Statement by William J. McDonough, Executive Vice President, Federal Reserve Board of New York, before the Subcommittee on Telecommunications and Finance of the Committee on Energy and Commerce, U.S. House of Representatives, March 17, 1993

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I am pleased to have the opportunity to appear before you in my capacity as Executive Vice President of the Federal Reserve Bank of New York responsible for the Financial Markets Group. As such, I have responsibility for domestic and foreign operations of the System Open Market Account and for the recently formed Market Surveillance Function. My statement this morning will discuss the market surveillance activities of the Federal Reserve Bank of New York and the overall subject of the official oversight and regulation of the government securities market.

We all share a common goal regarding the government securities market. That is, we all want to ensure that the integrity, health, and efficiency of the world's largest and most liquid securities market is preserved. Quite clearly, the American public and the world at large share an enormous interest in the continued vitality of the market for U.S. Treasury securities and its ability to meet both public and private needs.

Against this background, the immediate question before the subcommittee centers on how the legislative process can best support efforts to ensure that this vital market retains its status as the most efficient market in the world. As the subcommittee deliberates this important topic, I think it necessary to consider the strides taken over the past year to improve the monitoring of this market.

Salomon Brothers' admissions of deliberate and repeated violations of Treasury auction rules could well have damaged the public's confidence in the overall soundness of the government securities market. Fortunately, this did not happen, as evidenced by the efficiency with which the market has continued to perform. Nonetheless, some important questions were raised about the workings of that market and the official oversight of the market.

After the events of August 1991, the Treasury, the Securities and Exchange Commission (SEC), and the Federal Reserve moved quickly to address the various concerns that arose from the Salomon revelations. The agencies have set up a working group on market surveillance, with the Federal Reserve Bank of New York accepting primary responsibility for collecting and disseminating information. The Treasury facilitated broader auction participation, clarified and restated auction rules, and, with the Federal Reserve, strengthened the procedures for enforcement of those rules. Changes were made to the administration of the primary dealer system to provide greater access to participants who wished to service the central bank.

Ongoing automation initiatives will lend further support to ensuring that the primary and secondary markets are open and accessible. Our new system for automated Treasury auctions is in the final stages of testing, and its implementation is scheduled for next month. This effort will speed and further systematize the auction review process and further allow for broader bidder access. In addition, we have finalized many of the business requirements for the automation of our open market operations and have taken some initial steps in development, with a view toward implementing several capabilities next year. This effort will provide an efficient way of accommodating an expansion in the number of our trading counterparties--should such occur.

Market participants themselves have reviewed and improved internal compliance procedures and audits after the revelations of wrongdoing in 1991. Finally, it is important to restate that, in the face of apparent irregularities in the marketplace, securities and bank regulators already have access to individual dealer firms' books, records, and trading systems. Having said that, it should also be stressed that it is neither possible nor desirable to have absolutely fail-safe management and control systems or regulatory schemes that can prevent or detect every problem or potential problem. Nor is it desirable to discourage innovation with overly restrictive and duplicative rules. …