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Joint Report on the Government Market Securities Board of Governors Department of Securities and ofthe the Treasury Exchange Commission Federal Reserve System ^Sa January 1992 TREASURY. DEPARTMENT LIBRARY c. ^ Joint Report on the Government Market Securities Board ofGovernors Department of Securities and ofthe the Treasury Exchange Commission Federal Reserve System ..o°^=£2i;f^:^. 1'<ALVi.V^~.- LIBRARY ROOM 5030 li FEB 12- mi TREASURY DEPARTMENT January 1992 ForsalebyIheU.S.GovcmmcniPnntingOffice SuperinicndeniofDocuments.MailStop:SSOP.Wa.shington.DC 20402-9328 ISBN 0-16-036093-5 DEPARTMENT OF THE TREASURY WASHINGTON January 22, 1992 The Honorable J. Danforth Quayle President United States Senate Washington, D.C. 20510 Dear Mr. President: We are pleased to transmit our report on the government securities market, as promised in statements before Congressional subcommittees last year. The recent widely publicized events involving abuses in the government securities market have prompted us to undertake a thorough review of the market that the federal government relies upon to meet its borrowing needs. The Federal Reserve Bank of New York was a full participant in this review, and its views are reflected here as well. Our recommendations for legislation and changes in policies are contained in this report. We believe that these reforms will improve the fairness and efficiency of the market, to the benefit of taxpayers and investors alike. We urge the Congress to move swiftly in enacting our legislative recommendations. We are also transmitting the report to the Speaker of the House. Sincerely, kAcJ^ -^ Nicholas F Brady Richard C. Alan Greenspan Secretary Chairman Chairman Department of the Securities and Board of Governors Treasury Exchange Commission of the Federal Reserve System DEPARTMENT OF THE TREASURY WASHINGTON January 22, 1992 The Honorable Thomas S. Foley Speaker House of Representatives Washington, D.C. 20515 Dear Mr. Speaker: We are pleased to transmit our report on the government securities market, as promised in statements before Congressional subcommittees last year. The recent widely publicized events involving abuses in the government securities market have prompted us to undertake a thorough review of the market that the federal government relies upon to meet its borrowing needs. The Federal Reserve Bank of New York was a full participant in this review, and its views are reflected here as well. Our recommendations for legislation and changes in policies are contained in this report. We believe that these reforms will improve the fairness and efficiency of the market, to the benefit of taxpayers and investors alike. We urge the Congress to move swiftly in enacting our legislative recommendations. We are also transmitting the report to the President of the Senate. Sincerely, Nicholas F. Brady Richard C. Breeden Alan Greenspai Secretary Chairman Chairman Department of the Securities and Board of Governors Treasury Exchange Commission of the Federal Reserve System TABLE OF CONTENTS Page OVERVIEW OF THE GOVERNMENT SECURITIES MARKET ix SUMMARY OF REFORMS xiii JOINT REPORT 1 APPENDIX A: Background on the Treasury Securities Market 1. Characteristics of the Primary Market A-1 2. Characteristics of the Secondary Market A-7 3. Regulation of the Treasury Market A-12 APPENDIX B: Treasury Securities Market Issues 1. Short Squeezes B-1 2. Debt Management Approaches to Alleviating Squeezes B-4 3. Treasury Auction Issues A. Auction Technique B-17 B. International Comparison B-25 C. Auction Automation B-41 D. Auction Rule Enforcement B-48 E. Concentration of Auction Awards B-54 4. Hedge Funds B-64 vii 5. Government Securities Clearing Corporation B-71 6. Sales Practice Rules B-83 7. Information Access B-87 8. Reporting and Audit Trails B-92 APPENDIX C: The Events Involving Salomon Brothers and Alleged Government Securities Market Abuses 1. The Events Involving Salomon Brothers C-1 2. Short Squeezes C-5 3. Improper Practices Relating to GSE Securities C-7 APPENDIX D: Background on the Government-Sponsored Enterprise Securities Market D-1 APPENDIX E: The Primary Dealer System 1. Statement of the Federal Reserve Bank of New York E-1 2. Primary Dealers: Criteria and Procedures Applied to Firms Interested in Becoming and Remaining Primary Dealers .... E-11 vin