which are
who
dealers
continued to
in all maturities
although on a reduced
strongly influenced by day-to-day swings in the
scale. Investors at times
experienced a notable
money
markets
deterioration in the market's willingness to bid
coupon isbelow those of
for Treasury securities, particularly
sues,
even at prices significantly
quoted markets.
The
changes within the dealer
dustry from 1961 through mid- 1965
ample, the entry of
dealers
—
—
in-
for ex-
new bank and nonbank
contributed importantly to the result.
The very heavy
at
times be faced
needs of dealers, with a consequent sharp de-
make
use of borrowed
money
char-
markets.
even in periods of tightening
market can successfully adapt to the
Normally,
in
that structural
market may
with a sudden shortage of funds relative to the
terioration in dealers' capacity or willingness to
deterioration in the market's perform-
1966 appears to be explainable almost
wholly on cyclical grounds. It seems doubtful
ance
position of banks, also raise the danger
that the dealer
credit, the
relatively gradual
that develop.
Still,
changes in dealer loan terms
in
order to provide as large
a cushion as possible, dealers have attempted
to
broaden their sources of financing; they obfrom banks in leading money cen-
tain funds
servation of capital a dominant consideration
from other banks, from nonfinancial corand from others. During the 1960's,
however, there were no major shifts among the
sources of nonbank dealer financing and no
become
great enlargement in the availability of funds.
dependence of the dealer
about half of dealer positions, and banks both
of the industry encourages a large
acteristic
volume of
loss are small
for
when risks of
or moderate but makes the con-
stabilizing speculation
most participants when such
risks
ters,
porations,
Nonfinancial corporations continued to finance
large.
The very
great
New York
market on borrowed funds helps to transmit the
effects of monetary policy to markets. Official
inside
and outside of
much
of the remainder.
moves toward
either stimulation or restraint are
continued to obtain financing from time to time
transmitted very rapidly to financial markets as
through repurchase agreements with the Federal
borrowed funds lead
Government securities dealers to change prices
at which they will buy and sell securities and
to raise or lower their positions by sometimes
large amounts. But this very dependence on
Reserve System
changes
in
the cost of
at the
City financed
Nonbank
System's
dealers also
initiative.
Bank
dealers generally finance their positions through
use of bank funds, and these funds are costed
in a variety of
ways. But by and large the cost
appears related to the Federal funds
rate.
D
VIEWS OF MARKET PARTICIPANTS
V.
The changes
management
monetary and debt
in the use of
instruments,
policy
in
the
eco-
nomic environment, in the behavior of banks
and other institutions, and in the dealer market
itself in
the
first
many
half of the 1960's raised
questions in the minds of participants in the
Government
lyzing
how
securities market.
To
help in ana-
these changes were influencing the
Government
securities
whether
market,
ate-
and long-term Treasury coupon
deteriorated
during the
Treasury.
Federal Reserve transactions
coupon
in
Treasury
or unique to particular groups, and whether
market for such
securities
were issues susceptible to amelioration
through policy action, the Treasury and Fed-
and subject
sharp fluctuations
Reserve sought the views of
all
the U.S.
Government securities dealers as well as
large number of institutional investors.
VIEWS OF
U.S.
of a
20 primary dealers
GOVERNMENT
ties
naire
in
summer
of 1966,
Government
U.S.
some
securi-
submitted written replies to a questionand participated in individual meetings
with
officials
Reserve.'"'
of the Treasury and the Federal
The
dealers
presented their
dealers
tended to be destabilizing since the
to
was
relatively "thin"
Moreover,
transactions.
large
to
securities,
in
response
even when
actual Federal Reserve operations were small,
some
dealers felt that their potential size and
possible policy implications tended to dominate
SECURITIES DEALERS
In the spring and early
alleged,
longer-term
many
developing problems were permanent or temporary, whether problems were broadly based
eral
had
most often cited for this worsening were the
abandonment of the "bills usually" policy by
the Federal Reserve in favor of transactions in
all maturity areas of the market and the too
frequent use of advance refundings by the
any
there
issues
The reasons
1960's.
views
on a wide range of topics and made a number
market psychology, to create uncertainty in
the minds of market participants, and thus to
undermine initiative in forming independent
judgments about market trends based upon
underlying economic forces. A number of
dealers conceded that relatively small operations in longer-term coupon issues might not
be unsettling so long as they remained marginal
and were conducted in a manner that
did not imply an attempt to control
clearly
of proposals for improving the functioning of
longer-term interest rates. In this connection,
many dealers had no real quarrel with the
the market.
relatively
Market performance. Most
felt
of the dealers
that the secondary market for intermedi-
= These
included the
Bankers Trust Company,
bank dealers:
York; Chemical Bank
following
New
Illinois NaBank and Trust Company of Chicago; The
First National Bank of Chicago; First National City
Bank, New York; Harris Trust and Savings Bank,
Chicago; Morgan Guaranty Trust Company of New
New York
Trust
Company; Continental
tional
York; United California Bank, Los Angeles; and the
following nonbank dealers (all with head offices in
New York): Blyth & Co., Inc.; Briggs, Schaedle &
Co., Inc.; Discount Corporation of New York;
The First Boston Corporation; Aubrey G. Lanston &
Co., Inc.; Merrill Lynch, Pierce, Fenner & Smith,
Inc.;
New York
Pollock
&
Hanseatic
Corporation;
Wm.
E.
Quincey & Co.; D. W.
Salomon Brothers & Hutzler; and
Co., Inc.; Chas. E.
Rich & Co., Inc.;
Second District Securities Co.,
Inc.
more
limited transactions in
coupon
which the Federal Reserve had carried
out since the fall of 1965. A few dealers remained convinced, however, that the Federal
Reserve should intervene in the market for
issues
longer-term issues only to avoid or to correct
"disorderly" market conditions.
Treasury advance refundings introduced in
had also proved detrimental to
the early 1960's
the functioning of the
coupon
issues,
generally
many
conceded
secondary market for
dealers thought.
that
advance
It
was
refundings
were an excellent debt management device, but
one that had been used too frequently and on
too massive a scale in the 1960-65 period.
a result,
many
As
investors were able to satisfy
their portfolio objectives without going to the
secondary
Moreover,
market.
tended to be concentrated
and in the
market activity
intervals
ings,
in
trading
had
periods of financ-
between such periods
longer-term securities had
in
allegedly tended to atrophy.
Several dealers, while conceding the primary
importance of monetary and debt management
objectives, felt nevertheless that the
tation
much
objectives
these
of
implemen-
had involved too
1961-
intervention in the market in the
65 period, and
had been given
that not
enough consideration
impact on the functioning of the secondary market for Treasury cou-
pon
to the
long run, a well-functioning
issues. In the
secondary market was deemed essential to the
execution of both debt
effective
and monetary poUcy
market and other closely related
profits and necessarily remained active in the market in good years
and bad.
A number of dealers emphasized that even
the Treasury
markets for their
though they
ury
Among other developments viewed as detrimental to market performance was the relative
decline in holdings of Treasury obligations by
the functioning of the Treas-
felt
had
market
1960's, the market
still
deteriorated
in
the
performed quite well
view of the many obstacles it had to overcome. Most of the dealers also stressed that
the market for Treasury bills had continued to
function exceptionally well in recent years and
in
were continuously able to exevolume of business at, or very
prevailing market quotations.
that investors
cute a large
close to,
management
objectives.
bond
Most
of the dealers noted that the secondary
market for Federal agency securities had improved substantially in the 1960's when considerable growth had occurred in amounts of
agency issues outstanding. Some dealers did
commercial banks, considered to be the mainstay of the secondary market and the principal
express objections to the basic idea of issuing
lenders of securities to dealers. Concomitantly,
stead of direct Treasury obligations to finance
of intermediate- and long-term
had been acquired by traditionally
less active market participants such as pension
funds and official accounts. The trading activity
of institutional investors was further curtailed,
dealers maintained, by the generally narrow
interest-rate fluctuations over most of the
1961—65 period, which reduced opportunities
for profitable portfolio switches. Moreover, the
Government
blocks
large
securities
gradual
uptrend
in
yields
over
the
period,
which accelerated after mid- 19 65, discouraged
trades by investors reluctant to realize book
losses on their security holdings.
On
the positive side, at least from the stand-
point of investors, several dealers pointed to
the
competitiveness of the market
increased
during the 1961-65 period. In part, this was
related
new
to
the
establishment of several large
dealer firms, including dealer or quasi-
relatively
tures.
new Federal agency offerings during the
half of 1966. They believed that this concentration of new issues had contributed importantly to the upward escalation of interest
of
first
rates in that period.
Profitability
ices to customers,
nonbank dealer
might tend to displace the
firms,
who looked
primarily to
dealer operations.
The
narrow market fluctuations over most of the 1960-65 period and a
gradual uptrend in yields had made profitable
operations diflicult to achieve. The major
source of dealer profits, they noted, was the
correct anticipation of market swings from
which dealers could benefit through appropriate
adjustments
most sizable
profits
in
their
inventories.
The
were usually realized
periods of falling interest rates,
when
in
the value
of debt securities held in portfolios appreciated.
it
ing and the rendering of a wide range of serv-
of
dealers observed that
were alleged
to enjoy certain competitive ad-
expendi-
dealers also decried the bunching
Dealers found
vantages such as more ready access to financ-
quasi-Government
or
Many
some major banks. Concern was expressed that bank dealers, who
dealer departments at
Federal agency debt in-
expensive
it
much harder
to operate prof-
itably in periods of rising interest rates, since
was always technically difficult to build up
and maintain sizable net short positions.
Moreover, in periods of tight money market
conditions,
financing costs of dealers rose in
relation to interest returns
on
their inventories.
—
18
such times dealers often experienced a
vestment accounts and/or the Federal Reserve
"negative carry" on their inventories. Dealers
undertake to lend such issues on commercial
and
at
expressed
also
serious
about
concern
ability to find sufficient financing at
in periods of very tight
their
any cost
money market
condi-
mid-1966. Since the
tions.
firms
make
the necessary funds
directly or through banks.
difficulties
profitable
diversified
cluded higher minimum denominations for
Treasury obligations, more bunching of orders,
greater use of computers, and possibly the es-
the Federal Reserve
The
notably the
dealers,
auto-
transac-
Accordsaw an urgent need for
resort" and recommended that
ingly, several dealers
either
Many
securities
essential to
is
their continued functioning as dealers.
available
of dealers also urged that
accelerated toward a fully
and bank dealers, viewed odd-lot transactions as a costly and growing problem.
Suggestions for alleviating the problem in-
inventories, access to financing
a "lender of last
number
mated system for clearing
nonbank dealers, in particular, depend upon
borrowed funds to carry virtually all of their
tions such as prevailed in
A
terms.
progress be
encountered
operations
achieving
in
during the
1960's
had
tablishment of a central odd-lot house.
Dealer comments about the few brokers
who
are used as intermediaries for the purpose of
anonymous trading
of relatively small amounts
Some
compelled a number of firms to re-assess their
of Treasury
continued functioning as full-fledged dealers,
dealers stressed that brokers provided a useful
and indeed several firms reduced their activity
coupon issues after mid- 1965. However,
many firms remained quite optimistic about the
source of information about the market, while
long-run prospects for profitable operations in
rarily to the
in
coupon
issues varied widely.
other dealers noted that the brokers could be
used to influence market prices
at least
tempo-
advantage of individual dealers.
U.S. Government securities, and the profit ex-
Dealer views concerning a dealer association
perience of most firms improved markedly in
which might help to oversee market practices
were quite diverse. Many dealers stressed the
legal difficulties under the antitrust laws of
late
1966 and 1967.
Dealer views and suggestions on various
other topics. Many dealer recommendations
centered on a desire to obtain as much information as possible concerning the nature and
forming
an
such
Treasury
tage to be gained
Government
some
Accordingly, most of
the dealers urged that the Trading
Desk
iden-
active
sponsorship,
loss of
and appeared to envision
autonomy
as
members
of such an
association.
the accounts for which
it was conducting
namely Federal Open
Market Account, or "customer" accounts such
as Treasury investment accounts and foreign
official accounts. A few dealers recommended
that an approximation of the likely total
amount of each operation also be given. The
dealers alleged that such information was
important to them since the market impact
tify
without
Reserve
whereas some dealers saw no significant advan-
scope of Federal Reserve operations in U.S.
securities.
association
Federal
or
significant transactions,
of operations for the
FOMC
could
differ sig-
from that of similar transactions for
customer accounts where monetary policy was
nificantly
their
comments
About 400 major
U.S. Government
on
trading
facilities,
institutional
securities
investors
responded
in
a
to
mail questionnaire sent to them in mid-1966.
These investors submitted
ing
the
functioning of
Government
securities,
fundings, and official
operations
issues.
in
their views concern-
the
market for U.S.
Treasury advance re-
—System and Treasury
outstanding
Treasury
The questionnaire focused on
1961-65,
not a consideration.
In
VIEWS OF INSTITUTIONAL INVESTORS
but
comparative
also supplied for the period
coupon
the period
information
1955—60 and
was
for
several dealers noted the difficulty of borrow-
mid-1965
ing certain securities to execute short sales in
Institutional investors and the U.S. Government securities market. The question-
normal course of making markets for their
customers and proposed that the Treasury inthe
to
mid-1966.
naire sought information concerning both the
extent of participation by institutional investors
in the
and
market for U.S. Government obligations
the attitudes of these investors concerning
the functioning of the market.
The responses
lesser but
ance
Government
U.S.
fourths of the total
securities.
About threevolume reported appeared
be transacted through the primary dealers.
Nondealer commercial banks accounted for
to
a
preference
conducting
for
their
market operations through the primary dealers.
It was also found that the number of dealers
used by individual institutional investors was
directly related to the size of the investor firms.
While only 40 per cent of the firms
in
the
survey executed their transactions with six or
more primary dealers, these firms accounted
for more than 70 per cent of the holdings and
nearly 90 per cent of the trading of all the
Many
Among
by the
the criteria cited
transactions, price
Many
tant.
was by
institutional
institutions,
far the
most impor-
notably the smaller
in
and even primary importance to "other banking or financial business
with primary dealer or bank." Even so, the
apparently overriding importance of price for
major
institutional
along with the
investors,
tendency of the largest investors to distribute
among many
their business
dealers,
the hypothesis that the market
petitive.
About
highly
com-
half of the respondents felt that
among
competition
is
supports
the dealers had increased
during the 1960's, and only 7 per cent believed
such competition had decreased.
With reference
to
investors' ability to exe-
cute transactions, a majority of the respondents
felt
had been no change during the
there
of the invitation
suggestions
for improving
single
comment was one
of satisfaction with
the market.
Some 60
advance refundings.
in
per cent of the institutional investors
the survey reported that they had partici-
in
pated in Treasury advance refundings. These
among
investors tended to be
the larger institu-
and accounted for 85 per cent of the
survey group's market activity in 1965 and
72 per cent of its holdings of Government setions
Nearly
curities.
all
of the institutional investors
in the survey indicated either a favorable opin-
ion of the advance refunding technique or at
least a neutral attitude
toward
it.
large majority of the institutional investors
reported that advance refundings had not affected
trading
their
in
outstanding issues or
had actually increased such trading. Some of
the larger institutions were among the small
minority suggesting that advance refundings
had tended to decrease their secondary market
activity.
Influence of Treasury and Federal Reserve operations in coupon securities.
A
majority of the respondents reported that
their investment operations
were not affected
by Treasury or Federal Reserve transactions
those that were influenced tended to include
the
larger institutions.
Some
felt
that
oflScial
activity in the
market had tended to increase
their
to
ability
ability
execute
however,
balance,
to
those
transactions.
reporting
conduct their investment
activities
were willing to undertake. However, an impor-
market trading, and
minority concentrated
among
the
larger
investors felt that dealer willing-
ness to execute large transactions had deteriorated
in
all
maturity sectors of the
official
fact
total
suggested that
coupon area may have
reduced over-all trading by institutional investors to
market
Most
A
affected
during the mid-1965 to mid-1966 period.
activity in the
this
On
decreased
tended to account for a larger share of
institutional
in
outstanding Treasury coupon obligations, but
1960's in the size of transactions that dealers
tant
to
functioning of the market.
the market were made, but the most frequent
A
also gave high
size,
of the respondents to the question-
comment about the
Numerous specific
firms responding to the questionnaire.
investors in the selection of dealers to execute
had begun to deteriorate
issues
Participation
showed
larger institutions in the survey
distinct
coupon
in
naire availed themselves
most of the remaining business.
The
important number of generally
eariier in the decade.
indicated that a large part of the secondary
market transactions of institutional investors
were executed through the primary dealers in
still
larger investors also felt that dealer perform-
some
extent.
of the institutional investors
by
official activity in
who were
the market indi-
20
cated that their judgment of the course of interest rates
was influenced
Some
a "few weeks."
investors, generally in-
cluding smaller institutions, reported that their
expectations
tended
to
be influenced
a
for
D
period of a "few months."
OVER-ALL PERFORMANCE OF THE MARKET
VI.
As
for a "few days" or
a basis for analyzing the performance of the
U.S. Government securities market, not only
were the opinions and experience of dealers
and investors solicited but also statistical analyses were undertaken of the behavior, during
the 1950's and the 1960's (to 1966), of such
aggregative data on the market for U.S. Government securities as the volume of trading,
dealers' positions, and security prices. In particular, an effort was made to evaluate how
market performance was affected by the changing character of Treasury debt management
policy and of open market operations of the
market have been described
ing
as
"depth,
breadth, and resiliency," with these qualities
defined in terms of orders on the dealers' books.
The market
possesses depth when there are orders,
actual orders or orders that can be
readily uncovered, both above and below the
market. The market has breadth when these
orders are in volume and come from widely
divergent investor groups. It is resilient when
new orders pour promptly into the market to
take advantage of sharp and unexpected fluctuations in prices.'
.
.
.
either
Federal Reserve.
The analysis focused on the following specific
market indicators: the daily-average volume of
trading, the annual rate of turnover of the marketable U.S. debt, the 16th lowest daily volume
trading
of
each quarter," dealers'
in
Given the
hmitations of data availability, each indicator
was selected
sential
and
in
measured an esoperational characteristic of the market
part because it approximated desirable
in part
because
it
or undesirable attributes of the market. Since
performance
may
vary greatly in different seg-
ments of the market, the indicators were examined on a quarterly basis for selected maturity
classes
of U.S.
Government
other securities maturing in
securities
years,
and
profiles of
maturing in
1
1
securities
year or
—
bills,
less,
and
to 5 years, 5 to
as defined
by
the indicators, for each maturity class.
Key
characteristics of an efficiently function-
This indicator shows the low trading days; daily
trading would be below this level approximately 25
per cent of the time.
''
ing
and
itself
so rapidly and
discourages both short cover-
placement
the
In
*
it
of
offsetting
more general terms,
it
is
new
usually
agreed
that
Government
an
adequately
functioning
U.S.
market would have the
capacity to accommodate Treasury financings.
Federal Reserve open market operations, and
private
securities
investment transactions at reasonable
Such a market would be charwould
not exhibit extremely sharp daily price movements or very large spreads between bid and
speed and
cost.
acterized by continuity in trading and
asked prices suggesting investor or dealer unwillingness to maintain an active market. Al-
though lack of data on orders on the dealers'
books prevents development of statistical indicators directly measuring "depth, breadth, and
10
after 10 years. Charts 2 to 6 present
market performance,
menacingly that
orders."
large daily price changes, and the spread beprices.
the other extreme, in a disorderly declining
market, "selling feeds on
daily-
average positions, the frequency of small and
tween quoted bid and asked
At
1952 report of the Ad Hoc SubcomGovernment Securities Market. See U.S.
Congress, Joint Committee on the Economic Report,
Subcommittee on Economic Stabilization (Flanders
Committee), United States Monetary Policy: Recent
Thinking and Experience Hearings, 83rd Cong., 2nd
"From
the
mittee on the
Sess.,
1954, p. 265.
p. 268.
»Ibid.,
A
similar definition
disorderly rising market.
applies
to
a
—
Profile of
Market Performance, 1950-66
'50
I
For notes
'52
I
I
see Chart
'56
'SI
_
I
I
i
I
I
_ t
6.
were
do approximate some of
resiliency," the statistical indicators that
particularly
available for analysis
dealers in the
these technical characteristics, as well as the
time
more general
cal
signal
market
criteria.
At
changes over time
least
in
the
they
should
underlying
data reported informally by
1950's, and comparability over
not exact. Second, results of the
statisti-
regression analyses that were carried out
have to be interpreted carefully not only because of the data and other
characteristics.''
The conclusions with
is
the
statistical
problems
respect to market per-
but also because the results do not necessarily
formance based on analysis of the market indicators are summarized below. But two pre-
lems of dealers and their customers in the
cautions in interpretation are in order. First,
market.
adequately reflect day-to-day operating prob-
the data used were subject to inconsistencies,
Over-all, the
of deterioration
^ It should be noted that these definitions and the
selected indicators reflect activity of both dealers and
—
customers, since performance of a dealer market
as
distinct from performance of the dealers alone
depends on the behavior of the customers as well as
on the functioning of the dealers.
in
market showed few or no signs
from the 1950's to the 1960's
terms of the indicators studied. The indi-
showed few signs of
any long-term deterioration from the 1950's
cators based on trading
to the 1960's.
within
1
Only
in
coupon
issues
maturing
year was there clear-cut evidence of
[U.S.
GOVERNMENT SECURITIES (OTHER THAN
Profile of
8
1
Market Performance, 1950-66
BILLS)
MATURING
IN 1
YEAR OR LESS
M
^
U.S.
GOVERNMENT SECURITIES MATURING
I
Profile of
For notes
see
IN 1-5
YEARS
Market Performance, 1950-66
Chart
6.
period Studied. Thus, to the extent that ad-
over- 10-year issues, although this association
vance refundings made possible more long-term
was not
bond
The
offerings,
they contributed to a higher
average level of market activity. Treasury
fi-
1
statistically
1960's.
significant in the
stimulative impact in 5- to 10-
and over-
0-year bonds was associated with Treasury
nancings involving long-term bonds also ap-
investment-account operations; Federal Reserve
peared, however, to cause a widening of the
operations did not
spread between daily-average trading and trad-
ship to trading in these maturity areas.
ing on low days
—
as
measured by trading on
The
analysis of dealers' positions unearthed
little
saw a rise in trading on low days that was almost as much as the rise in the daily-average
volume of trading.
There was no evidence that official transactions in coupon securities caused market activity in the same quarter to dry up. On the
contrary, market activity
excluding official
activity
was positively related to official
from the 1950's
—
transactions in
bills,
5- to
10-year issues, and
significant relation-
or no evidence of secular deterioration
the 16th lowest day. Nevertheless, the 1960's
—
show a
perform-
to the 1960's in the
ance of dealers as gauged by their inventory
practices.'"
The raw data on
dealers'
daily-
average net positions showed a substantial
from the 1950's
to the
1960's in
categories with the exception of
1"
The
all
coupon
profitability of dealer operations
in Section VIII of this report.
is
rise
maturity
issues
discussed
U.S.
GOVERNMENT SECURITIES MATURING
IProfile of
Market Performance, 1950-66
IN 5-10
YEARS
g
U.S.
GOVERNMENT SECURITIES MATURING AFTER
Profile of
NOTES TO CHARTS
•
serve Bank of New York;
Division, Federal Reserve
quarterly.
"Trading volume:" Transactions include dealer purchases and
dealer sales, but exclude allotmenis of new issues, exchanges,
maturities, and repurchase agreements. Until mid-May 1960
securities were to be classified by first call date, thereafter
by
final maturity. Averages are based on the number
of trading
days in the quarter. Source: 1950 through mid-May 1960, Securities
YEARS
2-6
Indicates change in series.
Data are
10
Market Performance, 1950-66
Department, Federal Reserve Bank of
May 1960 on. Market
New York.
New
Statistics Division, Federal
York; midReserve Bank
mid-May 1960 on. Market
Bank of New York.
used m the calculations. Source, daily quotation sheets prepared by the Securities Department, Federal Reserve Bank of
New York and later by the Market Statistics Division, Federal
Reserve Bank of New York. The sizes of changes are as
follows:
of
"Turnover:" For coupon issues the annual rate equals daily
average gross dealer transactions multiplied by 249 divided by
marketable debt held by the public. Until mid-May I960
securities are classified by first call, thereafter by final
maturity. For Treasury bills the divisor is bills
outstanding.
"Dealers' net position:" Data are on a commitment basis and
include securities sold by dealers under repurchase agreement
since mid-May 1960. From 1950 through the fourth quarter
of 1960, however, some dealers may have reported differently.
Securities were to be classified by first call prior to mid-May
I960 and by final maturity thereafter. Averages are based on
number of trading days in the quarter. Source: 1950
through mid-May 1960, Securities Department, Federal Re-
the
Statistics
"Frequency of daily yield changes:" The 3-month bill and
usually two issues in each of the other maturity classes were
Chart 2
Chart 4
Charts 5 and 6
Large
Small
(minimum
(maximum
change)
change)
5 basis points
njo point
^fjo
point
1
basis point
';i2
-:tj
point
point
"Bid-asked spread:" The quarterly series were derived from
15th of each month (for Chart 3 on the
closest to the 15th). The typical spread is the one
that existed on the 15th of two out of the three months; or if
the spreads were different, the middle spread. Source: 1950
through February 1953. U.S. Treasury, Prices and Yields oj
Public Marketable Securities Issued by the U.S. Governrrtent
and Federal Agencies: beginning with March 1953, Board of
Governors of the Federal Reserve System, daily quotation
observations on the
Wednesday
sheets.
26
coupon market was there evidence of dealer
the
for Treasury
For the
bills.
coupon
show
less active
reduction of gross short positions as a result of
sector of the market, the available data
System purchases, though
no change
in several cases de-
were associated
clines in gross short positions
with Treasury trust account purchases.
The
day
or
in
(and yields)
in
during the
first
prices
security
in
few years of the
1
spreads on 5- to 10-year
around the same levels in the 1960's as
the 1950's, and a generally greater spread
over-10-year issues since 1958. However,
issues
dealers' response to the greater day-to-
stability
spreads on maturities of 5 years
in
less, fluctuation of
960's, through
mid- 1965, was to increase net long positions
rather than withdraw from the market. This rise
of available data on bid-asked
interpretation
spreads
price
caution
considerable
requires
do not always
since the quoted figures
reflect
probably reflected the lessened risk
the actual trading spreads in the market, with
of capital losses as well as an attempt to in-
the particular timing and size of trades having
in positions
— and
crease trading
riod
when
trading profits
—
pe-
in a
speculative profits were limited.
With respect
to
spreads between bid and
asked prices (or yields),
it
an influence on the quotations. The narrowing
of spreads, at least in the
appears that these
spreads declined from the 1950's to the 1960's
increased competition
active
other
market participants,
money market
area,
bill
among
may
reflect
dealers and other
as
well
from
as
D
instruments.
MARKET ACTIVITY BY TYPE OF DEALER
VII.
The Government
securities
market
composed
is
of a variety of dealers of differing sizes and
ownership bases. This section analyzes
how
pearing to offset reductions in holdings of securities
A
maturing in
1
to 5 years.
majority of individual dealers showed in-
coupon
transactions and positions of various types of
creases in average holdings of
firms related to the over-all performance of the
ties
market.
the 1960's. These dealers included both
Changes
tions in U.S.
in
individual dealer average posi-
Government
last half of the
securities
1950's and the
first
between the
part of the
1960's for the most part followed the trends in
the outstanding marketable debt in the various
maturity categories.
positions,
And
the variation in dealer
by maturity and type of
maturing in over 5 years
and nonbank
ever,
firms. It
securi-
in the period of
bank
should be noted, how-
that positions in securities maturing in
over 5 years were relatively concentrated, with
the three largest nonbank dealer firms holding
50 per cent of such positions on the average
during the 1961-66 period.
security, that
was not
did develop between the two periods
characterized by any consistent pattern of dif-
—
DEALER ACTIVITY IN PERIODS OF
MONETARY TIGHTENING
large or
In a further effort to analyze market perform-
holdings of most
ance by type of dealer, cross-sectional data on
positions and trading volume were compared
50 and 150 per
during periods of monetary tightening in the
cent from 1955-59 to 1961-66, and as a group
years 1955-59 and 1961-66. In such periods,
with free reserves declining and interest rates
ferences according to type of dealer
small,
For
bank or nonbank.
instance. Treasury
bill
dealers increased by between
bank
dealers'
positions
in
Treasury
bills
in-
creased in roughly the same proportion as did
nonbank
did
dealers' holdings.
increase Treasury
bill
Two
large dealers
positions
by con-
siderably greater relative amounts, in part ap-
rising, dealers generally
in at least
some
securities to
expected.
reduced their holdings
maturities of U.S.
below-average
Government
would be
levels, as
During the 1955-59 period, there was considerable diversity
categories in the
among
number
reduce positions and
in
the various maturity
who
firms.
did
adjustments during these turning-point periods
were limited to scattered individual dealers in
a few maturity categories. To the extent that
of dealers
were generally made by the large nonbank
During periods of monetary tightening
in the years
1961-66
nonbank dealers
the large
generally maintained considerably higher posirelative
tions
than they had
their average
to
1957 and 1959 and the troughs
1958 and 1961-62. Such
rates in
the magnitude of the
adjustments, although the largest relative reductions
interest rates in
in interest
any pattern existed as to the characteristics of
the dealers involved,
bank
both
firms,
it appeared that the larger
and nonbank, showed a
slightly greater willingness to
before the 1960's. At the same time there ap-
addition, even during the
peared to be some increase
1966 peak in
were adjusting
in
the extent to
which bank dealers and small nonbank firms
pared positions during periods of tightening in
the
The
to
some
when
1- to
in
dealers
made
rela-
and the most rapid position
5-year issues, and the large
nonbank dealers made the most'
IN
all
extent, the large dealers,
both bank and nonbank, generally
changes
BEHAVIOR AT TURNING POINTS
INTEREST RATES
speculative
months around the
interest rates,
tively the largest
1960's.
make
position adjustments than the smaller firms. In
substantial
additions to holdings of over-5-year maturities.
individual dealers included in this study
generally
made
fairly
in their portfolios
substantial
were clearly discernible
rates
up
built
adjustments
once turning points
—
that
in interest
is,
they
positions as interest rates declined and
reduced them as interest rates rose. However,
the evidence appears to
show
that dealers are
not always successful in adjusting positions in
TREASURY FINANCING PERIODS
All of the individual dealers
had above-average
trading activity and typically added significantly
their holdings of Government securities at
some stage in Treasury financing periods, from
announcement to payment or settlement date.
The largest increases in transactions occurred
to
anticipation of changes in the trend of interest
in
rates.
during the period from the announcement of
Only for the months around the peak in insummer 1966 was there any
broadly based evidence of dealers making fairly
the off'ering through the close of the subscrip-
adjustments prior to the
also resulted in a large rise in trading activity,
terest rates in late
large-scale
position
turning point in interest rates. During the period
just
before this peak, virtually
all
individual
dealers held very small positions in Treasury
bills
and also very small, or net short, positions
coupon issues maturing in
years. But as the peak in
in
1
and over 5
to 5
connection with rights exchanges, particularly
tion books, as dealers
and investors traded in
Cash financings
the issues eligible for exchange.
but
was
increase
the
generally
sustained
throughout the financing period.
The
extent of increases in activity and of
build-ups in position varied quite widely
individual
firms,
shown when
with
most
diversity
the financing included
new
among
being
rates
ap-
showed
evi-
with maturities in excess of 5 years. Although
dence of adding to their holdings, or reducing
showed quite diverse
and transactions during
Treasury financings, there was in general no
significant difference in behavior among bank
proached, almost
all
interest
of the dealers
or eliminating net short positions, in at least
some maturity
By
categories.
contrast, there
was no such broadly based
the
individual
patterns
in
dealers
positions
evidence of anticipatory position adjustments
and nonbank dealers
during the months around the cyclical peaks
various dealer-size groups.
in
issues
as a
group or among the
D
DEALER PROFITS AND CAPITAL AVAILABILITY
VIM.
While the position poHcies of dealers and the
trading volume in the dealer market indicate
little,
any, deterioration in market perform-
if
ance during the 1960's, the
to sustain a satisfactory
market
ability of the
performance depends
on operations being reasonably
profitable
so
the industry can maintain and attract capital.
narrowed with higher
rate levels
tendency for profitable carry
so that the
(the
difference
between interest earned on securities held in
position and the interest cost of financing them)
was lessened and eventually eliminated. Reports
however, indicate that the abrupt
1966,
for
drop
in security yields late in the
year led to a
very profitable period for dealers; this gave
PROFITS
support to the hypothesis that cyclical monetary
There was a deteriorating trend
in earnings of
U.S. Government securities dealers from 1961
through 1965, following several years of high
was a conThe principal
earnings. In 1966, however, there
rebound
siderable
in
profits.
conditions have dominated dealers' profit per-
formance.
In
long-term profitability in the
assessing
dealer
the
industry,
and
Federal
of
effects
private innovations in financial markets
more important. The extent
become
which
factors contributing to these developments are
relatively
noted below, with an attempt to evaluate the
Federal innovation, in the broad sense of
relative
importance
factors
as
public
markets
financial
in affecting profits of
and private innovations in
and cyclical interest-rate
movements as influenced by economic
tions and monetary policy.
A
such
fluctua-
from the
late
1940's, reveals a strong
new
and evolving fiscal and monetary action and
debt management, guided the prolonged expansion of the 1960's
interest-rate
—with
its
period of limited
movement from
about mid- 19 65
longer-run view of dealer profit perform-
ance,
to
—and
ket expectations
is diflficult
through
to measure. It
clear whether these essentially
produced
1961
doing so affected mar-
in
greater
or
is
un-
exogenous deciuncertainty
cyclical pattern of earnings, suggesting that the
sions
low
1960's were not
about rate movements and thus were a hin-
principal feature of the
drance or a help to profitable dealer operations.
profit levels of the early
out of pattern.
The
and uninterrupted interval of economic expansion, which
was accompanied by a generally rising and,
early
1960's was the extended
perhaps more importantly, nonvolatile level of
The wider
—
less
interest-rate swings since
more
mid- 1965
economic conditions and changes in monetary policy
led
perhaps to more uncertainty in markets but, at
associated with
same
volatile
more opportunities
—
for exper-
dealer
the
1961-65 inclusive, can be attributed
in great measure to the negative effects of declining security prices on dealer positions.
tise
of the dealer market in advising customers
and
in dealers'
Treasury
to affect dealer profits adversely in the first half
interest
rates.
The sharp reduction
in
profits, for
bill
yields rose in each of the 5 years
time, to
own
Developments
position policies.
in the
1961 through 1965, and long-term bond yields
of the 1960's.
moved
tivity of investable funds,
higher in every year but 1962. (In that
was some improvement in dealer
earnings.) Also in the 1961-65 period the
differential between long- and short-term rates
year,
there
The
private sector tended
greater mobility and sensi-
inherent in the growth
of Federal funds activity and expanded use of
certificates of deposit
flatter yield
curves for
by banks, contributed to
much
of the period and
29
1965 and
$86 milGovernment se-
to a relatively higher rate structure for financ-
lion in
ing positions. Both uses competed directly for
lion to their operations in U.S.
funds that otherwise might have been more
curities.
cheaply available to finance dealer positions.
third of estimated
Furthermore, the increased competition of these
ments,
instruments for short-term funds undoubtedly
capital requirements since the bulk of their po-
Bank
specifically allocated
who accounted
minimum capital
dealers,
in fact are
sition
quoted spreads for short-maturity U.S. Govern-
short, the
ment
able for margining securities
securities.
During the early 1960's, there was a further
increase in competition
from the entry of three
addition
the
This
of one
expansion
in
among dealers, arising
new bank dealers and
nonbank
sizable
numbers may
dealer.
also
have
brought increased pressure on spreads, while
cutting into existing dealers'
shares of rising
transactions.
require-
not actually subject to such
aggravated the pressure on dealers to reduce
financed
is
for one-
amount
with
own
their
funds.
In
of capital potentially avail-
for the industry as a whole,
enormous and,
is
is
not in
tech-
itself
a constraint on market performance,
nically
recognizing that dealer positions in securities
vary considerably over time in response to the
timing
of
changes
in
The
Treasury financing
market conditions.
and
new
dealers
available capital to
expand
willingness of both old and
actually to
commit
positions, however,
cyclical
largely unrelated to the
is
AVAILABILITY OF CAPITAL
amount
Despite the decline in profits during 1961-65,
of capital has practical significance only to the
the long-run outlook apparently remained satis-
extent that those with control over the capital
factory enough so that the
amount
of capital
possessed by nonbank dealers plus that potentially
available
remain well
to
bank dealers appeared
in excess of
probable needs in the
foreseeable future. Estimated
tal
minimum
capi-
requirements for supporting dealers' daily-
average positions
—
to
—preponderandy
short-term
1965 were between $40 million and $45
Of this total, nonbank dealers represented about $30 million. The nonbank dealers
reported an aggregate net worth of $261 milin
million.
technically available.
are willing to
Capital
is
commit
financial industries,
in
particularly so for diversified
as well as banks.
capital
the
is
availability
to dealer operations.
it
very mobile
The
nonbank dealers
Thus, the extent to which
committed
will
depend very much on
circumstances of the
moment
—
the profit
outlook and alternative investment or underwriting opportunities.
uses
did
not
exist,
And
even
"dormant"
some conditions may be
to expand positions.
if
alternative
capital
less costly
than
under
if
used
D
IX.
The dealer market
Government
for U.S.
ties as sucli is relatively free
securi-
of direct supervision
and regulation from governmental units or privately formed associations or groups, although
the banks and securities firms comprising the
dealer market are otherwise subject to a variety
of laws and regulations, including those administered through bank supervisory agencies
and the Securities and Exchange Commission.
Moreover, both the Treasury and the Federal
Reserve have available to them a considerable
body of continually reported financial data
from the various dealer firms. And the trading
staff at the
Federal Reserve
—which not only
erations for the
Bank
FOMC
of
New York
open market op-
carries out
market transactions
but also undertakes
as agent for Treasury
foreign official accounts
—
is in
contact with the market and
and
continuous daily
is
in
a position to
observe market behavior as reflected in bids
and
MARKET
OFFICIAL RELATIONSHIP TO THE
offers to the
Trading Desk.
The Trading Desk does not undertake
trans-
discontinued
when
trading
individual
dealers
made such
ac-
The System Account Manager
tion advisable.
in
with
deteriorating performance
New York
bears the responsibility for in-
forming the Treasury and the Federal Reserve
of undesirable
market practices or
financial
and
other market problems which affect any individual dealer or which appear to be developing
more
generally.
Among
the
statistics
reported by each in-
dividual dealer firm are daily reports on posi-
borrowing, and activity for Treasury bills
and Treasury coupon issues by maturity category. In addition, annual balance sheet and
income data are reported by the dealers, and
more frequent reports will be possible as efforts
tions,
to obtain consistent reporting progress.
of this statistical material has been
Much
reported
recommendations in the previous
Treasury-Federal Reserve study of the
market at the end of the 1950's, and the mateas a result of
joint
rial
has
provided
a basis
for
evaluation of
actions with dealers until they have a proven
market performance, including analyses under-
record of performance, and
taken in the current study.
it
has in the past
—
POLICY ISSUES, CONSIDERATIONS, AND CONCLUSIONS
X.
The
2
various policy issues that were considered
comments
market participants
and the Steering Committee's evaluation of the
market's performance are discussed below,
Treaswith conclusions, under five headings
ury debt management operations. Federal Rein light of the
of
—
serve open market operating techniques, availability of financing to the dealer
market, im-
provement of technical market performance,
and continuing evaluation of market perform-
—Of
the 400
Government
U.S.
as part of the
market surveyed
securities
staflF
studies,
about 60 per cent
participated in advance refundings. Less than
5 per cent reported an unfavorable attitude
toward advance refundings. Less than 15 per
cent reported that advance refundings had re-
duced
their transactions in outstanding issues,
while about 20 per cent indicated that advance
refundings had increased their secondary market activity.
ance.
institutional investors in the
The remaining 65 per
cent re-
ported that advance refundings contributed to
TREASURY DEBT MANAGEMENT OPERATIONS
no change
A:
When
other trading.
in their
allowance
is
made
for the relative im-
market of the investors included in the above percentages, broadly the
same results are obtained. For example, the
institutional investors whose secondary market trading was decreased by advance refundportance in the
Advance refundings were the principal aspect
of Treasury debt management operations considered. The advance refunding technique was
perhaps the most important debt management
innovation of the 1960's. It was also one for
which a few dealers advocated more hmited
use on the grounds that frequent and large adand sometimes appeared to, impair the performance of the secondary market for U.S. Government securities,
since with advance refundings investors might
vance
refundings
make a
could,
large portion of their portfolio adjust-
ments direcdy with the Treasury rather than
27 per cent of
total activity
who
indicated
counted
Finally,
for
increased
market
per
of
31
investors
cent
who were
advance refundings
—
less
ac-
activity
total
trading.
not in favor of
than 5 per cent
accounted for only about 8 per cent of the
trading volume reported by respondents.
3
Advance refundings have undoubted ad-
—
variety of other debt
vantages for the Treasury, including especially
proposals, pertaining to such tech-
the ability to time offerings so as to enhance
and maximum
auctions, were also
debt-lengthening opportunities without placing
through the market.
management
A
ings accounted for
reported in the survey, whereas those investors
nical items as bill strip financing
allotments to bidders in
bill
considered in the course of the study.
undue pressure on
interest rates. Further,
it is
possible to maintain contact with existing holdof debt outside the short-term area
ers
ADVANCE REFUNDINGS
—
in-
ducing those holders to take something longer
-instead of trying to sell long issues to hold-
—
•
Considerations:
1
—
ers of
Staff studies did not indicate
any
signifi-
cant reduction in over-all market activity associated with Treasury financings in the
area,
including
coupon
advance refundings. In
fact,
up new
maturing issues or to investors putting
cash. In short, the technique is suited to
maximizing debt-lengthening opportunities with
minimum market disruption or churning.
—
4
Dealers in Government securities recog-
and
nized the advantages to the Treasury of ad-
long-term coupon issues appears to have in-
vance refundings; most dealers did not raise
objections to advance refundings as such, but
secondary market trading
creased in the
1950's.
in intermediate-
1960's as compared with the
were more concerned with too frequent or too
massive a use of the advance refunding technique of debt management.
—At
the same time, it may well be that
management objectives would be served as
well, or even better, by somewhat more moder-
5
debt
advance refunding device than
ate use of the
prevailed at times in the 1960-65 period. Investors might be induced to
make maximum
use of each advance refunding opportunity as
it
in some of these, the bills were sold with payment permitted through crediting tax and loan
and this was intended to make the
accounts
—
money
of
way
not so simple a
bill strip is
tax-anticipation
a
say,
as,
to raise a bloc
bill,
it
would appear from experience that dealers as a
whole have not encountered undue difficulties
in pricing and trading the bills sold in strips.
2
occurs rather than to wait for the "next time
around."
While a
offering as readily salable as possible.
—With
1-year
respect to the size
and frequency of
auctions, there has been recurrent
bill
ness to investors and in view of the absence of
some of it inconsistent. For example,
some observers say that the amounts auctioned
each month are too large to be digested
smoothly before the next auction comes along.
Others assert that the bills sold each month are
soon locked in relatively permanent hands and
become virtually unavailable for trading. An-
any evidence that they disrupted the Govern-
other criticism
ment
comes
criticism,
Conclusions:
1
—Advance
refundings should be retained
as a technique of debt
management
their advantages to the
Treasury and attractive-
2
in
view of
securities market.
—Consideration
should
continue
be
to
monthly
that the
is
an awkward time
at
sale often
relative to other
Treasury financings and particularly that the
given to the impact on the Government securi-
timing makes
market of large and/or very frequent advance refundings.
option for the regular quarterly refundings that
ties
it
announced
are
difficult to price a
at the
end of the
short-term
month
of
amount
of
first
each quarter.
CERTAIN OTHER DEBT MANAGEMENT
TECHNIQUES
I
Considerations:
1
—With
multaneous
strip that
maturity),
On
the other hand, a significant
Treasury financing
-year
bills.
the 1-year
respect to
bill
strip financing
(si-
sale of differing bill maturities in a
includes equal amounts of each
some
gard the sale of
active
bill strips
as an
at times a relatively difficult,
ury to raise cash.
bill
market participants
From
re-
$100
made
ticular,
1-year
after
months
3
are
issues
bill
9-month
as
million in weekly increases
1960's,
when
offerings in the bill area in order to
its
the
debt
keep short-
And by coming
bills
to
meet
—adding
to
without overloading
must handle.
each month, the current sched-
ule of 1-year bill sales has attained
some degree
manage-
of routineness that permits other debt
ment and monetary
This
is
auctions of yearly
their size
bills
and timing,
other debt
3
steps to
go on unhampered.
preferable to larger and less frequent
—With
term rates from dropping too low, there was
bills
some conscious use of the bill strip as a further
means of keeping bill rates higher than they
otherwise would have been. This motive did
last several
in later bill strip financings. Indeed,
1967-68,
now reopened
bills
the initial supply that the market
management
in
certain of the objections noted above. In par-
for the Treas-
way
Treasury was deliberately concentrating
not figure
in fact
and these have gone some distance
the tradability of the
a debt
to raise funds. In the early
modifications in the use of
were
awkward, and
viewpoint, the sale of bills in strip form has
been a convenient way to raise some money
through enlarging the bill cycle, by doing it all
at once rather than waiting for the gradual
effect of, say,
Some
bill
being achieved by sale of
is
which might, because of
interfere significantly with
management
respect to
operations.
maximum
allotments of
to individual dealers in auctions, for the
years the Treasury has had an in-
formal guideline that single bidders would not
be able to purchase more than about 25 per
cent of the amount auctioned. There has been
comment
occasional
remove
to
this
that
it
limitation
would be desirable
order
in
to
give
greater scope to dealers and investors in reacting to market forces. Further,
that the rule
some bids
is
it
is
pointed out
cosdy to the Treasury
in that
are reduced in favor of lower bids.
From an
market viewpoint, however, an undue concentration of the immediate
over-all
floating supply in the
work
hands of one dealer could
to the detriment of the
Government
A
that
curities market.
major asset of
se-
market
ple of subscription lines to dealers, the lines to
nonbank
revamped within
dealers have been
the past few years to give explicit recognition to
performance in taking positions and
dealer
making a market, and not
just to the capital
had been the
structure of the dealer, which
chief guide earlier.
—
5
With respect to cash refundings, some
market participants have suggested that they
be eliminated. Small and medium-sized investors
have often voiced a preference for being
new
from the viewpoint of investors is the flexibility
and availability of supply. It could be shortsighted to sacrifice this for the benefit of an
immediate gain in terms of a possible higher
able to subscribe for
price to the Treasury.
cash refundings. The percentage allotment sub-
But there
is
per cent limit;
bility
it
nothing sacrosanct about a 25
can be administered with
as circumstances warrant.
principle, too high a limit
As
flexi-
a general
would permit con-
centration of an issue in the hands of one or
two
limit might unduly
market forces and the
ability of the dealer market to obtain sufficient
bills to service corporate and other investors.
dealers, while too
low a
inhibit the free play of
—With
4
Treasury
respect to subscription ceilings in
cash
financings,
where holders of
maturing issues do not have pre-emptive rights
to obtain the
new
securities, subscriptions are
with
issues in a refunding
knowledge
certain
they
that
awarded the amount they tender
a percentage allotment, as
jects the
jective
be
the practice with
is
buyer with a specific investment ob-
in
mind to considerable
know how large a
uncertainty,
as he does not
amount of
subscription
be sure of getting a speci-
to enter in order to
fied
will
—and not
for
the issue. Typically, the Treas-
minimum amount
ury awards a certain
in full,
say $50,000 to $100,000, and this can take
care of the needs of the smallest subscribers,
but even this practice produces some degree of
uncertainty
subscriber
the
as
usually
awarded
From
is
not
much may be
informed ahead of time how
in full.
the
Treasury's
standpoint,
cash
re-
generally limited for different categories of sub-
fundings have advantages and drawbacks com-
Government securiMarket StatisFederal Reserve Bank of
pared with exchange refundings, and on each
commercial banks, tender
advantage of avoiding
scribers.
Primary dealers
ties
who
tics
Division of the
New York
for
may,
like
an amount of the securities without de-
posit,
set
in
regularly report to the
but they are limited by subscription lines
by the Treasury with the advice of the
New
York Federal Reserve Bank. In
general, this
limitation as to subscription lines
is
needed
to
financing occasion there are pros and cons to
be weighed.
A
cash refunding has the major
attrition
issues fail to
refunding offering,
if
that
is
desired.
The cash refunding also lets
the amount of each new issue
which could lead to domination of the
market by a few and impair the secondary market for the new issue. At the same time, relief
from a deposit requirement permits active par-
may be an advantage
issue,
by nonbank dealers, who generally
operate on thin margins of capital and are key
underwriters of Treasury issues.
While there is little reason to alter the princiticipation
a net payout
The cash refunding also permits the Treasury
to raise some extra cash in connection with the
keep the primary dealers, or particular firms in
the dealer group, from absorbing too much of
an
—
some holders of the maturing
turn them in for the new offering.
of cash because
the Treasury set
to be sold. This
or not, depending on the
it may
how much
circumstances. In an uncertain market,
be desirable to
let
the market decide
of a particular issue
tain
situation
may
is
desired.
also be
But an uncer-
a useful time for
the Treasury to provide some guidance to the
market by setting the sizes of different issues.
It might also be argued that the cash refunding
—
34
is
fairer in that
scribe for the
permits
it
new
all
investors to sub-
not just those
issue,
who
hold or acquire the maturing issues.
6
—With
payment
respect
for
when
can be made
those instances
to
new Treasury
issues
of underwriters
would
broaden
sufficiently
total
interest so that the over-all average price paid
would be any higher. It may also be questioned
it
would be equitable for nonbank
whether
dealers to have a special subscription price that
not accorded to other nonbank subscribers as
by commercial banks through crediting U.S.
Government tax and loan accounts, rather than
well. Finally, in
by cash payment to Federal Reserve Banks,
tion,
the question has been raised as to whether this
not the bank dealer department, that would
does not work to the disadvantage of nonbank
dealers. If a
bank can subscribe
to a
new
issue
by crediting the Treasury's tax and loan account, the subscribing bank has the use of the
newly created deposit for a number of days
perhaps 7 to 20 days
until the Treasury calls
the money into its working balance at the Federal Reserve Banks. The use of this deposit
—
has a value to the banks, and they are willing
to
pay a
higher price for the securities in
little
order to obtain the deposit.
then generally
it
is
an issue of
secondary
The banks
will
the securities, particularly
sell
at a
bills,
market,
at
lower price
if
in the
which point nonbank
is
terms of interdealer competi-
should be noted that
it
the bank, and
it is
secure any benefit from the tax and loan privilege.
On
balance,
the
method of
counts of banks provides a useful and economi-
means
cal
for facilitating the underwriting of
large Treasury cash issues. Moreover,
nonbank
dealers are able to participate in the secondary
market distribution of such
The bulk
issues.
count privilege are normally resold by banks to
dealers, who are then able to provide
nonbank
their
to
customers with the new
coupon
issues,
the
With respect
bills.
nonbank
dealers
often been able to bid successfully for the
market
issue, despite
Even
Government
are at some
so,
securities
nonbank
dealers
in
tend to feel that they
relative disadvantage
buy new issues,
on what may be in
when banks
are permitted to
particularly
coupon
effect
issues,
It
banks
7
bills,
sell their
market as
awards.
respect to
reopening outstanding
issues in Treasury financings,
has been suggested that nonbank dealers
new
such issues also
available in the secondary
—With
have
tax-and-loan-account privilege to
the banks; and as with
become
more
favorable terms.
of
the Treasury bills sold with tax-and-loan-ac-
dealers can obtain the issue at a competitive
price.
the
crediting
proceeds of security sales to tax and loan ac-
has been sug-
it
gested that, wherever possible, the Treasury
sell
be given a comparable advantage by permitting
additional
them to purchase the securities for delayed payment (while earning interest from the issue
sues in preference to selling
date) or to purchase the securities at a lower
usually are difficult to trade because of the thin
would
price that
reflect at least a part of the
tax-and-loan-payment advantage.
It is
objective
is
to
new
issues.
is-
The
avoid small-sized issues that
market supply.
argued
would broaden the underTreasury issues and would be more
amounts of already outstanding
It
may
be noted, on the other hand, that re-
issues are not always the
that such treatment
opened
writing for
kinds to
sell.
Often, there
is
no
most
suitable
issue already
of considerations favor confining
outstanding in the appropriate maturity area
that lends itself to reopening. It must have not
the tax-and-loan-payment privilege to banks.
only the right maturity but also approximately
equitable than the existing arrangements.
A
One
number
consideration
payment by
is
that the system of
crediting tax
bank
and loan accounts
does not involve any cost to the Treasury while
a compensating price cut to others would.
nonbank
Treasury would take in
and
it is
If
dealers were given a lower price, the
less
money on
the sale,
not clear that the addition of this group
the right
coupon
rate so that
it
can be reopened
A
without too great a premium or discount.
large premium can discourage purchases, as can
a large discount that may discourage buyers
who prefer current income. And if the discount
is
large
enough the
effect create a
new
implicit capital gain
issue since
it
will
may
in
be subject
to the provisions of the tax laws that pertain to
"original issue discount."
8
—With
respect to problems of exposure to
information leaks in debt management operathe Treasury has undertaken
tions,
and most recently
safeguards,
leak that did develop
—
in
—procedures
packages,
the
its
leaks on
minimum.
numerous
light
of a
have been
tightened further. In order to secure the best
advice possible in designing
and procedures have
been tightened further to reduce exposure to
as 1-year bills are offered;
large refunding
Treasury meets with advisory
3
irreducible
feasible in terms of price, cou-
continue
to
size,
appears desir-
it
giving
consideration
to
the
opening of outstanding security issues
re-
in
fi-
nancings.
4
and
wide variety of
an
to
able from the viewpoint of market functioning
and Investment Bankers Association and obtains views from Federal Reserve officials and
A
—Where
terms
pon, and over-all issue
groups of the American Bankers Association
others in the Government.
financing
—
clear
It is
from the variety of comments
suggestions
about
from
received
and
and long-run
and economic environ-
financing
continuing
the
being
continually
Treasury
techniques,
short-
often received from these various
which the Treasury evaluates in terms
of the public policy objectives of the Government before coming to a final decision.
While the advice of the investment com-
changes
munity is sought in evaluating alternative financing proposals, the final financing decision
information to the Treasury from market par-
advice
is
sources,
is
made by
in the financial
ment, that
efficient
debt management opera-
Treasury of
operating techniques, as well
continuing availability of advice
the
as
its
and knowledge of the decision before
announcement has also always been available
to a very few persons. Necessary communication of the announcement to the public requires
preparation of press releases and offering circulars, which spreads knowledge of the announcement to persons not directly involved in
the decision-making process. But these prepara-
ticipants.
FEDERAL RESERVE OPEN
MARKET OPERATIONS AND
B:
TECHNIQUES
The operating techniques
were
serve
headings
—
of the Federal Re-
under
evaluated
day-to-day
various
niques,
and outright transactions
making an announce-
agency
will
achieve
broad,
simultaneous
coverage throughout the financial community.
—Most
of
the
issues
briefly
discussed
market participants from time to time. However, no significant change from current prac-
IN
appears required on the basis of the analy-
1
—While
problem,
in
many market
participants
Federal Reserve secondary market operations
in
coupon
issues,
a number were of the view
that such operations, especially in intermediate-
and longer-term issues, adversely affected the
performance of the market; and similar allegations have been made at times with re-
was
more
chology, with the result that dealers
2
—
flexible in the sense that
9-month
as wefl
saw no
terms of market functioning, with
and evidence currently available.
Such a conclusion recognizes that certain changes have been introduced as this
study has been in progress. For example, the
monthly bill auctions have become somewhat
sis
tech-
Federal
Considerations:
above are of relatively minor importance, but
they do represent aspects of Treasury financing which have been of concern to some
tice
in
issues.
OPEN MARKET OPERATIONS
COUPON ISSUES
Conclusions:
1
coupon
in
operating
issues,
the day consistent with
general
three
operations
outright
tions are undertaken as late as possible during
that
and
a very limited group in the Treas-
ury,
ment
by the
tions will require constant reappraisal
spect to Treasury trust account operations.
felt
potential
are
smaU
that System
size
that
It
operations are of such
even
if
actual
operations
they tend to dominate market psy-
become
—
make markets at prices very far
from what they conceive to be the official buyAnd some market participants
ing level.
thought that investors may be discouraged
less willing to
from being active
market,
—
Government
securities
they feel prices and yields do not
underlying demand-supply conditions.
reflect
2
if
in the
Staff
analyses have produced
statistical
results that are
somewhat mixed but
that gener-
and also
Treasury, operations in the secondary market
for coupon issues have not had any measurable adverse impact on indicators of market
performance. However, the results cannot be
considered as conclusive in view of the inher-
do support the view
ally
ent difficulties
that System,
isolating official
in
operations
from all of the other factors affecting the
market at any one time and in view of the
attitudinal shifts of market participants over
time that are
(a)
official
difficult to quantify.
There was no
evidence that
statistical
purchases of coupon issues by either
the System or the Treasury caused market activity in the
same quarter
to decrease.
On
to dry up, or even
the contrary, market activity
and over- 10-year
in bills, 5- to 10-year issues,
issues
related
showed some
to
association
The
official
signs of being positively
although this
transactions,
was not
significant
increases in trading in
in
coupon
the
helped and sometimes hindered their invest-
ment
depending on whether these
activities,
respondents happened to be on the buying or
selling side of the
studies
tical
market.
With respect
(c)
to dealers' positions, statis-
indicate
that
associated with increased gross and net long
positions
the
in
over-5-year area during the
1960's. Decreased gross short positions in inter-
mediate- and long-term maturities were also
significantly related to Treasury market pur-
though not to Federal Reserve pur-
chases,
chases.
long
The increased
positions
in
dealer willingness to take
viewed as favorable to market performance,
although it is also consistent with the view that
operations
official
do influence market psy-
chology and thereby affect market performance
by limiting the scope for price movements in a
direction other than that given by official operations.
(d)
It
is
probable that
comparative day-to-day
the
half of the
first
the relative interest rate stability
lying
economic forces than
the dealer
of the respondents indicated that
were not affected
account operations
less
in
coupon
issues.
than 10 per cent
more
to official
to under-
secondary
market operations. Nevertheless, the relative
and rates influenced
70 per cent
400 respondents,
during
dealers did
recognize the unique economic characteristics
stability in security prices
the
Many
of the period, however, and tended to attribute
(b) In the survey of 400 institutional in-
official
—
stability of rates
1960's.
vestors conducted as part of this study, about
Of
secondary
official
market operations in coupon issues both by
the Federal Reserve and by the Treasury
contributed, though to a minor extent, to the
were
fund
associated primarily with Treasury trust
by
bonds may be
long-term
1960's.
issues
operations.
their investment operations
purchases,
official
Federal Reserve purchases, were
particularly
community
in
several ways.
Most
importantly, the price stability, especially in the
mid- 1962 to riid-1965 period, affected dealers'
profitability adversely
on
by limiting
their ability to
And
reported that their ability to conduct transac-
make
market tended to decrease as a
result of official operations; however, these
respondents were mainly among the large institutions in the survey, and they accounted
for 31 per cent of total market activity and
absence of price fluctuation accompanied a
historically
18 per cent of total holdings of Government
for profits.
tions in the
securities
spondents,
stitutions,
reported in the survey.
who were
also
among
A
few
re-
the largest in-
noted that Treasury or Federal Re-
serve operations in coupon issues sometimes
profits
price swings.
this relative
upward interest-rate trend, so that
had comparatively little chance to anextended periods of rising prices, which
generally
dealers
ticipate
have provided their best opportunity
But secondly, there was no statistical
evidence that dealers responded by reducing
positions to any measurable degree; and in fact,
in many cases dealers responded by holding
larger positions presumably in an attempt to
—
37
increase profits from trading, given a lessened
used to implement reserve objectives, yield ob-
risk of capital losses.
jectives, or both.
—Coupon
3
operations have had the advan-
tage to the System of taking
pressure
short-term
off
when
some downward
rates,
especially
in
was a relatively small market supply of bills. While most academic and
other research findings indicate that System
periods
there
operations did not impart
that
rates
—
much
to
the
structure
interest-rate
over an
conducted
reserve
for
solely
—
—
in such a way
market availability
be executed
relation to
their effects
would
on
interest
for
example in
minimize
as to
This approach
rates.
also imply continuance of the policy of
coupon operations outside
keeping
of a "twist"
a decline in long rates relative to short
is,
When
(a)
purposes, such operations should continue to
ma-
the
ranges involved in a current Treasury
turity
financing.
extended period, there does appear to have
When
(b)
balance of payments considera-
downward
been some increase in private borrowing, especially in the form of new corporate bond
tions suggest efforts to avoid
when the System was very
coupon market. It also appears
that System coupon operations may have had
some direct effects on interest rates through
their impact at critical times on market psy-
might be supplied through purchases of coupon
chology.
for purposes of influencing the maturity struc-
issues during periods
active in the
—Some
on
sures
short-term
interest
pres-
reserves
rates,
issues rather than bills to the extent that
mar-
ket conditions permit.
(c)
When
compelling reasons
exist.
System
operations in coupon issues might also be used
ture of
market
coupon issues was not readily discernible and created
considerable market uncertainty. If coupon
transactions are continued, it was thought desirable that the reasons for them should be
clearly understood by the market and therefore
capital
markets. But there are limitations on
could be rationally taken into account in the
able circumstances can have a useful short-run
4
dealers indicated that at times the
purpose of System transactions
own
dealers'
in
—
In
market
to
use in disorderly
their
System purchases of coupon
issues should be continued as a useful supple-
ment
to bill purchases in providing
bank
re-
serves. Consideration should also be given to
absorbing
reserves
through
limited
sales
of
coupon issues from time to time. Such sales
would add flexibility to Trading Desk operations and occasionally might help the market
mechanism to be more responsive to investor
needs
—
the
long run
—
especially
and psychology are adverse
if
market forces
—without compro-
mising reserve objectives. Nevertheless, even
marginal operations
in
coupon
issues in favor-
MODIFICATIONS OF TRADING DESK
addition
situations,
the System's ability to influence a rate structure
in
market impact.
operations.
Conclusions:
1
rates or flows of funds in the
for example,
when
TECHNIQUES
Considerations:
—
1
Consultations with dealers produced
numerous suggestions about some of the Trading Desk's methods of operating in the Government securities market. A number of the sug-
gestions appeared to be related to particular
problems of individual dealers or reflected the
tendency of some dealers to overinterpret any
Desk
activity.
But
many
of
suggested
the
System holds a
very large share of an issue which is in strong
market demand. But any such sales would
have to be handled cautiously in order to avoid
changes by dealers, as well as operational adjustments suggested by the Trading Desk's own
a disproportionate effect on prices, especially
contribution to improvement of market func-
the
in the introductory period.
2
—Depending
upon market circumstances
System operations in coupon issues might be
experience, seemed to be broad enough in application
to
be evaluated
in
terms
of
their
tioning and to better market understanding of
operations,
without
interfering
achievement of System objectives.
with
the
38
2
—With
respect to
recommended
with respect to the identity
especially
data,
have
Desk provide more
the
that
of the accounts, the size of the operations,
and
even their purpose. Dealers obviously desire
to be in a better position to gauge the possible
market impact of Desk operations, and they
interested
particularly
are
3
providing information
to dealers concerning operations, dealers
in
whether or not monetary policy
is
—With
respect to the suggestion that opera-
coupon
tions in
be confined to a few of
issues
the large dealers,
does appear that only a
it
few such dealers assume the considerable risk
of making consistent and meaningful markets
and long-term issues. Greater
market stability would probably be fostered,
and privilege would be more closely equated
in intermediate-
Desk
determining
with responsibility,
a considera-
transactions to selected dealers
the
if
limited
its
bond
who make
rea-
tion in these operations.
sonable markets under a wide range of condi-
While it would not be appropriate for the
Trading Desk to provide running interpretations
tions.
of the monetary policy objectives of particular
may
actions
—
in the
for themselves
main these actions must speak
—
nevertheless feasible for
is
it
certain technical information to be provided to
Desk has
the market. In fact, the
already, in
the course of the current study, taken steps to
operating for
is
System or customer accounts (though not the
names of particular accounts) and the approxi-
mate
size of certain operations.
especially
operations,
those
On
large-scale
involving
"go-
arounds" of the whole market, the dealers are
when
often informed
the
Desk
customer account (foreign
is
operating for
official
Treasury investment accounts).
accounts or
And
in the "go-
arounds" for customer accounts, recent practice
has often been to indicate the approximate
total
amount
sions, the
Desk planned
the
in
involved.
buy has
coupon
to
"go-arounds" in
— although
account
this is
because the amount
size
On some
recent occa-
approximate aggregate amount that
been revealed
issues for System
also
not always feasible
may depend
partly
on the
it
cannot commit
itself to
toits
dissem-
all market circumwould seriously curtail the
Desk's operational flexibihty and in some cases
hinder and perhaps prevent the attainment of
inate such information under
stances.
To do
a willingness to
other hand,
serve to broaden the
all
dealers
coupon market over
it
appears that the
bulk of the Trading Desk's operations in cou-
pon
are
issues
with those
make
4
—
naturally
quite
dealers
who
carry
'
—conducted
and
positions
the best markets.
—With
respect to modification of repur-
chase agreement procedures, a number of suggestions were considered:
(a)
Make
the day.
repurchase agreements earher in
At times
the
Desk
deliberately waits as
long as possible before deciding whether or not
to make repurchase agreements. This complicates
financing
dealer
and delivery arrange-
ments. However, the Desk must avoid hasty
action that would risk producing undesirable
money market. Early impressions
money market conditions are frequendy
results in the
of
modified as the day unfolds, and dealer progress
along with other
funds elsewhere
—
in obtaining
—
money market may often
be an important clue. The Desk cannot give
developments
in the
assurances that
only that
it
will
it
will act
make
its
by a given time, but
decision as soon as
reasonably possible.
and nature of offerings presented.
While the Desk has gone some distance
ward providing more information about
operations,
the
the long run. In any event,
more information than formerly
give dealers
concerning whether the Desk
On
undertake coupon transactions with
so
the Desk's objectives. In general, however, the
(b)
Substitution of securities.
dealers
procedures,
Under present
who withdraw
securities
held by the System under repurchase agree-
ments
automatically
reduce
their
access
Federal Reserve credit unless the Desk
ing to
make
at least
is
to
will-
an equal amount of new
agreements on the same day. If an equivalent
amount of new agreements were obtainable at
Desk can undertake to provide information
when that is possible without detriment to
the dealers' option they would, in effect, be able
operations.
need.
to substitute securities for particular issues they
The
pricing of the securities submitted
—
under the new contract would be
but
different,
amount of repurchase agreements outstanding would remain approximately un-
the total
changed.
There are times when the Desk is reluctant
reasons related to banking statistics or
money market indicators to see repurchase
agreements withdrawn before maturity simply
for
—
because dealers need particular
permitting
situations,
issues. In
such
would be
substitutions
helpful in meeting reserve objectives.
On
other
occasions, however, repurchase agreement with-
drawals are a useful means of absorbing reserves
if
money market
availabiUty and reserve
supply unexpectedly increase. Consequently,
would appear desirable
stitute securities
it
to permit dealers to sub-
held under repurchase agree-
ments only at the Desk's option.
(c) Inform all dealers when
agreements are to be made.
As
Desk has markedly
on "go-arounds" to execute its operations in Treasury bills. Since 1966
this technique has been used on most occasions
when the Desk bought coupon issues for the
System and frequendy on sizable Treasury and
foreign account orders. Large operations can
now often be accomplished by this method.
However, there is a practical minimum to the
size of an operation that can be accomplished
the last several years, the
increased
efficientiy
mum
reliance
through a "go-around." The mini-
market conditions
and with the area of the market involved.
varies with changing
Therefore,
it
is
not feasible to execute smaller,
routine business of the
arounds."
Constantly
"go-arounds"
petual
handle
repurchase
its
uneven,
the
Desk by means of "goalmost per-
recurring,
would
be
required
to
flow
of
unpredictable
operations during the day.
a matter found
(c)
to be
dealer
to
good market relations and not detrimental
Desk operations in any way, the Desk has
be useful under some market conditions and
to achieve certain objectives but would not be
already adopted a policy of simultaneously in-
forming bank dealers as well as nonbank deal-
whenever
ers
it
is
in
the process of
making
repurchase agreements, although bank dealers
do not
5
participate in such agreements.
—Among
other proposals considered affect-
Desk techniques were
ing Trading
the follow-
ing:
(a)
More
operations
day
1
later)
for
regular
delivery
instead of cash (same-
day delivery). This suggestion stems from the
sometimes costly and troublesome delivery and
financing problems
of
dealers.
Cash trading
extremely useful to the Desk and has be-
come an
tates
rotating basis. This technique might
appropriate as a regular procedure.
The
ability
and automatically among dealers presupposes equal dependability and performance by all dealers. Such a
to rotate such orders regularly
presupposition
for the
Desk
is
unrealistic,
to limit
its
nor
is it
ability to
desirable
buy or
sell
securities at a given time to the position, con-
(delivery
is
Place orders for coupon issues with one
on a
integral part of
its
operations.
It facili-
both the delay and the acceleration of
operations so that the
optimum time may be
from the standpoint of reserve objectives, market impact, and the management of
investments for customer accounts. Thus, cash
trading is likely to remain the principal form of
selected
operation,
but
well-defined
opportunities
to
trade for regular delivery, or delayed delivery,
and outlook of any one dealer.
Timing of operations. The Desk is
acutely conscious of the market effects of its
operations and deliberately seeks to avoid
whenever possible timing that would be generally disruptive. Within such a framework.
tacts,
(d)
System and Treasury operations must be timed
for maximum achievement of over-all policy
objectives when such are involved and for
satisfactory execution of routine Treasury investment account and foreign orders. The timing of operations
ity
is
influenced by the availabil-
of statistics and emerging market conditions,
and the Desk cannot forego its right to initiate
operations at any time that the market is open.
should not be overlooked. Moreover, necessary
cash trading should be undertaken as early in
the day as
is
consistent with other objectives.
(b) All operations by "go-arounds." During
Conclusions:
—
1
Trading Desk techniques have already
been modified in the course of this study in
ways
some suggestions
that give effect to
re-
ceived from dealers, and the Desk should be
alert to the possibility of further
sacrificing
ability to
its
Among
tives.
market
improve
would
changes that
without
functioning
achieve policy objec-
the modifications that should be
continued, where feasible, are:
revealing
(a)
whether operations are for System or customer
account;
providing indications as to size
(b)
and
of operations;
greater use of "go-
(c)
—Some suggested procedures can only be
undertaken by the Desk
tions permit,
as
for regular delivery, convenient
operations,
of
in principle as condi-
and with no commitment, such
more trading
timing
make repurchase
earlier
agreements,
agreements
before
—Some
A
good deal of
the agency market is
accounted for by the frequency of financings,
short-term
outside
of
but activity
financing periods holds up fairly well and has
maturity with
new
orders,
all
grown
forfeiture of the right to operate at cer-
for example, before Treasury bill
in
issues
in recent years.
—Dealer
3
positions
early
agency issues
in
(in-
have increased markedly since
cluding PC's)
the
suggestions cannot be considered
such as "go-arounds" on
tain times,
trading activity in
and
execute than
difficult to
Treasury coupon area.
in the
size,
in particular issues
to
placing orders with dealers on a rotating basis,
and
more
are thus often
the
smaller in
to
disclosure of the purpose of operations.
3
much
market transactions
decisions
agreements to run to the same maturity, and
feasible,
sues, the issues are
permission
permit dealers to replace withdrawals of repurchase
more active than, the short-term Treasury
coupon market. At the same time, however, the
agency market has many more individual islarge
arounds."
2
and the nature of trading activity. Indicators
of market performance that bear on those
points show that the over-all market has expanded in breadth and depth in recent years,
and in the short-term area as a whole (within
1
year) appears comparable with, or even
1960's with the increase
reflected
both in issues maturing within and beyond a
year. Net dealer positions averaged about $114
million
in
and $365 million
1961
in
1967.
one-third of net positions in 1967 were
About
in securities with maturities of
average
of
level
positions
over
in
1
year.
The
agency issues
auctions.
fluctuates widely
FEDERAL RESERVE OUTRIGHT
TRANSACTIONS IN FEDERAL AGENCY
ISSUES
very
different
coupon
4
and shows characteristics not
from positions in Treasury
issues.
—The
rise in dealer positions
and transac-
tions in Federal agency issues reflects largely
Considerations:
1
repur-
chase agreements against Federal agency issues
under authority of the amendment to the Federal
and
Reserve Act that permits the System to buy
is
the open market
in
sell
which
any obligation
a direct obligation of, or fully guaran-
teed by, any agency of the United States. This
amendment was
originally enacted
on a tem-
porary basis in September 1966 and was subsequently
2
made permanent.
—The
increase
the
—The Federal Reserve now makes
capacity of the
in
the
supply
of
agency debt,
with outstanding agency issues (including marketable PC's)
held by the public rising from
in mid- 1960 to around
end of 1967. Also at the end
of 1967 issues maturing in a year or less
amounted to about $11 billion and those in
over a year amounted to $12 billion; nearly
half of the latter were marketable PC's. (By
around $8Vi
billion
$23
billion at the
way
of comparison, outstanding Treasury cou-
pon
issues
maturing
in a
year or less held by
the public at the end of 1967 totaled $17.9
agency market to
billion,
and those maturing
in
over a year
absorb System operations, while not becoming
totaled $91.5 billion; bankers' acceptances out-
dominated by such operations, depends broadly
standing amounted to $4.3 billion.)
on the
5
A critical question is whether the data
on the agency market are indicative of the size
over-all
and market
size
of the market,
availability of
individual
the
size
issues.
—
—
—
and activity of a single basically homogenous
market or whether there are really several
smaller markets for various types of agency
issues. (As with other markets there are differences by maturity of issue, with the longer
could accommodate, on both the buy and the
end,
thought they would enhance the presdge of
the Federal agency securities market, stimulate
as
noted,
earlier
than
active
less
the
shorter end and attractive to different investor
sides of the market, more than token
Federal Reserve transactions, although not all
of such dealers favored the transactions.
sell
who
Dealers
did
recommend such
operations
The evidence gathered appears to
is fairly homog-
investor activity in such obligations, and tend
indicate that the agency market
to
enous. There are rather small yield differences
bring them into closer alignment with yields
groups.)
between issues of similar maturity of the
as
various
smooth
various
agencies;
that
can
curve
yield
agency
to
is
a
say,
be
traced
a
rather
utilizing
lower interest rates on agency issues and
on U.S. Government
securities.
Some
small-
scale outright transactions in the agency
ket have been undertaken by the
Desk
maracting
relatively
for Treasury investment accounts, but thus far
smooth yield curve can be derived from Treasury coupon issues. With respect to how in-
the great bulk of acquisitions of agency issues
vestors
issues,
as
just
may view agency
issues, the
ownership
and PC's by these accounts have been
from the issuers.
data (using data for the nonguaranteed issues
major agencies) indicate that investor groups do not appear to show any very
significant
preferences for one agency as
of the five
against
—with
another
the
exception
relatively greater preference of
institutions
cial
for Federal
nonbank
home
the
of
finan-
loan bank
presumably due to the holdings by savand loan associations of such issues
issues,
ings
some
although, of course,
investor groups have
a larger proportion of agency issues taken to-
—Dealers
were divided
to the desirability of Federal
transactions
in their views
as
Reserve outright
agency issues from the point
in
A
of view of market functioning.
major argu-
ment of those who advised against such transactions was the probability that strong political
pressures might develop for the support of particular issues
or financings.
Some
dealers, in
fact,
attached great weight to this considera-
tion,
both
in
its
implications for the System's
open market
policy in an environment relatively free from
day-to-day political pressures and in its imcontinued
ability
to
conduct
plications for the viability of the Federal agency
market
itself.
Some
dealers
also
stressed
possibly disturbing impact on the
market of
—Under present circumstances, operational
difficulties
Desk
ing
would be encountered by the Trad-
in executing transactions for the Sys-
tem Open Market Account. The
agency issues
ual
size of individ-
generally quite small in
is
issues,^- and
amounts of individual
issues that can be readily bought or sold in
the secondary market tend to be correspondingly limited. An attempt by the System to
conduct transactions in the amounts that are
customary in Treasury coupon issues and
meaningful from the standpoint of System objectives
could therefore have a disproportionate impact on prices and yields in the agency
comparison with Treasury coupon
as
a consequence,
the
—
gether than do others.
6
7
directly
relatively large and,
the
secondary
by nature,
dis-
—
The
market.
availability
would make
issues
it
and
most
for
the
undertake more than token opera-
System
to
tions
undue market dominance
if
agency
size of
difficult
is
to
be
es-
chewed. In addition, because of the frequency
of
new agency
offerings there are limitations
the timing of operations
if
the System
is
on
to
avoid having an undue influence on the marketing process for individual agency issues. Total
new
offerings
of
the
five
major agencies
Federal land banks. Federal intermediate credit
banks,
National
banks
for
cooperatives.
Federal
Mortgage Association, and Federal
continuous Federal Reserve operations.
On
the other hand, a
number
^=
of dealers
that the short-term sector of the agency
felt
market
The average size of an agency issue is about $300
compared with SlVi billion for the typical
million,
Treasury coupon
issue.
42
—
home
average about four each
loan banks
month; and there are in addition periodic offerings by other agencies, including FNMA and
Export-Import Bank participation certificates.
could under current circumstances tend to exert
a dominating influence on the Federal agency
market, giving
dispel.
Conclusions:
1
—At
ket's
the present time and under current
market circumstances, outright operations in
Federal agency securities would not facilitate,
in any material way, the ability of the System
to alter the supply of reserves in the market.
Purely technical operational
noted
difficulties,
above, would seriously limit the
size,
scope,
and opportunities for such transactions. Moreover, the frequent marketing of new Federal
agency issues would considerably reduce op-
4
made more
be
variety
to replace
2
maturing
—A broadening
of market instruments for
the conduct of open market operations
a
itself
is
in
worthwhile objective for the longer
run, provided that operational difficulties can
be resolved.
It is
doubtful, however, that mar-
new
issues into fewer but
under the aegis of a
blocs and thereby facilitate
sactions without
market availabilities of direct Treasury
Continued growth of the Federal agency
securities market, both absolutely and relative
to the Treasury market, would of course countive
debt.
a reexamination of this conclusion.
3
—
nal
It is
not clear that occasional and margi-
System
would
operations
significantly
in
agency
securities
improve the functioning of
the agency market. Sizable, frequent, and significant
System operations
in
agency securities
the
undue
more sizable tranon market quo-
effects
financings could be reduced as could the potential
periods of System inactivity in this market.
In general, the problems raised by the multi-
agency securities and the allocation of
among them would be
plicity of
System
transactions
eliminated.
5
—
It
is
recognized that market conditions
—
develop
for
example,
as
a result of
further growth in the agency market, the de-
velopment of
supply
make
less
frequent and larger agency
or the availability of a large floating
issues,
of
agency
securities^which
might
outright operations in agency issues in
market by the Federal Reserve appear
desirable. Moreover, the Federal Reserve
should keep under review the desirability and
more
and prospec-
distributed
Moreover, the frequency of agency
tations.
the
reserves, given the large current
that
development would tend to m'ake agency
available in larger and more tradable
would make any
ket operations in supplying or absorbing bank
agent
funds raised to the individual agencies. Such
outright transactions in Federal agency
sel
marketing
single
issues
present time to the effectiveness of open mar-
and feasible if the
were reduced and
individual Federal agencies were
larger offerings, possibly
ginal
real contribution at the
agency issues would
issues
to consolidate their
could
issues.
if
in
attractive
agency
of
especially
undue influence on the market's
and absorption of the new issues. The System
would also encounter technical difficulties when
its holdings of particular agency issues matured
unless special arrangements were made with
The prob-
its
for executing transactions.
—System operations
issues
lem has been overcome in the case of direct
Treasury debt where facilities exist for the
automatic rollover of Treasury notes and bonds
held by the System and where bidding is feasible for a desired amount of new Treasury bills
and per-
continued development by impairing
mechanism
a
the agencies for their replacement.
uncertainties
false
functioning as a free, self-reliant, and effective
portunities for meaningful operations without
appraisal
to
rise
hopes which would be hard to
The result might be to inhibit the mar-
haps to
feasibility of conducting outright operations in
Federal agency securities in light of the overall objectives of System policy. Meanwhile, the
System should continue to make repurchase
agreements against Federal agency securities.
Such repurchase agreements, which were first
undertaken in late 1966, have proved to be a
useful
supplement to repurchase agreements
against direct Treasury obligations, given the
sometimes limited
able to
collateral
immediately avail-
nonbank dealers and the System's need
for large
transactions.
Moreover, repurchase
43
—
4
transactions are not subject to the operational
problems involved
purchases
outright
in
or
Daily fluctuations in the cost and avail-
abihty of financing are an integral and well-
understood aspect of the dealer market
sales outlined above.
Government
C: AVAILABILITY OF FINANCING
TO THE DEALER MARKET
Considerations:
1
—Financing
to the dealer
market
is
pro-
vided by a wide variety of sources, including
banks
and outside major
in
financial centers,
business corporations, and public funds. Dealers
on
financing
obtain
nationwide
through
a
day-to-day
with
basis
The
securities.
large
in U.S.
and unpre-
dictable daily inflows or outflows of funds affect
individual banks and institutions by differing
and changing degrees, so that dealers have attempted to develop as extensive sources of
financing as possible. But the market has come
to rely on a relatively few major money market
banks for
"last resort"-type financing.
residual
Erosion
of such banks to provide
willingness
the
in
even
financing,
at
temporarily very
potential
high interest rates, can lead to excessive pres-
lenders, but they tend to rely
on major money
sures in the securities market as dealers are
New
York, for financ-
market banks,
contacts
chiefly in
ing to cover residual needs not
accommodated
forced to liquidate
inventories
become
rapid pace, or
at
unwilling
an overly
—because
financing—
of
through other sources.
2
The interest rates charged dealers vary
position securities in order to, say, help in the
day with fluctuating money market
secondary market distribution of a Treasury
with the level of rates generally
financing.
—
from day
to
conditions,
above the Federal funds
rate.
In
uncertainties
providing
5
residual, or "last resort," lending to the dealer
is
market, the major
daily interest rates
These
to dealers.
the
at
high
end
money market banks post
on new and renewal loans
interest
of
the
rates
are normally
spectrum
of
daily
financing charges that dealers pay.
3
—The
to dealers are one of the most important means
by which banks make continuous adjustments
to daily, and often unpredictable, inflows and
outflows of funds. Day-to-day swings in
money
position can be especially large at the major
rate depositors
tile
portions
money
large corpo-
and which have the most vola-
of
positions
Treasury deposits.
become
As
stringent,
their
banks
on new loans
by individual banks to levels
that would discourage any borrowing by dealers. Interest rates on renewal loans would also
be raised at times to levels that might force
borrowers to seek for funds elsewhere. Some
major money market banks have from time to
would tend
time simply posted no
daily
sources
of
availability of financing to
to
dealers
a problem chiefly in periods of monetary re-
but
straint,
financing
difiiculty.
activity,
this
does not necessarily make the
problem an isolated or temporary
In recent years of strong economic
some degree
of monetary restraint has
and
in
such periods
been quite costly
dealer financing has often
relative to the interest return
on
securities held
by dealers. Indeed, the imposition of a high
cost of carrying an inventory of U.S. Govern-
ment
securities
is
one of the ways that moneits effects in dampening
tary restraint achieves
economy,
the
effects
that
spread
from the
Government securities market to the financial
markets more generally, and then to expenditures in the economy at large. At times, how-
to raise interest rates
to dealers, often
the
to
generally been present,
changing terms on which they lend
money market banks, which have
—The
as
money
easy, dealer loan rates
become more
new
loan rate.
When
becomes
are lowered, and banks
position
of banks
willing to lend.
ever, the rapidity of increases in financing costs
in itself
seems to have been a disruptive market
factor,
and
at other times
financing that
is
even the high-cost
generally available during tight
money periods has appeared to be limited and
on the verge of drying up. In particular, the
effects
in
on dealer financing of day-to-day swings
money positions can be exacerbated
banks'
when
tight
these swings take place within generally
market conditions.
6
—Presumably,
if
residual dealer financing
up more or less completely for a time,
the System would provide temporary funds,
did dry
as
it
has in the past, for instance, consistent
with directives of the
a disorderly
FOMC—rather
Government
than
let
market en-
securities
But the continued effective functioning of
Government securities market depends
in part on a steady stream of financing becoming available from banks and other sources
in the private economy, so that daily price
adjustments in the securities market are not
excessive and cumulative, "distress selling" of
securities is minimized, and the market can
absorb and distribute Federal Reserve operations and Treasury financings, while also accommodating the buy-and-sell orders from
private sectors of the economy.
sue.
the U.S.
such as evolution in the regulations
Federal
Reserve Bank discount
1
—Dealer
3
—
problem, especially
although
it
is
a recurrent
in periods of tight
recognized
that
a
money,
restrictive
monetary policy unavoidably involves pressures
on dealer financing as part of the process of acchieving monetary restraint.
Some
official
as-
It
is
recommended
that at the Trading
Desk's option dealers be allowed, in
"substitute collateral"
effect, to
on regular System repur-
chase agreements, as indicated
in the
previous
discussion on possible modifications of Trading
Desk
4
techniques.
—
time.
agreements
repurchase
of
Institution
not recommended at
this
Such dealers appear to have more
as-
with bank dealers
sured
sources
dealers
is
financing
of
—although
nonbank
than
recognized
that
the
bank dealer departments must compete
for
and
financing has been
facilities
(which are currendy being considered in light
of the Federal Reserve System study, "Reappraisal of the Federal Reserve Discount Mechanism," pubHshed in July 1968).
funds
Conclusions:
afl'ecting
with
this
is
other departments
may
ability to
it
of
the
well result in constraints
take positions.
As an
bank,
on
their
offset to not
having repurchase agreements, banks in general,
although not bank dealer departments as
some
such, have the advantage of paying for
new Treasury
Treasury
issues through direct crediting of
tax
and
loan
accounts,
of
direct
sistance can help to assure continuity in the
financing in the Federal funds market, and of
availability of dealer financing funds
and the
performance of the market without impeding the market's role in transmitting
borrowing at the discount window.
satisfactory
ble that a better rationale for
chase agreements with dealer banks could be
monetary
developed, to the extent that dealer depart-
policy. This could involve flexible use
window in relation to banks
finance nonbank dealers or that
of the discount
ments of banks were separated
that actively
from the
rest of the
in
bank and did
have active dealer departments themselves, and
financing from
could also involve flexible use of repurchase
ployed by the nonbank dealers.
It is
possi-
making repur-
some way
their
own
sources similar to those em-
agreements available through the Trading Desk.
2
—So
as not to impair the functioning of
monetary poficy, the availability of
Federal Reserve resources in providing, or
backstopping, dealer financing would have to
be under carefully controlled terms and conditions, and for relatively limited periods. The
general
exact nature of any
official
—
D: IMPROVEMENT OF TECHNICAL MARKET PERFORMANCE
THROUGH CLEARING AND AUTOMATION OF TRANSACTIONS IN
GOVERNMENT SECURITIES
assistance to the
market that is, relation of
to market rates, amount of
oflScial interest rates
tion of assistance over time,
and the mechanism
assistance, distribu-
through which any assistance
may be made
Considerations:
1
—
Since most trading in the
securides market
is
adequacy of clearing arrangeis of paramount imporIn view of the increased volume of
delivery,
the
depend on market
ments
New York
conditions and on institutional developments.
tance.
available
—
will,
of course,
Government
New York
conducted for
in
have found
trading, practically all dealers
in-
creasing difficulty with the existing clearance
arrangements"
large
by two
furnished
principally
New York
banks, and there have been
reports of a growing
number
of delivery
fail-
may
process of implementation
ping
stone
provide a step-
broader book-entry system
a
to
geared toward trading since
some important market
mated arrangements.
it
will
accustom
participants to auto-
ures.
2
—
—such
—by
as earlier closing hours for deliv-
the
eries
New York
a further effort
being
is
Reserve Bank of
Clearing
House banks,
made by
New York
Government
ings of
to
the Federal
improve
clear-
securities transactions. This
further effort involves the establishment of a
new mechanism
to process
and
settle,
on a net-
balance basis, interdealer and interbank trans-
New York
actions in
City so as to limit physi-
cal deliveries of securities. This
already in operation between 10
member banks and
of
Conclusions:
In addition to the adoption of certain
rules
New
inter-
the Federal Reserve
is
and
intradistrict transactions
weekly, representing an average $3 billion in
aggregate par amount. With the introduction of
and data processing equipmechanism is expected to produce
an even greater improvement in Government
this
securities
3
tween each participating
it
may be
2
—Clearing
desirable to seek a full-scale
an even further improvement of the
market mechanism and reduction of physical
available
to
Government
Government
at
would be
im-
all
investors in marketable U.S.
securities.
CONTINUING EVALUATION OF
E:
1
—The
dealer market for U.S.
securities has
Government
been relatively free of direct su-
or
and regulation from governmental
privately formed associations or
It
comprises a relatively small num-
pervision
bodies
groups.
ber of dealers with varying capital structures
who perform
an important function for the
investing public,
Reserve.
eral
the Treasury, and the Fed-
A
market as a
this
diminution of confidence in
result of questionable
market
practices, speculative excesses, or financial difficulties
would have widespread adverse reperall financial markets and would
cussions on
impede Treasury debt management
seriously
securities currently held
Federal Reserve Banks
now
and Federal Reserve open market operations.
in
2
—
It is
ernment
"The
arrangements
and
districts.
MARKET PERFORMANCE
handling of securities. The book-entry system
custody
New York bank
Considerations:
book-entry system for the market, which would
in
and
a general book-entry system which would be
result in
for U.S.
to the good,
proved further by the ultimate development of
clearing arrangements being devel-
oped in New York can be viewed as a step toward a more rational and efficient trading
mechanism for the U.S. Government securities
market. The clearance of trades throughout the
U.S. Government securities market could probably be made more efficient, less costly, and
less time-consuming by the expansion of present and planned clearing arrangements. Ultimately,
all
accounts in other Federal Reserve
market operations.
—The
to date in developing
is
Federal Reserve wire transfers are used be-
electronic switching
ment,
made
erate its expansion. The steps in process in New
York are expected to lead to clearing locally
among the major banks, thereby supplementing
the clearing arrangements already in effect when
Bank
accommodating upwards
progress
practicable steps should be taken to accel-
all
City
is
York, and
of 5,000
arrangement
New York
—The
1
a better clearing system
term "clearance arrangements" as used here
the receipt and delivery of securities, and
the processing of payments, by a New York City bank
on behalf of another bank or nonbank dealer, but it
refers to
does not involve the offsetting or "netting" of transactions as accomplished by the Federal Reserve Bank.
part,
—
believed that participants in the
Gov-
market have, for the most
securities
maintained high standards of performance
relatively free of undesirable
or dealer financial
exception
to
the
difficulties.
typically
market practices
A
noteworthy
high standards of
46
performance
in the
market was the recent revmarket
improving market
analysis.
Nevertheless,
in
elation that certain individuals in the
general,
had received advance confidential information
on the terms of Treasury financing operations;
the leak was quickly investigated, and official
be in order to provide a firm basis for evaluat-
and policy are not so well defined
came
uals
undesirable
was trading by
to light
some
at
ernment
practice
of
the
recently
certain individ-
firms
dealer
securities for their
that
own
in
Gov-
account, with-
out the knowledge of the employing firms and
in
some
cases in violation of the rules of those
as they
might
ing market performance and practices.
4
procedures were revised to prevent recurrence.
Another
the lines of responsibility, authority,
—The
attitude
of
market participants to
more direct official surveillance of
the U.S. Government securities market may be
somewhat mixed at this time. Some participants
further or
may
feel that they are already subject to
siderable
scrutiny
—
not
con-
an informal
only of
nature from Treasury and System
officials
but
from other governmental and private agen-
firms or of the organized securities exchanges;
also
violations of the antifraud provisions of the se-
cies to the extent that the dealers are involved
and exchange laws have also been
with other securities markets or with banking.
curities
Some
charged.
—While
may
participants
feel,
too, that further
the present informal observation
surveillance might tend to discourage healthy
and at times moral suasion exercised by System
and Treasury officials appear to have worked
reasonably well in dealing with most questions
of market practice, the charged violations noted
in the above paragraph have called for a re-
innovation and initiative in the market at a
3
consideration of whether present procedures are
sufficient.
Indeed, such a reconsideration
is
al-
ready under way in the form of a renewed
study
group
by a
joint
—with
Treasury-Federal
Reserve
a view to developing specific rec-
ommendations in the area of market supervision. At present, ofl[icial surveillance is limited
to receipt of daily reports of dealer position,
trading,
and financing
Division
Statistics
Bank
figures
the
Federal
the
of
to
Market
Reserve
New
time
when
tracted to
talent
it.
On
and expertise need
the other side,
—
ciation,
approaches.
Conclusions:
1
—While
the present official relationship to
worked reasonably well in fosmarket that is on the whole viable
the market has
tering a
and healthy, some recent evidences of inappropriate market behavior by a few participants
have served most needs
and access
by
dealers.
The
responsibiUties for
to the various types of information
are diffused throughout the Treasury and the
System.
Until
recently,
Manager, who has had
the
System Account
in practice the
chief
and dealing with
market problems, has not had access to individual dealer statistics. However, in line with recommendations made in the course of the current study, the Account Manager and other
officials of the Trading Desk now have access
responsibility for reporting of
to
individual dealer statistics for purposes of
at-
some form perhaps through a dealer assoor more directly by an official body
itself, or through some combination of these
in
Desk, including occasional additional data subit
be
behavior point to a need for better surveillance
probably
mitted to
to
can be argued
recent instances of inappropriate market
that
York; annual and possibly eventually more frequent balance sheets and income statements to that division; and the
continuous market contacts of the Trading
of
it
suggest that a stronger element of surveillance
is
needed. At the same time, given
the valuable relationships of the past, which
well,
it
would appear
on
to be desirable as far as possible to build
existing relationships rather than to construct
entirely
2
new
—The
ones.
and continuing interest of the
Treasury and the FOMC in the proper functioning of the market is self-evident. Day-todirect
day operating responsibilities in this regard
should remain entrusted to the Manager of the
System Open Market Account,
with
appropriate
senior staff
in consultation
officers
at
the
Treasury and the Board of Governors.
3
—The Manager,
in consultation with senior
—
staff officials at the
Treasury and the Board of
Governors, has the responsibility for informing
tions
and functioning of the Government
FOMC,
the Treasury and the Federal Reserve of any
the Treasury and the
undesirable activity on the part of an individual
subject to Treasury and
dealer or of any
undesirable activity which
appears to be developing more generally.
4
—
In order to underscore the interest of
the Treasury
and the Federal Reserve
Government
functioning
of
market,
Secretariat
the
Government
the
securities
of
the
in the
—Some form
approval, as
statistical reports.
of dealer organization might
perform a useful function, provided that
could
be organized
securities
antitrust
present U.S.
concern
market study should be
publishing studies
FOMC
warranted, and overseeing
5
se-
market, submitting periodic reports to
curities
laws.
itself
and trading
in
Such
full
an
it
conformity with
organization
could
with such matters as quotation
practices,
hours of trading, and
could become a principal source
continued on a permanent basis. This group
the like; and
which comprises senior staff representatives
from the Treasury, the Board of Governors of
the Federal Reserve System, and the Federal
Reserve Bank of New York should be
charged with continuing study of the opera-
of contact regarding matters of market practices
between the market and the Treasury-Federal
Reserve. It might also become involved in
some degree of supervision over market ac-
—
tivities,
it
n
XI.
STAFF STUDIES
Most
of the studies listed
AHEARN, LOUISE,
Official
below
Studies
Operations
in
will
be published, and
all
are available
upon
Government Securities Market Performance
Coupon Issues Day-to-Day Performance.
of
—
Market Performance
AHEARN, LOUISE, and PESKiN, JANICE,
request.
in
the
Wake
of
as Reflected in Aggregative In-
dicators.
BANYAS, LAWRENCE,
Ncw
BERNARD, NORMAND,
Views of the U.S. Government
Techniques
Dealer
COLBY, WILLIAM G.,
Industry, 1955-65.
COOPER, ROBERT
Profits
in
Debt Management
since the Late 1950's.
Securities Dealers.
and Capital Availability
in the U.S.
Government
Techniques of the Federal Reserve Trading Desk
L.,
in
Securities
1960's Con-
the
trasted with the Bills Preferably Period.
DAVIS, FELIX
ETTIN,
T.,
and HOEY, M.
EDWARD c.
The
J.,
Automating Government
Financial and
Securities
Economic Environment of
Market Operations.
the 1960's in Relation to the
The Changing InternaEnvironment and Foreign Demand for U.S. Treasury Issues).
U.S. Government Securities Market. (Appendix by Carl H. Stem:
tional Financial
MEEK, PAUL,
The Changing
PESKIN, JANICE,
Effects
ROTHWELL, JACK c,
Funds Over Shorter Time
SCHERER, JOSEPH,
Structure of the Dealer
Federal Agency Debt and
Its
of Operations in
Market
in
Government
Securities.
Secondary Market.
Coupon
Issues
on
Interest Rates
and Flows of
Intervals.
Institutional Investors
and the U.S. Government
Securities Market.
The Position of Nonbank Dealers When Treasury
WENDEL, HELMUT,
with Payment Permitted in Tax and Loan Accounts.
Securities
Are Issued
@FedFRASER