Statements to the Congress - David W. Mullins Jr. testimony concerning government securities market reform - Transcript

Federal Reserve Bulletin, April, 1992

Indeed, automation and enhanced market monitoring also present the opportunity to correct a longstanding market misimpression. Although the Federal Reserve Bank of New York has no statutory authority to regulate the primary dealers, many people view the primary dealer system as evidence of some measure of oversight of those firms by the Federal Reserve Bank of New York. Ongoing automation and enhanced monitoring capabilities will let the Bank move to a more open set of trading relationships, thus disabusing market participants of the notion that the primary dealers have a special status. To further that end, the Bank will eliminate its dealer surveillance unit, showing unambiguously that responsibility rests with the primary regulator. The Bank will also lower the impediments to primary-dealer membership, thereby encouraging a broadening of membership in the primary-dealer system.

The careful monitoring of the market will be made more credible by action: Persistent and large-scale price anomalies consistent with a manipulative squeeze will call forth two sets of policy responses. First, if other evidence (including discussions with market participants) suggests manipulation, then the SEC will begin an investigation to determine if any security laws have been broken. Second, and more immediately, the Treasury will act in the market to narrow those price anomalies, thereby limiting the extent of the market disruption in general and reducing the potential gain if manipulative behavior was the root cause. The Treasury's actions will be effected by either holding a new auction of the sought-after security--a reopening--or through the sale of those securities into the market by the Trading Desk of the Federal Reserve Bank of New York on behalf of the Treasury--a tap issuance. The resulting expansion of supply should slash the manipulator's potential gain, making it unlikely that any one would even try to manipulate the market. Circumstance and experience over time will dictate when an increase in supply will be required and which means of augmenting the issue will be taken.

It is the judgment of the Board of Governors that the reforms that I have outlined--changes in auction mechanisms, active and rigorous monitoring of market rates, and the clear willingness to use relative supplies to punish manipulative behavior--will work to prevent a replay of last year's events. These reforms are fundamental changes in market mechanisms that promise to open this market to broad-based participation while, at the same time, enhancing regulatory surveillance and remedial capabilities. These responses are measured, targeted, and commensurate to the problem at hand and in our view obviate the need to punish many with reporting burdens because of the actions of a few. This strategy also offers flexibility to deal with future problems as they arise. It is perhaps ironic that the most serious abuses in the history of this market--the Salomon Brothers episode--have served as the catalyst for changes that promise substantial long-term benefits. Taken together, these proposals and those already implemented constitute a thorough, thoughtful, and feasible renovation of the government securities market and will result in a healthier, more efficient market for U.S. government securities.