Statement by David W. Mullins, Jr., Vice Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Securities of the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, January 23, 1992
Statement by David W. Mullins, Jr., Vice Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Securities of the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, January 23, 1992.
Thank you for this opportunity to present the Federal Reserve Board's views on reforms to the regulation of the government securities market. Since September, when I last testified before this committee, the staff of the Federal Reserve, the Treasury Department, and the Securities and Exchange Commission (SEC) have conducted an exhaustive examination of this market, the results of which were released yesterday. My prepared remarks will touch upon some of the main conclusions of this report from the particular perspective of the Board of Governors of the Federal Reserve System. Our perspective differs somewhat from that of the other agencies contributing to the report because of differences in legislative mandates.
The Board of Governors has little direct regulatory authority for the U.S. government securities market. Although the Board has general oversight responsibility for all Federal Reserve District Banks, the District Banks act as fiscal agents of the Treasury, thus sharing with the Treasury operating responsibility for the market. The SEC's charge is to enforce the securities laws that seek to foster a high degree of fairness in the marketplace. With neither the direct responsibilities of funding the government nor substantial regulatory oversight, the Board of Governors can view this market from a somewhat different vantage point-a policy perspective that allows us to examine these issues in an economy-wide context.
When we look to the government securities market, we see a market that works as well as any on earth. U.S. government debt is an ideal trading vehicle because it is all closely substitutable and has none of the default risk or idiosyncratic problems of private issues. As a result, market participants, in the aggregate, willingly commit substantial amounts of risk capital and exchange a large volume of securities each day. Positions are large, yet trading skills are so sharply refined that bid-ask spreads are razor thin, a small fraction of the size of spreads in major equity markets.
This market generates widespread macroeconomic benefits. The government securities market efficiently absorbs the large quantity of new issues required to finance the deficit. With realtime quotes on a range of instruments, this market serves as the foundation for private market rates and a haven for ready liquidity. Further, this deep and liquid market gives the Federal Reserve a powerful, reliable mechanism to implement monetary policy.
Nonetheless, the admission of wrongdoing by Salomon Brothers, episodes of price distortions, and other evidence uncovered in our joint study all suggest that this market has faults. It can be improved. The proposals contained in the joint report, along with other reforms announced earlier, constitute the comprehensive modernization of the mechanisms and practices in the government securities market. Implementing these proposals represents a formidable, though feasible, task in our view.
Over the longer term, the most effective force in enhancing market efficiency and reducing the potential for manipulative abuses is the force of competition. And the joint report provides a blueprint to open up the government securities market to broader-based participation. Automating Treasury auctions; facilitating direct bidding by customers, including nonprimary dealers; implementing a single-price, open auction technique; and reducing the barriers to primary-dealer membership all will serve, in time, to broaden participation in the primary market and in the secondary market for newly issued securities. More depth and breadth in this end of the market should increase efficiency, reduce Treasury financing costs, and lessen the potential for manipulative trading abuses. …