Did Salomon's Scheming Raise Interest Rates?

The U. S. government-securities market affects every corner of the economy, since Treasury securities are the benchmark for setting borrowing costs on all kinds of debt, from consumer loans to mortgages to corporate bonds. This raises the crucial question: Did Salomon Brothers Inc.'s shenanigans in the Treasury market cost the economy a bundle? Are borrowers paying a higher interest rate because of Salomon?

Thus far, the answer is: probably not. But economists agree that left unchecked, Salomon's rule-breaking activities would eventually have damaged the government-securities market, raising everybody's borrowing costs.

STAY-AWAYS. Indeed, it seems that taxpayers actually benefited from the auctions at which Salomon admits it bought more than the 35% limit. To grab that big a chunk of bonds, Salomon had to submit a slightly higher price than other dealers. And a higher bond price means a lower interest rate, saving the Treasury and taxpayers millions. Of course, Salomon pocketed millions, too, as it charged other dealers above-market prices to buy the bonds they needed to cover short positions.

Yet the consequences would have changed dramatically over time if investors had come to believe that Salomon, or any dealer for that matter, could consistently corner Treasury auctions on its own or in collusion with others. "The perception that there is an unfair market will lead buyers and bidders to stay away, which in the long run would lessen competition," says Lawrence H. White of New York University. There would be fewer bidders at Treasury auctions, causing the prices of government securities to drop. Interest rates would rise, and borrowing costs throughout the economy would soon follow suit.

Salomon Brothers may not have intentionally set out to act like a monopolist, but the effect over time would be the same. As Nobel laureate Paul A. Samuelson puts it: "One wants to jealously guard the openness of the markets so that no one has undue influence on prices." For that reason alone, punishing Salomon or any other Wall Street miscreant that violated the Treasury's auction rules makes good economic sense.

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