Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Institutionalization of Treasury Note and Bond Auctions, 1970-75

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Institutionalization of Treasury Note and Bond Auctions, 1970-75

Article excerpt

* Despite the appeal of auctions as an effective way to offer securities, the U.S. Treasury failed in its first two attempts, in 1935 and 1963, to introduce a program of regular auction sales of long-term bonds.

* That pattern changed between 1970 and 1975, when the Treasury replaced its fixed-price offerings of notes and bonds with regular auctions--a practice that continues today.

* An analysis of the Treasury market suggests that the turnaround in the early 1970s owes to three key decisions: the Treasury closely imitated its successful and well-known bill auction process; it announced auctions for securities of gradually increasing maturity, rather than immediately auctioning long-term bonds; and it was willing to alter the auction process when improvements were called for.

1. INTRODUCTION

Since 1976, the U.S. Treasury has financed the federal deficit, and refinanced maturing debt, primarily with auction sales of bills, notes, and bonds. However, prior to 1970 the Treasury did not auction coupon-bearing securities. (It did auction bills, more or less as it does today.) Instead, it raised new cash, and refinanced maturing debt, with fixed-price subscription and exchange offerings of notes and bonds.

The substitution of market-driven auctions for fixed-price offerings between 1970 and 1975 was a milestone in the evolution of the Treasury market. However, the outcome of the effort was initially quite uncertain. The Treasury had tried twice before--in 1935 and 1963--to auction long-term bonds, but both attempts had failed. Although many observers believed that auctions would be a more efficient way to identify market-clearing prices, it was far from evident--especially in light of past experience--how to introduce successfully a program of regular auction sales.

This article examines the introduction of regular auction offerings of Treasury notes and bonds in the early 1970s. We do not take issue with the conventional wisdom that auctions are more efficient and less costly than fixed-price offerings. Rather, we seek to identify why the Treasury twice tried and failed to adopt the more efficient method but succeeded on its third attempt. We suggest that the success of the effort rested on three pillars. First, the Treasury closely imitated its successful and well-known bill auction process. This strategy gave dealers a familiar starting point for developing the risk management and sales programs needed to support auction bidding for coupon-bearing securities. Second, the Treasury announced auctions for securities of gradually increasing maturity, rather than jumping immediately to auctioning long-term bonds, as it did in 1935 and 1963. This action allowed dealers an opportunity to build up their risk management and sales programs in an orderly fashion. Third, the Treasury demonstrated a willingness to alter the auction process when shortcomings appeared--rather than simply jettisoning the entire effort, as it did in 1935 and 1963. By combining familiarity, gradualism, and a willingness to improvise, the Treasury successfully moved the primary market for coupon-bearing securities to a more efficient configuration.

The history of the Treasury's attempts to institutionalize auction offerings of notes and bonds is important in its own right, but also for its larger implications. It suggests that the mere prospect of greater efficiency may not necessarily effect change that requires a large number of actors to alter familiar patterns of behavior; change sometimes also depends on following a path that facilitates learning and implementation of new patterns. The Treasury accomplished its objectives in the early 1970s because it gave dealers an opportunity to learn gradually about how to participate in note and bond auctions and because it was itself willing to learn from experience.

The article proceeds as follows. The next two sections set the stage by describing how the Treasury sold securities before 1970: Section 2 looks at fixed-price offerings of notes and bonds and Section 3 explains how bills were auctioned. …

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