Statements to the Congress - statement by E. Gerald Corrigan - Transcript

Federal Reserve Bulletin, Nov, 1991

Statement by E. Gerald Corrigan, President, Federal Reserve Bank of New York, before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, U.S. House of Representatives, September 4, 1991

I appreciate the opportunity to provide the subcommittee with my views concerning the recent disclosures by Salomon Brothers Inc. and the implications of those disclosures for the government securities market. These disclosures are clearly serious matters that must be addressed to ensure that confidence in the U.S. government securities market is maintained at the highest levels. My statement touches on three topics: first, the role of the Federal Reserve Bank of New York as it relates to the government securities market; second, the Bank's understanding of the circumstances surrounding Salomon Brothers' disclosures over the period August 9 to August 19, including the steps the firm has taken or is planning to take to protect against similar problems in the future; and third, my thoughts on a prudent course for the near term.

THE STRUCTURE OF THE GOVERNMENT SECURITIES MARKET AND ROLE OF THE FEDERAL RESERVE BANK OF NEw YORK

As the subcommittee knows, the market for U.S. government securities is the world's largest, most efficient, and most important securities market. Given the sheer size of the federal government debt that needs to be financed, we all have a big stake in ensuring that the debt is financed at the lowest possible cost and that the liquidity and efficiency of this market is preserved.

The market consists of several broad categories of private and public participants. First, there is the U.S. government itself as issuer of the securities. Second, there are Federal Reserve Banks operating as the Treasury Department's fiscal agent. Third, there is the Federal Reserve Bank of New York, acting on behalf of the Federal Open Market Committee, in entering the market for day-to-day purchases and sales of government securities as the chief instrument for the implementation of monetary policy. Further, the New York Bank also acts in the market as agent for foreign central banks and other official institutions. Fourth, there are government securities dealers and banks that act as intermediaries between the Treasury and others in the distribution and trading of government securities. Finally, there is the multitude of individual and institutional holders of the Treasury's securities.

For descriptive purposes, it may be useful to think of the operation of the market in two separate but closely related classes of activities. First, there are those activities that center on the issuance of new debt (or the rollover of existing debt) by the Treasury. This function is performed under rules established by the Treasury, including the so-called 35 percent rule. Primary dealers (whose characteristics are described below) are the major takers of new debt issued by the Treasury either for the dealer's own account or for the accounts of their clients or customers. Entities that are not primary dealers may also submit competitive bids on their own, but many choose to make such bids through primary dealers. Finally, any entity or individual may submit noncompetitive bids in an amount up to $1 million. Such bids are accepted by the Treasury at the average price that results from the competitive bidding process.

The second class of activity relates to investing and trading in the vast stock of Treasury debt that makes up the market as a whole. At this level, the scope of the market widens appreciably and ultimately encompasses the millions of individuals and institutions on a global basis that are active in the market for U.S. government securities. This vast secondary market in government securities functions with elements of liquidity, efficiency, and resiliency that are unique, on a global scale, to that market. In part, this is made possible by the Treasury-Federal Reserve bookentry system for the electronic custody and transfer of these securities.

As noted above, among the private participants in the market are the so-called primary dealers in U.S. government securities with whom the Federal Reserve Bank of New York conducts its open market operations. The primary dealers are the main market makers for government debt. They maintain two-way markets for government securities and participate directly and actively in the Treasury's auctions. Today, there are about forty primary dealers-about half are banks or securities affiliates of banks and half are diversified or specialized securities firms. All Federal Reserve transactions in the market, whether for its own account or for the accounts of other official institutions, are conducted with the primary dealers. During 1990, the aggregate volume of such transactions conducted by the Federal Reserve with primary dealers was close to $525 billion.

The mere fact that the Federal Reserve Bank of New York must conduct transactions with private-sector counter-parties implies, of necessity, that the Bank incurs the same elements of counterparty credit, delivery, and settlement risk that any private-sector market participant also incurs. For this reason, the Bank has established criteria for selecting those firms with whom the Bank does business. (The criteria for primary dealers are described in Attachment A. 1) It should also be noted that in several other major industrial countries there are broadly similar arrangements between central banks and a designated group of firms with whom those other central banks conduct their business.