Salomon Is Not Too Big To Punish

The $2.2 trillion market for U.S. Treasury securities is the largest, the most liquid, and probably the cleanest in the world. In the 1980s, markets for other American securities such as stocks, commodities, and junk bonds were plagued by scandals that raised serious questions about their integrity. But until Aug. 9, no serious questions of impropriety had been raised about the Treasury market. On that day, Salomon Brothers Inc., the market's leading player, admitted that in some recent Treasury auctions the firm violated government bidding rules. Then, on Aug. 14, the firm conceded that its top management, including Chairman and CEO John H. Gutfreund, was aware of bidding irregularities in April but failed to take appropriate action.

No charges have been filed against Salomon, but some market participants contend that the firm was trying to manipulate Treasury prices for its own benefit and to the detriment of other dealers. If the firm is found to have rigged the market, the question becomes what penalties should be imposed. One penalty would be removing Salomon as a primary dealer in Treasury securities. Some contend, however, that Salomon is too big to bar from future auctions. That would undermine the market's liquidity and reduce the government's proceeds from its securities sales, the argument runs.

This reasoning is specious. Barring Salomon would be an extreme step and should not be taken unless the facts point in that direction. Indeed, it would create temporary instability and uncertainty. But eventually, other players would move forcefully to fill the void. After all, the ultimate buyers of these securities are investors, not securities firms.

But there is a much broader reason for cracking down hard on any miscreant, no matter how big and powerful. The perception of the Treasury market's purity is essential. The U.S. needs the market to finance its budget deficits. Treasury securities are owned by central banks throughout the world. The Federal Reserve uses the market to implement monetary policy. If holders of Treasury debt come to believe that the market is rigged and that regulators lack the will to police violations, the results could be catastrophic. The resulting sell-off could push the government's borrowing costs up by billions of dollars. That's why regulators must hack out any abuses in the market and impose appropriate penalties. Let the chips fall where they may.

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