The very size of the market for U. S. Treasury securities makes the notion of a squeeze seem silly. After all, who could amass the capital to corner any part of the world's biggest, deepest, and most liquid market? Plus, thousands of traders monitor Treasuries around the clock, prepared to pounce whenever rates move one-hundredth of a percentage point.
The revelation that Salomon Brothers Inc. muscled the Treasury market--controlling up to 57% of one issue--kills this smug assurance. The system clearly needs an overhaul, but there's a right way and a wrong way.
Upsetting as Solly's Folly is, the biggest damage to the $2.3 trillion Treasuries market might come from a congressional backlash. Congress is inclined to respond to abuses in any market by shouting: "Crack down!" Stiffened regulation mandated by Capitol Hill, however, may drive investors away, making it more difficult to finance the national debt and adding billions to the government's interest costs.
Treasury Secretary Nicholas F. Brady and New York Fed President E. Gerald Corrigan hope the punishment they've meted out to Salomon--barring it from bidding on customers' behalf--will keep traders in line. Still, that's not enough. The regulators can fix the system with powers they already have. Here's how:
-- Strengthen the cops. Three agencies split the chore of policing the market. Treasury sets the rules, such as the 35% limit on any one bidder's share of an auction, but lacks investigative powers. The New York Fed gets reports on primary dealers' bond and note holdings, although the data are too skimpy for adequate enforcement. The Securities & Exchange Commission is called in only after violations are detected. Result: The government hadn't noticed anything wrong in three of the five auctions in which Salomon admitted to violating rules.
Some say the solution is to lower the 35% cap. But squeezers could get around any ceiling if the monitoring is only a joke. And the panacea is not to create a single regulator, which would take years of political wrangling to accomplish. Instead, a simple and effective step for Corrigan would be to beef up the New York Fed's weak dealer-surveillance unit into a sharper-eyed monitor of bidding and trading. The SEC would be happy to show him how to get better, more timely information from market players.
-- Open the market. Treasury's auctions are still paper-and-pencil affairs. Primary dealers use runners to deliver handwritten bids to the New York Fed. In theory, anyone can offer a competitive bid. In practice, only the 40 primary dealers have the information to bid successfully for themselves and their customers.
Treasury is considering requiring large customers to submit bids directly rather than buying through dealers. A better idea: set up a computerized market open to direct bids by hundreds of institutions.
-- Swamp the squeezers. Treasury has the power to break a squeeze by hitting the market with a special issue of notes. It hasn't done so because that would disrupt its announced borrowing schedule. Treasury should realize that a squeeze does more damage than does a minor calendar change.
If handled badly, the Salomon scandal could bring a replay of the banking credit crunch. "Lax regulation that suddenly turns tough at exactly the wrong time could choke this market," frets an official at one primary dealer. The Treasury and the Fed have the power to prevent that by shaping rules that guarantee a robust yet fair market. They shouldn't wait any longer.