1960 study dealer market government securities jec

8/2/2019 1960 Study Dealer Market Government Securities JEC

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JOINT COMMITTEE PRINT

A STUDY OF THE DEALER MARKET FORFEDERAL GOVERNMENT SECURITIES

MATERIALS PREPAREDFOR THEJOINT ECONOMIC COMMITTEECONGRESS OF THE UNITED STATES

Printed for the use of the Joint Economic CommitteeU N I T E D S T A T E S

G O V E R N M E N T P R I N T I N G O F F I C E62471 W AS HIN GT ON : 1960

For sale by the Superintendent of Documents, U.S. Government Printing OfficeWashington 25, D. O . - Price 40 cents


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J O I N T E C O N O M I C C O M M I T T E E(Created pursuant to sec. 5(a) of Public Law 304, 79tb Cong.)

PA X JL H . D O U G L A S, I l l i no i s , ChairmanW R I G H T P A T M A N , T ex as , Vice ChairmanS E N A T EJ O H N S P A R K M A N , A l a b a m aJ . W I L L I A M F U L B R I G H T , A rk a ns asJ O S E P H C . O ' M A H O N E Y , W y o m i ngJ O H N F . K E N N E D Y , M a ss ac h us et tsP R E S C O T T B U S H , C o n n e c t i c u tJ O H N M A R S H A L L B U T L E R , M a ry la n dJ A C O B K . J A V I T S , N e w Y o r k

J O H N W . L E H M A N ,

H O U S E O F R E P R E S E N T A T I V E SR I C H A R D B O L L I N G , M i s s o u r iH A L E BO G G S, L ou i s i a naH E N R Y S . R E U S S , W i s c o n s i nF R A N K M . C O F F I N , M a in eT H O M A S B . C U R T I S , M i s s o u r iC L A R E N C E E . K I L B U R N , N e w Y o rkW I L L I A M B . W I D N A L L , N ew Je rs eyClerk and Acting Executive Director

I I


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L E T T E R S OF T R A N S M I T T A LDECEMBER 30,1960.To Members of the Joint Econom ic Com mittee:F o r the i n f o r m a t i o n of the m em b er s of the J o i n t E co n o m i c C o m mi t t ee and o ther s in t e res t ed there is t r an s m i t t ed h e r ew i t h an ana lys i sof the o p e r a t i o n s of dea le r s opera t ing in the m a r k e t for F e d e r a lGov ernm en t secu r i ti es .

A s you k n o w , the s tudy g rew out of the repor ts co l lected f rom the17 dealers in Governmen t secu r i t i es in the fa l l of 1959 to s u p p l e m e n tthe in fo rmat ion ob ta ined in the commi t t ee ' s hear ings wh ich were con duc ted in connect ion wi th the s t u d y of " E m p l o y m e n t , G r o w t h , andPr ice Leve l s . "Th i s s tudy of the Governmen t secu r i t i es marke t is a p ioneer ing oneand should be of p e r m an en t v a l u e as a source of i n f o r m a t i o n in u n d e r s t an d i n g the m a r k e t for Governmen t secu r i t i es . No o ther s tudy ofcomparable scope has ever been made of t h i s m ar k e t . The F e d e r a lReserve-Treasu ry s tudy wh ich was r ep o r t ed to the co m m i t t ee d u r i n gi t s hear ings in connect ion wi th the s t u d y on " E m p l o y m e n t , G r o w t h ,and P r i ce Leve l s" p rov ided much in fo rmat ion abou t the F e d e r a lsecu r i t i es marke t and the deve lopmen ts in the m a r k e t d u r i n g 1957and 1958. The cu r ren t ana lys i s covers the ent i re per iod f rom 1948t o 1959 and i n t e r re l a t es the f ac tua l mate r i a l f rom the dea le r s wi tho ther in fo rmat ion ob ta ined by the commi t t ee in its h e a r i n g s and w i t hthe Federa l Reserve-Treasu ry s tudy .Th i s s tudy wi l l be va luab le to t hose concerned wi th ana lyz ing thebehav io r of t h i s m ar k e t , to t h o s e ch a r g ed w i t h m an ag em en t of theS ubl ic debt and wi th moneta ry po l i cy , and also should assist in theeve lopmen t of a u n i f o r m and r egu la r sy s tem of s t a t i s t i ca l r epo r t ingf o r t h i s i m p o r t an t m a r k e t . P A U L H. D O U G L A S ,Chairman, Joint Econom ic Com mittee.

DECEMBER 19,1960.Hon. P A U L H. D O U G L A S ,Chairman, Joint Econom ic Com mittee,U.S. Senate, Washington, D.C.

D E A R S E N A T O R D O U G L A S : T r a n s m i t t e d h e r e w i t h is "A S t u d y of theD ea l e r M ar k e t for F ed e r a l G o v e r n m en t S ecu r i t i e s " p r ep a r ed in response to the commi t t ee ' s in s t ruc t ions in its annual repor t f i led wi ththe Congress Feb ruary 29 , 1960 (S. Rept. 1152, 86th Cong., 2d sess . ) .This analys is covers the opera t ions of the 17 dealers in F ed e r a l G o v ernmen t secu r i t i es as set fo r th in the repor ts f i led wi th the commi t t eeby the dea le r s in connect ion wi th the committee 's 1959 study on "Emp l o y m en t , G r o w t h , and Pr ice Leve l s . " In connec t ion wi th tha t s tudy ,

i n


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IV L E T T E R O F T R A N S M I T T A Lon No vem ber 2 , 1959, th e dealers were requested to furn ish in form at ion concern ing thei r operat ions as fo l lows:(1 ) S ta t em en t o f ea rn ings and expenses ;(2) Po si t io n and sources of f inancing on selected da te s;

(3) F in an cia l posi t ion in secur i t ies , 1948-59 ;(4 ) Y ea r ly g ross t r ansac t ions in U .S . Go vernm en t secu r i t i es ,1948-59 ; and(5) B alan ce sheets , 1948-59 .A set of four for m s w^as sup plie d to each dea ler upo n w hic h to rec ordthe i r repor ts . T he las t o f these da ta was received in Ma rc h of 1961 ,the delay being due to diff icul t ies experienced by some of the dealersin comple t ing the t abu la t ion o f the in fo rmat ion , par t i cu la r ly fo rear l ie r yea rs . I n com plet ing the s tud y th is yea r , i t was d iscoveredth a t add i t ion a l in fo rm at ion was needed , inc lud ing bo th add i t iona lda ta and expla nat ion s of cer ta in i tems wh ich we re no t com plete ly c lear .Th e reques t fo r add i t iona l in fo rm at ion was m ade to the dea le r s inJu ne . I n Ju ly , a num ber of the dea le r s were v i s it ed in New Y or kto c lar i fy the meaning of the in format ion suppl ied .T he t abu la t ions and ana lyses were p re par ed and the r ep o r t waswr i t t en by P ro f s . Al l an H. Mel t ze r and Ger t von der L inde , o f Car neg ie In s t i tu t e o f Techno logy , P i t t sb u rg h . Ja m es W . Kn ow les o f thecommit tee s taf f p rovided the general d i rect ion and superv is ion , des igned the quest ionnai re and carr ied ou t the in i t ia l phases of theinvest igat ion in connect ion wi th the s tud ies of employment , g rowth ,an d pric e levels d u ri n g the fal l of 1959.This s tudy has been carr ied ou t in complete conformi ty wi th Commi t t ee R u le No . 23 , wh ich p rov ides th a t th e in fo rm at ion con ta inedin an y books , pa pe rs , o r docum ents furn ishe d to the com mit tee by anind iv idua l , pa r tner sh ip , co rpo ra t ion , o r o ther l ega l en t i ty sha l l , uponthe reques t o f the ind iv idua l , pa r tner sh ip , co rpo ra t ion , o r en t i ty fu r n is h in g th e same, be m ain ta in ed in s t r ic t conf idence by the m em bersand staff o f the com mit tee . U n de r the com mit tee ru les the on ly pe rsons ha vi ng access to th is f ile have been Messrs . Kn ow les , Mel tzer , andvon der L inde who were fo rmal ly des igna ted to ca r ry ou t the s tudy .In the repor t submit ted herewi th , the conf ident ia l character o f theind iv id ua l responses has been fu l ly pro tec ted .One unpubl ished and three publ ished sources have been of g reatass is tance to the au tho rs in the course of th is s tud y . T he unp ubl is hedvo lume, "The Marke t fo r Un i t ed S ta t es Treasu ry Ob l iga t ions , " p re pared fo r the Nat iona l Bureau o f Economic Research by Mor r i s Men-de lson and Ro lan d Rob inson was ex t remely he lp fu l in co r ro bora t ingrepor ts f rom dealers and in descr ib ing the funct ion ing of the market .The th ree p r inc ipa l pub l i shed sou rces have been acknowledged a tap pr op r ia te p laces in the tex t . T he fu ll c i ta t ions , how ever , ar e g ivenh e r e :

( 1 ) " T h e T r e a s u r y - F ed e r a l R es e r v e S t u d y o f t h e G o v e r n m en tS ecu r i ti e s M ar k e t , " p a r t I , J u l y 1 9 5 9 ; p a r t i t , F eb r u a r y 1 9 6 0 ; p a r tI I I , F eb ru ar y 1960 . T hi s i s refer re d to in the tex t as th e Tre as ury -Federa l Reserve s tudy .( 2 ) " U n i t ed S t a t e s M o n e t a r y P o l i cy : R ecen t T h i n k i n g an d E x p e r i ence , " hear in gs befo re the Subcomm i t tee on Economic S tab i l i za t iono f the Jo in t Commi t t ee on the Economic Repor t , Congress o f theU ni ted S ta t es , W ash ing to n , 1954. Th i s vo lume con ta in s a copy o f


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L E T T E R O F T R A N S M I T T A L Vt h e " F ed e r a l O p en M ar k e t C o m m i t t ee R ep o r t o f t h e Ad Hoc Subcomm it tee on the Go vern m ent S ecur i t ies M ark et , Nove mber 12 , 1952 ."These a re r e fe r red to as "H ea r ing s , 1954" and "A d H oc R epo r t . "(3 ) "E m ploy m en t , Grow th , and P r i ce Leve l s , " hear ing s befo re theJo in t Economic Commi t t ee , Congress o f the Un i t ed S ta t es , Wash ing ton , 1959 . P a r t s 6A, 6B , an d 6C. I n the tex t , these vo lumes are c itedas "H ea r ing s , 1959 ."Numerous in t e rv iews o r mee t ings were he ld wi th Governmen t secu r i t ies dealers , the de bt m ana gem ent s taff o f th e Trea su ry , severaloff icers and staff members of the Board of Governors of the FederalReserve Sys tem, the Federa l Reserve Bank o f New York , and theFe der a l Open M ark e t Com mi t t ee . A l l of those invo lved con t r ibu tedmea su rab ly to th i s r epo r t . W i th ou t the i r who lehear t ed coopera t ionthe repor t could no t have been completed .

Process ing of the data was in par t accompl ished through the helpfu l ass is tance of M. H. Schwar tz and Cather ine Whis t ler o f theDiv i s ion o f Research and S ta t i s t i cs , Board o f Governo rs , Federa lReserve System, af ter the data had been coded and punched to pro tectthe conf ident ia l ity of the resp onde nts .Messrs . Mel tzer and von der Linde wish me to express , too , thei rindebtedness to thei r co l leagues , G. L. Bach and Edwin Mansf ie ld ofCarnegie Ins t i tu te of Technology for valuable d iscuss ion and cr i t i c ism of ideas and analy t ical techniques used in th is repor t and toM r s . M. Blank whose ass i s t ance in p repar ing the r epo r t wen t f a rbeyond the ob l igat ions of a sec retary .Final ly , the commit tee should no te par t icu lar ly that i t was d i f f icu l tto ar r ive a t a consol idated p ic ture of the market because of the lackof un i formi ty in record keeping pract ices and repor t ing in the indust r y du r in g pr io r yea rs . T hi s ha s m ade i t d if ficult bo th for the dealersin supply ing data and for the s taf f in reconst ruct ing reasonable es t i mates of to ta ls for the market ; and i t has pu t cer ta in l imi ta t ions , no tedin the tex t , upon the conclus ions that can be drawn.Respec t fu l ly submi t t ed .J O H N W . L E H M A N ,Clerk and Acting Executive Director.


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C O N T E N T SPaceCha pter I . Th e role of the dealer ma rket 1Introduct ion 1Identifying th e dealers 2Dea ler functions 3Definitions 3Th e dealer m ark et and the saving-investme nt process 5Arbitrage in the ma rke t 5Scope of the stu dy 9

Cha pter II . The dealer m ark et: T rading organization and philosophy ofdealer firms 11Inter nal organization for tradin g 11Custom er services and informa tion flow 13De aler views of dea ler function s 15Making ma rkets 15Interdealer tradings 18Size of tra nsa cti on s 19Sho rt sales 20Dealers , brokers , and l ieutena nts 21The Federal Reserve and the dealer ma rket 22Tra nsac tions with the dealers 22Clearing securities transa ction s 24Recognizing Go vern me nt securities dealers 25Cha pter II I . Dealer posit ions 27Definitions and problem s in the me asure me nt of dealer positions 27W hat is to be included _ 27Go vernm ent gua ran teed issues, agencies, and others 27Repurchase agreements 28Executed versus com mitm ent reporting 29Inve stme nt accounts 30How should positions be mea sured 31Ne t versus gross measu res 31Pa r versus m ark et versus cost price .. 32Tim ing of th e rep orts 33Summary 34

En d of year inve ntories 35Dea ler holdings of th e public deb t 39M idyea r positions 41Ind ivid ual dealers portfolios 45Inves tm ent accounts 46Findings 47C ha pte r IV. Volume and compo sition of tran sac tion s in U.S. securities 49Deve lopmen t of tradin g in the dealer ma rket 49Scope of da ta and typ es of tran sac tion s 50Volume of dealer trad ing 57Com position of dealer trad ing 65Con centration of trad ing in the dealer ma rket 66Findings 68Ch apter V. Financing the Gov ernme nt securities ma rket 71Sources an d uses of funds 72Com parison of dealer com mitm ents and dealer net positions 78M agn itud e and distrib ution of sources and uses of dealers ' fun ds , 79Di strib utio n of sources for individu al dealers 82Ra tes on dealer loans 85Changes in the rate s tructu re over t ime 87Effect of th e ra te str uc tu re on sources of financing 89Leverage and margin requirem ents 90Cash balanc es 93Findings 94vn


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VIII C O N T E N T SP a g eC h a p t e r V I . L e g a l o r g a n i z a t i o n a n d c a p i t a l b a s e 9 7L e g a l o r g a n i z a t i o n , c a p i t a l b a s e , a n d c r e d i t w o r t h i n e s s 9 7L e g a l f o r m of o r g a n i z a t i o n of t h e 1 2 n o n b a n k d e a l e r s 9 8S i ze a n d o r g a n i z a t i o n 9 8T a x c o n s i d e r a t i o n s 9 9T r a d i n g r i s k a n d l i m i t e d l i a b i l i t y 1 00D e a l e r s c a p i t a l b a s e 1 0 1C a p i t a l b a s e a n d c a s h a c c o u n t s 1 0 3F i n d i n g s 1 0 4C h a p t e r V I I . S o u r c e s of r e v e n u e , e x p e n s e s a n d e a r n i n g s 1 0 5S c o p e of d a t a a n d d e f i n i t io n a l p r o b l e m s 1 0 5S o u r c e s of e a r n i n g s f r o m c u r r e n t o p e r a t i o n s 1 0 6T r a d i n g p r o f i t s , s p r e a d s , a n d p r o f i t m a r g i n s 110I n t e r e s t r e c e i v e d a n d i n t e r e s t p a i d 1 1 8O t h e r e a r n i n g s a n d p r o f i t s f r o m i n v e s t m e n t a c c o u n t s 1 2 4C u r r e n t o p e r a t i n g e x p e n s e s 1 26Sa la r i es 126O t h e r c u r r e n t o p e r a t i n g e x p e n s e s a n d s p e c i a l c h a r g e s o n g a i n s 1 2 8S u m m a r y 1 30N e t i n c o m e b e f o r e t a x e s 1 3 2N e t i n c o m e b e f o r e t a x e s a n d d e a l e r c a p i t a l 1 3 5F ind ings___ 140C h a p t e r V I I I . O p e r a t i o n of t h e d e a l e r m a r k e t 1 4 1S um m ar y of t h e m ajo r findings 141

T A B L E ST a b l e I I I1 . D i s t r i b u t i o n of D e c e m b e r 3 1 b y d a y s of t h e w e e k , 1 9 4 7 - 5 8 . 3 3T a b l e I I I - 2 . A g g r e g a t e d e a l e r p o s i t i o n s a t e n d o f y e a r s 1 9 4 7 - 5 8 c l a s s i f i e db y m a t u r i t y 3 7T a b l e I I I - 3 . P e r c e n t a g e d i s t r i b u t i o n of d e a l e r s p o s i t i o n b y m a t u r i t yc l as ses on D ec em be r 31 , 1947 , t o 1958 38T a b l e I I I - 4 . P e r c e n t a g e c o m p o s i t i o n of m a t u r i t y c l as s es of o u t s t a n d i n gm a r k e t a b l e d e b t a t 1 9 4 7 - 5 8 y e a r e n d 4 0T a b l e I I I - 5 . D e a l e r s ' p o s i t i o n a s a p e r c e n t a g e o f o u t s t a n d i n g m a r k e t a b l ed e b t , b y m a t u r i t y c la s se s a t 1 9 4 7 - 5 8 y e a r e n d 4 0T a b l e I I I - 6 . C o m p a r i s o n of n e t d e a le r p o s i t i o n s , J u n e a n d D e c e m b e r1 9 4 8 - 5 8 4 1T a b l e I I I 7 . T o t a l n e t p o s i t i o n l a s t W e d n e s d a y o f D e c e m b e r / l a s t W e d n e s d a y of J u n e f o r 1 4 i n d i v i d u a l d e a l e r s 4 4T a b l e I I I - 8 . P e r c e n t a g e d i s t r i b u t i o n of i n d i v i d u a l d e a l e r p o s i t i o n s 4 6T a b l e I I I - 9 . D e a l e r i n v e s t m e n t a c c o u n t s 4 7T a b l e I V - 1 . A l l o t m e n t s t o b r o k e r s a n d d e a l e r s o n s u b s c r i p t i o n s f o r p u b l i cm a r k e t a b l e s e c u r it i es , 1 9 5 3 - 5 8 5 6T a b l e I V - 2 . T o t a l t r a n s a c t i o n s v o l u m e a n d r a t e of c h a n g e i n v o l u m e b ym a t u r i t y c l a ss , a ll r e p o r t i n g d e a l e r s , 1 9 4 8 - 5 S 5 8T a b l e I V - 3 . R a t i o s o f s a l e s v o l u m e t o s e c u r i t i e s o u t s t a n d i n g a t t h e e n dof c a l e n d a r y e a r s 1 9 4 8 - 5 8 5 9T a b l e I V - 4 . O u t s t a n d i n g p u b l i c m a r k e t a b l e U . S . s e c u r i t ie s , e n d of c a l e n d a ry e a r s , 1 9 4 8 - 5 8 6 0T a b l e I V - 5 . P e r c e n t a g e c o m p o s i t i o n of p u b l i c m a r k e t a b l e U . S . s e c u r i t ie s ,e n d of c a l e n d a r y e a r s , 1 9 4 8 - 5 8 6 2T a b l e I V - 6 . C o m p o s i t i o n of t o t a l t r a d i n g v o l u m e , a l l r e p o r t i n g d e a l e r s ,1 9 4 8 - 5 8 6 5T a b l e I V - 7 . C o m p o s i t io n o f t r a d i n g v o l u m e a n n u a l h i g h , l o w , a n da v e r a g e r a t i o s f o r i n d i v i d u a l d e a l e r s , 1 9 4 8 - 5 8 6 6T a b l e I V - 8 . S h a r e of m a r k e t t r a n s a c t i o n s , 1 9 4 8 - 5 8 6 7T a b l e V - l . R a t i o of d e a l e r c o m m i t m e n t s t o d e a l e r n e t p o s i t i o n s f or 1 2n o n b a n k d e a l e r s a t e n d of y e a r 7 8T ab le V -2 . Sou rces an d uses of dea l e r financing (12 no n ba nk de a l e r s ) ,1 9 4 7 - 5 8 8 0T a b l e V - 3 . P e r c e n t a g e d i s t ri b u t i o n of s o u r c e s f or f o u r n o n b a n k d e a l e r s . _ 8 3T a b l e V - 4 . R e p o r t e d r a t e s o n l o a n s a n d R P ' s i n p e r c e n t 8 8T a b l e V - 5 . A n n u a l l e v e r a g e r a t i o s ; n o n b a n k d e a l e r s 9 1T a b l e V - 6 . M a r g i n r e q u i r e m e n t s o n c o l l a t e ra l l o a n s 9 2T a b l e V I - 1 . L e g a l f o r m of 4 0 0 l e a d i n g i n v e s t m e n t b a n k e r s b y si ze c l a s s e s . _ 99T a b l e V I - 2 . R a t i o s of p o s i t i o n s t o n e t w o r t h , a ll n o n b a n k d e a l e rs , 1 9 4 8 - 5 8 . 1 0 1


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C O N T E N T S I XP a g eT a b l e V I - 3 . N o n b a n k d e a l e r l o n g - t e r m f in a n c in g a n d n e t w o r t h , 1 9 4 8 -5 8 _ _ 102T a b l e V I - 4 . L o n g - t e r m d e b t , f o r a l l d e a l e r c o r p o r a t i o n s , 1 9 4 8 - 5 8 1 0 2T a b l e V I - 5 . C a s h p o s i t i o n s a n d t o t a l l o n g - t e r m f i n a n c i n g , 1 2 n o n b a n kd e a l e r s , 1 9 4 8 - 5 8 1 0 3T a b l e V I I - 1 . C o m p o s i t i o n o f g r o s s e a r n i n g s f r o m c u r r e n t o p e r a t i o n s a n d

o p e r a t i n g e x p e n s e s f o r r e p o r t i n g d e a l e r s , 1 9 4 8 - 5 8 1 0 8T a b l e V I I - 2 . E a r n i n g s a n d e x p e n s e i t e m s a s p e r c e n t a g e s of g r o s s e a r n i n g sf r o m c u r r e n t o p e r a t i o n s , a l l r e p o r t i n g d e a l e r s , 1 9 4 8 - 5 8 1 0 9T a b l e V I I - 3 . P r i c e q u o t a t i o n s f or U . S . T r e a s u r y b o n d s a n d n o t e s 1 1 1T a b l e V I I - 4 . E a r n i n g s a n d e x p e n s e i t e m s i n d o l l a r s p e r $ 1 , 0 0 0 , 0 0 0 o fsa l e s , a l l r e p o r t i n g d e a l e r s , 1 9 4 8 - 5 8 1 1 4T a b l e V I I - 5 . T o t a l t r a d i n g p ro f it a s p e r c e n t a g e of g r o s s e a r n i n g s a n d i ndo l l a r s pe r $1 ,000 ,00 0 of sa l es , a l l r ep or t ing dea l e r s , 19 48 -5 8 116T a b l e V I I - 6 . I n t e r e s t r e c ei v e d a n d i n t e r e s t p a i d a s p e r c e n t a g e s of g r o s se a r n i n g s , a l l r e p o r t i n g d e a l e r s , 1 9 4 8 - 5 8 1 1 8T a b l e V I I - 7 . I n t e r e s t r e c e iv e d a n d i n t e r e s t p a i d i n d o l l a rs p e r $ 1 ,0 0 0 , 00 0of sa l es , a l l r ep or t in g dea l e r s , 19 48- 58 120T a b l e V I I - 8 . O t h e r e a r n i n g s a n d p r o f it s f ro m i n v e s t m e n t a c c o u n t s , al lr e p o r t i n g d e a l e r s , 1 9 4 8 - 5 8 1 2 5T a b l e V I I - 9 . S a l a r ie s a s p e r c e n t a g e of g r o s s e a r n i n g s a n d in d o l l a r s p e r$1 ,000 ,000 of sa l es , a l l r ep or t in g dea l e r s , 19 48- 58 127T a b l e V I I - 1 0 . O t h e r c u r r e n t e x p e n s e s a s p e r c e n t a g e of g r o s s e a r n i n g s a n din do l l a r s pe r $1 ,000 ,00 0 of sa l es , a l l r ep or t in g dea l e r s , 194 8-5 8 129T a b l e V I I - 1 1 . S e l e c t e d e a r n i n g s a n d e x p e n s e i t e m s f o r d i v e rs i fi e d n o n b a n kd e a l e r s a n d a l l b a n k d e a l e r s , 1 9 4 8 - 5 8 1 3 1T a b l e V I I - 1 2 . G r o s s a n d n e t e a r n i n g s a s p e r c e n t a g e s of n e t w o r t h a n dt o t a l l o n g - t e r m fin an cin g, a l l r e p o r t i n g n o n b a n k d e a l e r s , 1 9 4 8 - 5 8 1 3 3T a b l e V I I - 1 3 . N e t i n c o m e b e f o r e s p e c i a l c h a r g e s a n d t a x e s a s p e r c e n t a g eof g ross ea rn ings and in do l l a r s pe r $1 ,000 ,000 of sa l es , a l l r epor t ingd e a l e r s , 1 9 4 8 - 5 8 1 3 4T a b l e V I I - 1 4 . R a t e s of r e t u r n f or s e l e c te d i n d u s t r y g r o u p s , 1 9 4 8 - 5 8 1 3 8


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C H A P T E R IT H E R O L E O F T H E D E A L E R M A R K E T

INTRODUCTIONMonetary po l i cy and the managemen t o f the pub l i c deb t a re amongth e m ost freq uen tly discussed topic s in th e econom ic an d f inanciall i ter a tu re . Pu bl ic he ar in gs , books , scholar ly pa pe rs , d iscuss ions inthe f inancial and lay press have analyzed and reanalyzed act ions

taken o r avo ided by the Fe de ra l Reserve and the Tr eas u ry . N um er ous prop osals for modif icat ion of ex is t ing proce dures or imp rove m entsin techniques for funding the debt o r s tab i l iz ing the economy haveappe ared . T he re ha s been no app are n t t endency fo r the pop u la r i ty o fthese subjects to d im in ish in recent yea rs . O n th e co nt ra ry , as economic s t ab i l i za t ion and deb t managemen t p rob lems have become moreacute the d iscuss ion ha s e xpa nded .L i t e ra tu re abou t the func t ion ing and per fo rmance o f the marke t fo rGo vern me nt secur i t ies dealers i s in m ark ed con t ras t . U nt i l recen t ly ,sources of in format ion about dealer operat ions in th is market werere la t ive ly scarce . Q ua n t i t a t ive in fo rm at ion ab ou t th i s m ark e t wasbased on in te l l igen t guesswork o r i l l u s t r a t ive exam ples pr inc ipa l lythose contained in tes t imo ny g iven a t congress ional hea r ing s . D etai le drepor ts o f operat ions which have been co l lected for many years by oneFedera l Reserve bank were submi t t ed to the bank by the dea le r s wi ththe unders t and ing tha t such repo r t s wou ld no t be made par t o f thepubl ic record .Secrecy abou t the agg rega te opera t ions o f Governmen t secu r i t i esdealers i s surpr is ing in v iew of thei r impor tan t ro le in the economyand the read i ly avai lab le s ta t i s t ics on comm ercia l ba nks , sav ing s bank s ,insurance companies , and o ther f inancial ins t i tu t ions which regular lyapp ear in the Fe de ra l Reserve and Tre asu ry bu l l e t in s . I t is evenmo re su rp r i s ing in v iew o f the f ac t t ha t these dea le r s fo rm the l a rg es tsecur i t ies m ar ke t in the co untr y an d one wh ich i s so hea vi ly ves ted w i ththe publ ic in teres t .Two p r inc ipa l r easons make the opera t ion o f th i s marke t an impor tan t sou rce o f in fo rmat ion abou t the work ing o f the economy.F i r s t , mone ta ry po l i cy and deb t managemen t opera t ions bo th cond i t ion and are condi t ioned by the operat ions which take p lace in thedea le r m arke t . Second , the ro le wh ich the dea le r m ark e t p l ays in thesav ings - inves tmen t p rocess m er i t s mo re de ta i l ed examina t ion t ha n ha sbeen possible in th e p as t .T h ro ug h the dea le r m ark e t pass v i r tu a l ly a l l o f the secondary t r an s act ions in G ove rnm ent secur i t ies . Effor ts by th e Fe de ra l Re serve toinfluence the free reserves of commercial banks are most often carr iedou t th ro ug h open m ark e t pu rchases o r sa les . F o r these pu rposes , t hedea le r m arke t i s the open m arke t . E f fo r t s by the Tr ea su r y to fundthe debt o r ra ise new cash depend in par t on the funct ion ing of thedealers as underwri ters o f new issues .

1


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2 S T U D Y O F F E D E R A L G O V E R N M E N T S E C U R I T I E S D E A L E R SIDENTIFYING THE DEALERS

Unti l recent ly , few quant i f ied s ta tements about dealer operat ionswe re avai lab le . E ve n the es t im ated num ber of act ive dealers wassubject to some var ia t ion in the few publ ic ly avai lab le accounts ofGov ernme n t secu r it i es opera t ions . Th e Fe dera l Op en M arke t Commi t t ee r epo r t o f the ad hoc Subcommi t t ee on the Governmen t Secu r i t ies M ark et , p re pa red in 1952, refers to "ab out 20 dealers inc lud ings o m e b an k s w i t h t r ad i n g d ep a r t m en t s . " * Koosa, wr i t ing in 1956 ,suggests that there are between 15 and 20 "quasi -specia l i s t s ." 2Test imony before the Jo in t Economic Commit tee in 1959 ident i f ies17 Go vern m ent secur i t ies dea lers , 5 ban ks , and 12 nonb anks .3 L i s t eda lphabe t i ca l ly , t he 17 dea le r s a re :Bank dealers Nonban k dealers1. Ban kers Tr ust Co. 1. Bartow , Leeds & Co.

2. Chemical Ban k New York Tru st Co. 2. Briggs, Schaedle & Co., Inc .(formerly Chemical Ba nk & T ru st 3. C. F . Childs & Co., Inc.Co.). 4. C. J. Devine & Co.3. Continental I l l inois Nation al Ba nk 5. Discount Corp.& Tr ust Co. (Chic ago). 6. Fi rs t Boston Corp.4. Fi rs t Na tional Ban k of Chicago. 7. Aubrey G. La nston & Co.5. Morgan Gu aran ty Tr ust Co. (for- 8. New York Ha nseatic Corp.merly Gu aran ty Tr us t Co.) . 9. Wm. E. Pollock & Co., Inc.10. Chas. E . Quincey & Co.11 . D. W. Rich & Co., Inc.12. Salomon Bros. & Hutzler .Two of the banks and one of the nonbanks (C. F . Chi lds) have headquar ters in Chicago , bu t most o f the t rad ing i s done in New York .As ide f rom the i r t r ansac t ions in the Governmen t secu r i t i es marke t ,the re a re f ew s imi la r i t ies am ong the dea le r s . F ou r of the non ban kdea le r s a re par tner s h ips . Tw o o f the f irms a re l ead ing u nd erw r i t e r sof new corporate i ssues and two o thers par t ic ipate in many offer ings .Two are members o f the New York S tock Exchange ; a t l eas t two a react ive in the acceptance m ark et . Seve ral are dealers in m unic ipal ,agency , and In te rna t ion a l B ank bonds , and some un der w r i t e the in i t i a ld is t r ibu t ion of such i ssues . O the r d if ferences, pa r t ic u la r ly thoseWhich reflect on their operat ions as Government securi t ies dealers, wil lbe d iscussed a t a la te r po in t . E n ou gh has been said to sugg est th a tthe dealer funct ion i s performed by a var ie ty of d i f feren t types offirms.F ro m 1944 to 1953, a d is t inct ion between dealers was mad e by theFe de ra l Reserve B an k o f New York . Tw elve dea le r s were r ecogn izedfo r t r a d i ng pu rposes by th e Op en M ark e t Com mi t t ee . Th e rem ain ing 5 dea le r s Bar tow Leeds , B r igg s Schaed le , Po l lock , La ns ton , andN ew Y o r k H an s ea t i c n o w p a r t i c i p a t e in o p en m ar k e t t r an s ac t i o n swi th the Federal Reserve on an equal foo t ing wi th the o ther 12 .4 Since1953, the terms "recognized" and "unrecognized" have ceased to havethe i r fo rmer me an ing in th i s mark e t .

1 This report was made public In 1954 as a part of "United States Monetary Policy:Recent Thinking and Experience," hearings before the Subcommittee on Economic Stabilization of the Join t Comm ittee on the Economic Repo rt, Wa shington, 1954. The quota tionabove is from p. 261 of the hearings.2 R. V. Roosa, "Federal Reserve Operations in the Money and Government SecuritiesMarket," Federal Reserve Bank of New York, 1956, p. 35.3 "Employment, Growth, and Price Levels," hearings before the Joint Economic Committee, pt. 6B: "The Government's Management of Its Monetary, Fiscal, and Debt Operat ions." W ashingto n, 1959. p. 1508. This rep ort will be referred to as He aring s 6B.* Hearings, op. ci t , pt . 6B, pp. 1509 and 1515.


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S T U D Y O F F E D E R A L G O V E R N M E N T S E C U R I T I E S D E A L E R S 3D E A L E R F U N C T I O N S

One par t o f dealer operat ions in Government secur i t ies i s the underw ri t i ng of new issues of T rea su ry secur i ties . De alers , a long wi t hmany o ther g roups , ass is t in the d is t r ibu t ion of new cash i ssues or re-fun ding s in a va rie ty of wa ys. If t he securi t ies are sold at auct ion ,dealers b id for th ei r own accoun t and f urn ish advice on the expectedyield of a for thc om ing i ssue to o ther b idders . D eale rs buy a port ion of most new issues which are sold for cash and faci l i tate theexchang e of o ld issues for new secur i t ies when the T rea su ry exchang esissues an d when r i gh ts are offered.A fter a new issue has app eare d , the dea lers become a pr in cip al me ansby w hich seconda ry d is t r ibu t ion i s effected. B an ks an d o the rs buyfor the account o f cus tomers and correspondents and ass is t in thesecondary d is t r ibu t ion , bu t dealers act ively buy and sel l the new secur i t ies in the open m ark et .Even when dea le r s do no t d i rec t ly par t i c ipa te in the underwr i t ing ,they usual ly are wi l l ing to t rade the i ssue in the secondary market .They thereby faci l i ta te the "seasoning" of new issues and the es tabl i shment of a y ie ld which ref lects the market ' s op in ion of the valueof the new issue in re la t ion to o ther ou ts tanding secur i t ies .Government secur i t ies dealers cont inue to buy and sel l ex is t ingissues for thei r own account and r i sk dur ing the l i fe o f the secur i ty .Not al l dealers t rade in al l issues as wil l be seen more ful ly in chapterI I , but a l l Government secur i t ies dealers are wi l l ing to buy and sel lsome rang e o f ma tu r i t ies frequen t ly in l a rge amoun t s at the p ri ceswh ich they quo te over the te lephone . A s a gr ou p , the 17 dealersl i s ted above are the pr i nc ipa l (a t t imes the on ly) m ar ke t for ou t s t an d ing Trea su ry i s sues a t quo ted p r i ces . The y thereby perm i t theorderly exchange of issues for cash or other issues.

D E F I N I T I O N SSev eral term s wi l l be used repe ated ly in th is s tud y . T o avoid repet i t ion , and poss ib le misunders tanding , they are def ined here:The term "Government secur i t ies" wi l l be used to refer to the marketab le debt avai lab le for t ra d i ng . A l l o f the pub l i c ly he ld marke t able issues plus those issues or port ions of regular issues held by Treasu ry t ru s t accoun ts and the Fe de ra l Eeserve a re inc luded here . Specia l i ssues and nonmarketab le i ssues are excluded ."Government ob l igat ions" i s def ined as to ta l Government secur i t iesp lus nonmarke tab le and spec ia l Treasu ry i s sues , p lu s ou t s t and ingagency i ssues . Inc lud ed in the agency i ssues are Fe de ral hom e loanba nk bon ds , ob l igat ions of the Fe de ral in te rm edia te cred i t ban ks , theFe de ra l Nat iona l Mo r tgag e Assoc ia tion and s imi la r agenc ies . Matur i ty c lasses , as used here , wi l l refer to the fo l lowing groups un lesso t h e r w i s e n o t ed :1. Bi l l s shor t - t e rm Gove rnme n t secu r it ies (und er 1 ye ar ) wh ichwhen i ssued weekly have 91 or 182 days to matur i ty , p lus 1-year bil lsi ssued quar ter ly s ince Apr i l 1959 , and specia l b i l l s i ssued a t i r regularinte rva ls . B il ls ar e issued on a disco unt basis an d ar e usu al ly offeredby the auc t ion method .2. Cert i ficates or cer ti ficates of indebtedn ess are shor t - te rm secur i t ies w i th 1 ye ar o r less to m at ur i ty w hen issued . I n the pas t , the


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4 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERSTreasury has issued certificates both with and without coupon attached. A ll of the presently outstan ding issues are coupon securities.A special kind of certificate known as the tax anticipation certificatehas been issued at variou s times since Ju ly 1953. These are pa rticu larly attractive to corporations as a medium by which funds accumulated for tax pu rposes may be invested tem pora rily. Inte rest is usually paid beyond the date on which taxes are due.3. Notes are issued with original matu rity of 1 to 5 years. Theyare coupon securities issued at pa r v alue.4. Bonds may be issued in any maturity but have usually beenissued with 5 or more years to m aturity . Like notes they are couponsecurities issued at pa r. Th ey may or may not have an option al callfeature which permits the Treasury to retire or refund them prior toth eir final m atu rity . M ost often the call feature can be first exercised5 years before final maturity but both longer and shorter call dateshave been used.5. "Lo ng-term bo nd s" as used here, usually refers to issues w ith 5 ormore years to maturi ty on a part icular date.6. Under 1-year maturities include all bills and certificates plusnotes and b onds which ha ve less tha n 1 yea r to final m atu rity .Since the publication of the ad hoc subcommittee report, the phrase"depth, breadth, and resiliency" has been used in discussions of thedealer m ark et. Th is ph rase is defined in the subcomm ittee re po rt andwe quote : 5

In s tr ictly market terms, the inside market, i .e . , the market which is reflectedon the order books of specialists and dealers, possesses depth when there areorders , either actual orders or orders that can be readily uncovered, both aboveand below the market . The mark et has breadth when these orders are involume and come from widely divergent investor groups. I t is resil ient whennew orders pour promptly into the market to take advantage of sharp and unexpected fluctuations in prices.The market or a particular issue or maturity range is characterizedas "th in " when dep th, bread th, and resiliency are not characteristic ofoperations in the m arket, issue, or m atu rity range. Th ere is a "widegap between the prices at which the least firm holders are willing tosell and poten tial buy ers are w illing to pur chas e." Qu otations fluctuate widely "eith er in response to relatively small buy or sell ord ers, ormore frequently, as a result of professional efforts to stimulate interestby m arking quotations up or dow n."6The "bills only policy" refers to that policy of the Federal OpenMarket Committee adopted and abandoned in the spring of 1953 andreado pted in the fall of 1953 which ha s led to the pra ctice of executingpurch ases an d sales for the account of the Com mittee m ainly in Trea sury bills.7 W hile exceptions have been mad e, this policy ha s preva iledsince September 1953.

5 He aring s, op. cit. , December 1954, p. 265. See also hearin gs, op. cit. , 1959, pt. 6C, pp.1922^-1926 for the definitions offered by the 17 dealers.* He aring s, 1954, p. 266.7 A recent statement of the rationale for this policy is : R. A. Young and Yager, C, "TheEconomics of 'Bills Preferably'," Quarterly Journal of Economics, August 1960.


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STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERS 5T H E D E A L E R M A R K E T A N D T H E S A V I N G - IN V E S T M E N T P RO C E SS

T he Go vern m ent secur i t ies m ark et d if fers f rom o the r secur i tiesm ark ets in a var ie ty of w ays . I n several o f the ch ap ters w hich fo l lowspecif ic ch ara cte rist ic s of thi s m ar ke t wil l be cons idered . W e w il l findth a t the s ize o f th e mark e t (measu red by the va lue o f t r an sac t ion s ) ,the ra tes a t which dealers borrow, the amount of leverage, the cos t o fmak ing t r ansac t ions , and numerous o ther opera t ing charac te r i s t i csd if fer sub stan t ia l ly f rom those found in o the r secu r i ty m ark ets . I ncombination these characterist ics are suff icient to suggest that thism arke t be r egard ed as a un ique in s t i tu t ion .F ro m the v iewpo in t o f the economy, the par t i cu la r ro le wh ich theGovernment secur i t ies market takes in the funct ion ing of the f inancialsys tem is o f g reater s ign i f icance than i t s un ique operat ing ar rangemen t s . Th e func t ions wh ich a re per fo rm ed by th i s m arke t the ro lewhich i t p lays in the sav ing- investment process and i t s use as amechan i sm fo r t r ansmi t t ing changes in the supp ly o f money to theeconomy make the opera t ion of the m ark et o f concern to those w hoare no t secur i ty dealers o r specia l i s t s .

A R B IT R A G E I N T H E D E A LE R M A R K E TTh e dea le r m ark e t fo r Gove rnme n t secu ri ti es opera tes as a p r in c ip a lb r idg e be tween the money m ark e t and the cap i t a l ma rke t s . A t one

end , Tr ea su ry b i l l s are exch ange d for cash . A s th e above d iscuss ionof T rea su ry b i l l s ind ic ates , they m ay ha ve as m uch as 1 ye ar o r as l i t t leas 1 week o r 1 day to m atu r i ty . Th e ou t s t a nd in g amou n t of suchsecur i t ies ha s an averag e m at ur i ty of less th an 3 m onth s . Of a l l th eou ts tan din g secur i t ies , the y are th e c loses t sub st i tu te for cash . T hisis t rue no t on ly because of thei r shor t matur i ty , o r the guaran tee ofp r inc ipa l and in te res t by the Federa l Governmen t bu t a l so becausethe y can be so ld for ca sh in the m ark et a t mo st times , in v i r tu al ly anyam ou nt, w ith rela t ive ly m ino r pric e f luctuations.At the o ther end o f the matu r i ty r ange a re the Treasu ry ' s long - t e rmbonds. The se m ust d i rect ly compe te for funds wi th i ssues of S ta teand local governments as wel l as wi th long- term obl igat ions i ssued byGovernment agencies , corporate secur i t ies , mor tgages , and o ther long-t e rm deb t in s t rum en t s . Ea ch of these in s t rum en t s mus t be p r i ced toat t ra ct funds f rom th e cap i ta l m ark et a t the t ime i t i s o ffered . Th ere af ter , the cap i ta l market reevaluates a par t icu lar o f fer ing re la t ive toa l l o ther ou t s t and ing marke tab le ob l iga t ions each t ime a pu rch ase andsale is exec uted.Many of the secur i t ies o f fered to po ten t ia l buyers in the cap i ta lm arke t do no t t r a de ac t ive ly . Some a re p r iva te ly p laced and re ma inin the por t fo l ios of the or ig inal purchaser f rom the date of i ssue un t i lthe final m at ur i ty i s reache d . O the rs are i ssued in smal l am oun ts an dcan be so ld on ly in l imi ted quant i t ies o r wi th po ten t ia l ly large pr icechanges . S t i l l o the rs are t ra de d m ore f req uen t ly ; fo r these , an activemarket i s sa id to ex is t in which pr ices are real ized in t ransact ions andquoted on a dai ly basis .


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6 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERSBecause the money c rea t ing and t ax ing power o f the Un i t ed S ta t esi s a gua ran te e tha t bo th the in te res t and p r in c ipa l o f T rea su ry secu r it ies wi l l be paid when due and because Government secur i t ies dealers

ma in ta in a mark e t fo r T rea su r y bonds , pu rch aser s a re able to sel lsome of th ei r bonds a t any t ime . A s a resu l t , such bon ds are ge nera l lyrega rded as more l iqu id th an com pet ing deb t in s t rum en t s . T hegreater l iquidi ty and lower r isk are reflected in the difference betweenthe average y ie ld on Treasury bonds and the average y ie lds on ob l igat ions of S ta tes , mu nicipa l i t ies , and corpo rat ions . O n the wh ole , are la t ively constan t d i f ference in mean y ie ld has been main ta ined between Treasu r i es and co rpo ra tes , wh i l e marg ina l y i e ld s , measu red byth e yield on new issues, ha ve gen era l ly f luctuated in resp ons e tochang es in the dem and for o r supply of money .The t ax -exempt s t a tu s o f S ta t e and mun ic ipa l bonds keeps the i rave rage y ie ld below the y ie ld on Tre asu r ies . Ho w ever , the increasedstock of tax-exempts has been accompanied by a wider d is t r ibu t ionof ou ts ta nd ing i ssues . T o increase the dem and for tax-ex em pts bythose in o ther than the h ighest tax brackets , the average y ie ld onmun ic ipa l s has r i sen more rap id ly than the average y ie ld on Treas ur ies and the d i f ference between the two has narrowed dur ing thep o s t w a r p e r i o d .Arb i t r age be tween the co rpo ra te , mun ic ipa l , and Treasu ry marke t sad jus ts the y ie lds on ou ts tanding i ssues to general changes in theeconomy and speci f ic changes in the supply of ou ts tanding i ssues .Since many Government dealers are a lso act ive dealers in corporateand municipal bonds , i t i s l ikely that they are among the act ive arb i t ra ge rs . M oreover , increases in the s tock of cor por ate and m uni cipa lbonds ou ts tanding have been accompanied by a decl ine in the abso lu teamoun t o f long - t e rm Treasu r i es wh ich in su rance compan ies , banks ,an d some o the r ins t i tu t iona l inves to rs ho ld . E ve n i f the T re as ur y isno t i ssu ing new long- term bonds , compet i t ion for funds by o ther i s suer s wi l l t emporar i ly increase the f low o f ou t s t and ing Treasu r i esto the dealer m ark et and reduce the i r p r ice .Thus a t one end o f the matu r i ty r ange , the re a re Treasu ry i s sueswhich are c lose subst i tu tes for money , whi le a t the o ther end there aresecur i t ies which compete for funds in the cap i ta l market o r markets .In between there are a var ie ty of o ther types of secur i t ies as we movefrom bi l l s to cer t if icates and s hor t - term notes or bon ds in to in te r m ed iate and longe r ter m secur i t ies . I n pr inc ip le , each of these issuesshould offer a y ie ld such that none of the owners of a par t icu larissue would prefer to sel l that issue to obtain any other issue at theexis t ing pr ices or y ie lds . I f a pa r t ic u la r issue i s p r iced re la t ively h ighor low when compared to o ther i ssues , arb i t rage could take p laceprof i tab ly e l iminat ing the d iscrepancy in y ie lds .T he Tre asu ry has a l a rg er am oun t of ou t s t an d ing deb t and awid er r an ge o f m atu r i es than any o ther bo r row er in the economy. Ofcourse there a re some gaps in the matu r i ty s t ruc tu re and some spec ia lfeatures a t tached to par t icu lar i ssues which are no t avai lab le on o therissues . Th ese create d if ferences which m ak e Tr ea su ry secur i t ies lessthan perfect ly homogeneous for reasons o ther than d i f ferences inlen gth to m at ur i ty . Ne ver theless , i t seems reasonable to bel ieve th atmarket t rad ing wi l l evaluate these d i f ferences and ad jus t the ra testo compensate ho lders for cal l p rovis ions and o ther specia l features


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S T U D Y O F F E D E R A L G O V E R N M E N T S E C U R I T I E S D E A L E R S 7provided that there i s an oppor tun i ty to buy or se l l a comparablesecur i ty which does no t have the pa r t ic u la r feature .At the sho r t es t end , the Treasu ry i s sues domina te the marke t .As the ev idence in la ter chapters wi l l show, "depth , b read th , andres i l iency" are chara cter i s t ics o f th is m ark et . Re lat ively lar ge t ra ns act ions take p lace a t quoted pr ices and demand and supply schedulesex is t on the books of dealers in a l l bu t the most d isorder ly markets .The f low of secur i t ies to the market in response to ra te changes i s suff icient ly large to permit speculators to quickly arbi trage differences inyields between th e va riou s bi l l issues, betw een bi l ls , certi f icates, an do ther sho r t - t e rm Tre asu ry in s t rume n t s as wel l as be tween ou t s t and ingshor t - term Treasury secur i t ies and shor t - term obl igat ions of o therissuers. T his suggests th a t the T rea su ry does m ore th an supp ly astock of nonmoney l iquid assets when i t issues bi l ls and cert i f icates.I t a l so provides an ef fect ive medium for the rap id ad jus tment of shor t -term in teres t ra tes .De alers in G ove rnm ent secur i t ies ar ra ng e a lar ge p a r t of the i r f inancing th r ou gh the mon ey m ark ets . A s wi l l be shown in mo re deta i l inchapter V, par t ic ipants in the dealer market ef fect ively arb i t rage between the money an d sho r t - term secur i t ies m ark ets . M oreover , ban ksview the purchase of very shor t - term Treasury b i l l s as a subst i tu te forthe sa le of Fed era l fund s and r eg ar d such b i l l s as the c loses t subs t i tu tefo r money . F ro m the i r v i ewpo in t , t he Tr ea su r y b il l ma rke t is a pa r tof the money m arke t .

Arb i t r age opera t ions , as has been sugges ted , r e l a t e the averageyields on Treasur ies wi th the average y ie lds on o ther ins t ruments .Through the dea le r marke t , t he y ie ld s on Treasu ry secu r i t i es o f a l lm atu r i t ie s are a lso re la ted . A s wi l l be shown in la te r ch apte rs ,dep th , b read th , and res i l iency are far less character i s t ic o f the long-t e rm marke t . A t t imes a rb i t r a ge opera t ions canno t t ake p lace asrap id ly between shor t - and long- term issues and between long- termGovernments and o ther cap i ta l market i ssues as they do in the moneyand secur i t ies market .Never theless , the Treasury has ou ts tanding a larger s tock of act ivelyt ra de d i ssues th an any o ther ins t i tu t io n . M at ur i ty as ide , these secur i t ies are mo re homoge neous tha n the ob l igat ions of any o the r i ssuer .I t i s l ikely , therefore , that much of the arb i t rage between long , in ter me diate , and shor t - ter m rate s of in teres t or between th e money andcap i t a l ma rke t s is accompl ished th r ou gh the Go vernm en t secu r i ti esm arke t . Ce r t a in ly th i s has been t ru e du r in g pa r t of the pos tw arper iod . F o r example , the abso rp t ion by the m ark e t of a g rea t lyincreased s tock of corporate secur i t ies has been faci l i ta ted by thereduc t ion in the amoun t o f ou t s t and ing long - t e rm Governmen t secu r i t ies in the por t fo l ios of insura nce companies and o thers . A bsorp t ionof these i ssues th r ou gh the d ealer ma rk et has been accompl ished in p a r tby ra is ing the y ie ld on T re as ur y bonds f rom i t s ex is t ing level. F u rther ad jus tmen t s , t h r ou gh in te rm ed ia te and sho r t - t e rm y ie ld s , a l t e r thesha pe of the yield curv e to the new equ il ibrium level of rate s.Sh ould the T rea su ry seek to increase the averag e m at ur i ty of i t sou ts tanding marketab le debt and thereby af fect the re la t ionsh ip between shor t - an d long - term y ields? M uch of th e pre sen t p ract ic ean d d iscussion of deb t m ana ge m ent i s p red icate d on th e bel ief th at i tshould . B ut , m any fa i l to recognize th a t the T rea su ry ha s been pr i nc ipa l ly engage d in r e fun d ing deb t du r in g the pos twa r year s . W i th

6247160* 2


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8 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERSthe except ion of a few years of recess ion and the Korean war , newcash bo r rowing has been a r e l a t ive ly smal l pa r t o f Treasu ry deb topera t ions .

At t empts to increase the average matu r i ty o f the deb t du r ing re -f un din gs a l te r the s t ru ctu re of in teres t ra tes by increa s ing the s up plyo f longer matu r i t i es wh i l e r educ ing the supp ly o f sho r t e r matu r i t i es .To ex tend the matu r i ty o f the deb t , t he Treasu ry mus t a t t r ac t in tothe long- term market some of the money re leased a t the shor t end ofthe matur i ty s t ructure or an equivalen t amount of cash f rom elsewhe re . L ik e co rpo ra t ions wh ich i ssue long - t e rm bonds , the T rea su rymust pay more than the average y ie ld on outs tanding i ssues , i f i tis to sel l a new issue of bon ds. I n pe rio ds of t ig ht mone y, th e different ial between new r i ssue ra tes on Aaa corporates and the averageyield of h ighest g rade corporate bonds has been as much as one-hal fo r 1 percen t . Th i s p rem ium is the p r i ce pa id to a t t r ac t a dd i t ion a lfund s to the cap i ta l m ark ets f rom o the r uses. I t r i ses w hen mon eyi s t igh t and sho r t - t e rm ra tes app roach long - t e rm ra tes .Judg ing f rom the per fo rmance o f the co rpo ra te bond marke t s , t hed i f feren t ia l between the ra te paid on new issues and the average y ie ldon ou ts ta nd ing secur it ies wi l l fa l l du r in g recess ion . H ow eve r , i f th eTreasu ry t akes advan tage o f the oppor tun i ty to ex tend the averagem at ur i ty of the debt dur in g recess ion , i t widen s the d i f feren t ia l between sho r t - t e rm ra tes and long - t e rm ra tes and slows the dow nw ardadju s tm ent of in tere s t ra t es in the cap i ta l m ark ets . A s a resu l t , i tmay reduce the amoun t o f cap i t a l i nves tmen t and h inder the r ead jus t ments of the economy.S ince the ou t s t and ing marke tab le deb t r emains r e l a t ive ly cons tan tand the Treasury has ch ief ly refunding operat ions to consider , themanagemen t o f the pub l i c deb t cou ld be d i rec ted toward improv ingin te res t r a t e ad jus tmen t s be tween sho r t - and long - t e rm marke t s .Refund ing opera t ions r e l ease money a t one end o f the matu r i ty s t ructu re an d absorb i t a t o the r po in ts . N o chan ge in the mone y sup plytakes p lace . W i th ap p ro p r i a t e deb t ma nage me n t there need be l i t t lechange in the level of interest rates or the differential between shortan d lon g ra tes as a resu l t o f th e refu nd ing ope rat ion . T his could beaccomplished, i f desired, by abandoning efforts to increase the average m at u r i ty o f the deb t and concen t ra t ing on m ain ta in ing a cons tan tm a t u r i t y s t r u c t u r e .I f t he qua n t i ty an d the m atu r i ty com pos i tion of the deb t a re roug h lycons tan t , r e fund ing opera t ions have l i t t l e impac t on the s t ructu re of in tere s t ra tes . Ch ang es wh ich occur wi l l be ad jus te d byarb i t r age , p rov ided on ly tha t the s tock o f secu r i t i es in each matu r i tyclass is suff icient to permit "depth, breadth, and resi l iency" to bechara c te r i s t i c o f t r a d i ng in each sec to r . Moreover , by m ain ta in inga lmos t cons tan t matu r i ty compos i t ion and improv ing the oppor tun i t i es fo r a rb i t r age , the Tre asu ry m akes a g rea te r con t r ibu t ion to theadju s tm ent of the economy. W he n the level o f in teres t ra te s chang es ,e .g ., as a resu l t of mo neta ry po l icy , arb i t r ag e a long the y ie ld curv e wi l lcha nge th e s t ru ctu re of in tere s t ra te s in response to the de m and s ofthe pr iv at e economy. If le nd ers expe ct inflat ion, efforts to sel l lon g-t e rm a nd buy sho r t - t e rm in s t rum en t s wi l l qu ick ly change the s t ruc tu reof ra tes and ad jus t the y ie lds upward to ref lect market considerat ions .The dea le r marke t then wi l l t r ansmi t in t e res t r a t e changes upo r down the s t ruc tu re o f r a t es . Th ro ug h a rb i t r a ge be tween the


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STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERS 9dea le r marke t and the money and cap i t a l marke t s , new sav ings f lowto the sectors o f the cap i ta l market most a t t ract ive to par t icu lar lenders . The dealer market serves as one of the pr incipal mechanisms bywhich the in teres t ra te s t ructure more rap id ly ad jus ts the f low ofsav ings in to investment in response to the demands of borrowers andlenders .The po ten t i a l ro le o f p resen t deb t opera t ions i s in marked con t ras tto func t ions of Tre asu ry deb t ma nage me n t du r in g the year s of wa r anddepress ion . T he n th e am oun t of new cash bo rrow ing gre at ly exceededthe am oun t o f r e fun d ing . Th e ra t e wh ich the Trea su ry o ffe red to themarket had to be suff icient to at t ract new savings from the economyor to act iva te id le balances . Th e money wh ich the Tre as ur y ob taine dw as used to pa y deficits an d to finance pu blic w ork s pro jects . T h emoney supp ly was increased . U nd er such cond i t ions , t he imp ac t onthe level o f ra tes or the quest ion of compet i t ion wi th pr ivate investorswere impor tan t cons idera t ions in dec id ing upon the matu r i ty o f newT rea sur y f inancing. A n d th e ro le of the Tr ea su ry wa s pr in cip al lyone of p ro vid ing fu nds for new Gove rnm ent investm ent or new mil i t a r y ex p en d i t u r e .Inc rea s in g the f lexib ility of in teres t ad jus tme nts requi res impro veme n t in oppo r tun i t i es fo r a rb i t r a ge . T he ex ten t to wh ich a rb i t r a gerem ains impe rfect wi l l be considered a t a la te r po in t . E no ug h hasbeen said to suggest that evaluat ion of the presen t ro le of the dealermarket for Government secur i t ies in the economy largely reduces toana lys i s o f i t s pe r fo rmance in p rov id ing a means th rough wh ich in terest rate changes can be rapidly spread from one sector of the f inanc ia l ma rke t s to the o ther s . F o r i t i s t h r ou gh a rb i t r age opera t ionsthat the ef fects o f monetary po l icy are car r ied up or down the in teres tra te s t ructure and ra tes are a l lowed to a l locate the f low of sav ingsin to par t icu lar inves tment channels in response to the demands of thepr ivate economy, s ta tes , municipal i t ies , and o thers .

S C O P E O F T H E S T U D YThis study is based on a series of f inancial reports which the 17

dea le r s in the Go vernm en t secu r i ti es m ark e t vo lun ta r i ly comple teda t the r eques t of the Jo i n t Econ omic Com mi t t ee . I n add i t ion , severa ldea le r s were ab le to supp lemen t the i r own reco rds wi th in fo rmat ionp rev ious ly submi t t ed to the Federa l Reserve Bank o f New York .Add i t iona l mate r i a l and subs tan t i a l he lp in in t e rp re ta t ion o f accoun t ing reco rds was ob ta ined th rough in te rv iews wi th more than two-thirds of the dealers as well as with off icers of the Federal ReserveBank of New York and the s taf f o f the Board of Governors of theF ed e r a l R es e rv e S y s t em .T he ma in focus of the s tudy i s the ma rke t in wh ich ou t s t an d ing Tr eas u ry i ssues a re t r ad ed , and by fa r the l a rge r pa r t o f thed iscuss ion i s a descr ip t ion of the way in which the market operates .Chapter I I concent ra tes on market o rganizat ion , d i f ferences betweenindiv idual dealer operat ions , and dealer v iews of thei r own operat ions .Succeeding chapters consider in turn each of the f inancial reports subm it te d by the 17 de al er s: pos i t ion, t ra ns ac t ion s, sources of f inancing,cap i ta l , and ea rn in gs . A t the end , a b r ief sum m ary of some of thepr i nc ipa l findings i s p ro vid ed a nd some quest ions are posed conce rn ingth e ro le of the ma rke t in the economy.


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C H A P T E R I IT H E D E A L E R M A R K E T : T R A D I N G O R G A N IZ A T IO N A N D

P H I L O S O P H Y OF D E A L E R F I R M SThe in ternal o rganizat ion of dealer f i rms i s c losely re la ted to thesize of tot al op era t ion s. I n five cases, G ov ern m en t securi t ies operat ions are conducted in a re la t ively smal l depar tment of a large bank .F o r some nonb ank dea le r s o ther ac t iv it i es deal ing in co rpo ra te o rmun ic ipa l bonds , underwr i t ing new i s sues , o r t r ad ing on o rgan izedexchanges are rega rded as the p r in c ipa l occupa t ion of the f irm .Size of the dealer operat ion in Government secur i t ies i s a moreimpor tan t de te rminan t o f the manner in wh ich Governmen t secu r i t i esare t raded than the number or k ind of a l ternat ive act iv i t ies in whichthe f irm engage s . L ar ge dealer o rga niza t ions are m ore th an s im plem ul t ip les of sma l ler f irms. I n gene ral , lar ge r f irms (1) p ro vide add i t ional serv ices to cus tomers , (2 ) have greater access to in format ion oncha ng in g m ark e t cond i t ions , and (3 ) per ha ps mos t im po r tan t o f a l l,hav e d i fferen t ph i losophies which guide the i r ope rat ion s .For the benef i t o f those readers who have no t had the oppor tun i tyto wi tness bond t ra d i ng , a b rief de scr ip t ion of some aspects o f in ter na lo rgan iza t ion is p rov ided . Rea ders f am i l i a r wi th the opera t ion ofthe market may prefer to go d i rect ly to the sect ion in which someof the implicat ions of the differences between large and small f i rmsare exam ined. D iscussion of differences in th e lega l form of org aniz at ion wi l l be found in cha p te r V I .

INTERNAL, ORGANIZATION FOR TRADINGF o r the pu rposes of th i s s tudy , the dea le r m arke t ma y be regard ed as

composed of th e 17 f irms l i s ted ear l ier . F i ve a re dep ar tm en ts of larg eNew Y ork or Chic ago ba nk s; the rem ain ing 12 are f irms whose pr i ncipal business i s the purc ha se an d sale of secur i t ies . A t var ious t imess ince 1947 at leas t s ix addi t ional par t ic ipants in the market 1 have re po r t ed on the i r opera t ions in Governmen t secu r i t i es to the Federa lReserve Ba nk of New Y ork . Tw o of the s ix hav e been act ive d ur in gthe las t 4 or 5 years , bu t thei r scale of o pera t ions in Gov ernm ent secur i t ies ha s been qui te sm al l .Vi r tua l ly a l l t r ansac t ions in Governmen t secu r i t i es a re conduc tedby te lepho ne or te le typ e. T he t ra de r opera tes f rom a desk equippedwith a ser ies o f d i rect connect ions wi th the t rad ing desk of the Federal Rese rve B an k of New Y ork and each of the o the r dealers . Inaddi t ion , there are a number of o ther te lephone l ines connect ing thesa les depar tmen t wi th banks , in su rance compan ies , and o ther cus to mers .3 One t e l ephone swi tchboard and a b lackboard , fo r r eco rd ing

1 No rthern Tr us t Co., Blair & Co., J. B. Roll, Schroder Rockefeller & Co., Harvey Fisk &Sons, and Malon S. Andrus, Inc.2 In a large firm customer calls are usually handled by a salesman . The "tra de r" dealsalmost exclusively with other traders. 11


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12 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERScurren t quotat ions and d i rect ion of p r ice change for the var ious i ssuesof Government secur i t ies , const i tu tes a l l o f the equipment used bya sm al l dealer . I n a b ig ger operat ion , a lar ge nu m be r of iden t ic alswi tchboards wi l l be manned by an equal number of specia l i s t s eachresponsib le for t rad ing a par t icu lar c lass of matur i t ies o r g roup ofissues . A "hea d t ra de r ," f requent ly a pr i nc ipa l o f the f irm, superv isesthe opera t ion f rom a cen t ra l desk . L ar ge or d iff icult t ransa ct io ns an dmost o f the purchases f rom and sales to the open market desk a t theFe de ra l Keserve wi l l be ha nd led by h im . I n lar ge dealer f irms, ther eare several p r in cip als pa r tne rs or officers o r s tockho lders as th e casema y be . Ty p ica l ly each superv ises a pa r t i cu la r m atu r i ty r an ge .An elect r ic quotat ion board may rep lace the b lackboard of the smal ldealer . L as t p r ices or quo tat ion s on a l l i ssues of G ove rnm ent se cur i t ies , and the h ighest and lowest quotat ion of the day are recorded below the c los ing pr ice for the prev ious day ' s t rad es . W hi l e the sm al ldealer may only post a few selected issues in which he is act ively interested or which are close subst i tutes for those he owns, the large dealerkeeps a curren t record on the en t i re l i s t o f Government secur i t ies andre la t ed i s suesagency and o ther guaran teed ob l iga t ions .As t rad ing proceeds , purchases and sales are recorded on a sheet d i r ec t ly in f ron t o f the t r ad er . Th e am oun t of ou t s t and ing repu rcha seagreements and the dates on which the secur i t ies wi l l be redel iveredare no ted the re a lso . I n th i s wa y , the t rad er is ke p t aw are of theprecise amount of secur i t ies which he has avai lab le , the amount whichhe i s "shor t ," and the amounts which are due to be del ivered on subseq u en t t r ad i n g d ay s .I n la rge f irms, a "m oney d esk " in the t ra d i ng are a is respons ib le fora r r an gi ng the f inancing of th e com pan y ' s posi t ion in G ove rnm entsecu ri t ies or in rel ate d secu ri t ies. A copy of each pu rc ha se or saleord er is fu rn ish ed to the mo ney desk . A record is m ain ta i ne d of theexact am ou nt of add i t ion al f inancing needed to balance the dai ly cashflow ag ain st th e da i ly f low of secu ri t ies. K ates an d rese rve posi t ion sa t money marke t banks and o ther l a rge banks th roughou t the coun t ryare checked ; r epu rchase ag reemen t s a re sough t wi th co rpo ra t ionsth roughou t the coun t ry ; in t e res t r a t e changes in the money marke ta re no ted .In a small dealer f i rm, f inancing wil l be combined with t rading.The "money marke t desk" i s r educed to a co lumn on the page wh ichreco rds th e com pan y ' s ne t posi t ion . A s secur i t ies are so ld or pu rchased , th e "am ou nt rem ain ing to be f inanced" w i l l ind ic ate the da y ' schange in cash posi t ion as a posi t ive or negat ive amount .F requen t " feedback" be tween the t r ad ing desk and the money deskw i l l in fluence the course of t ra d i ng . I f mone y i s t ig h t on a p ar t ic u l arday, prices wil l be shaded in an effort to dispose of securi t ies for cash.As a resu l t , t igh t condi t ions in the money market are ref lected in thesecu r i ti es m ark e t th r ou gh a f a l l i n the p r i ce of secu r it i es. T h r ou gh thecons tan t in t e rp lay be tween the t r ad ing desk , the money desk , and themarke t s , changes a re t r ansmi t t ed to the var ious marke t s on wh ich in t e res t r a t es a re fo rmed . Moreover , i f t r a d i ng in Go vernm en t secu r it i esi s done in bu t one depar tmen t o f a mu l t idepar tmen t secu r i t i es house ,there mus t be coo rd ina t ion be tween the t r ad ing in co rpo ra te and mun ic ipa l ob l iga t ions and the Go vernm en t secu r i t ies dep ar tm en t . A tleast one of the f i rms which offers a wide range of securi t ies, coordi-


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STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERS 13na tes i ts t r a d i ng ac t iv i ti es by p lac ing the t r ad in g desks fo r the v ar ioussecu r i ti es corpora te , mu n ic ipa l , and Governm en t in ad jacen t a reas .T he m oney desk is used to bala nce the inflow an d outf low of cash on al lm ar ke ts. I t th us becomes th e con trol cen ter for a f i rm's cash f lows toor f rom a var ie ty of secur i t ies markets .A m on g the ban k dea le r s , t he p rob lem o f coo rd ina t ion i s hand led ina s im i lar w ay . I n man y cases, the ba nk ' s por t fo l io , the deale r funct ion , and the reserve or money posi t ion are handled th rough a s ing lev ice pres iden t . H e decides on the a l locat ion of the bank ' s reserve posi t ion between the Government secur i t ies and por t fo l io or investmentde pa r tm en ts . F o r most o f the ba nk dealers th is officer i s th e pr i nc ipa lmea ns of co ord ina t ing act iv i t ies in the var io us secur i ty m ark ets . H eal locates funds in ternal ly and borrows or lends Federal funds in themoney ma rke t . Dif ferences in sources an d ava i lab i l i ty of funds as ide ,i t is clear from the above that his funct ion differs l i t t le in principlef rom the operat ion of a money desk a t a mul t idepar tment dealer f i rm.In these aspects o f in ternal o rganizat ion for f inancing and t rad ing ,large f i rms are s imply more complex or more e laborate reproduct ionsof the i r smal ler compe t i to rs . B ut , as no ted above, larg e f irms pro videaddi t ional serv ices to cus tomers and engage in operat ions whichsma l ler f irms avoid . The se serv ices p la y an im po r ta n t p a r t in thefunc t ion ing o f the marke t and the t r ansmiss ion o f in t e res t r a t echan ges. T he y bo th reflect an d con dit ion th e policy aim s of dealerfirms.

C U S T O M E R S E R V IC E S A N D I N F O R M A T I O N F L O WTh e t r a d i ng room o f any l a rge dea le r appea r s to the un in i t i a t ed as a

E lace of hub bub and confusion . Q uota t ions are shouted back and for thetween t ra de rs , sa lesmen, and c lerks . R un ne rs ca r ry messages between the var ious dep ar tm en t s . Th e sa les de pa r tm en t and t e l e typeroom, nei ther o f which i s general ly found in a smal ler f i rm, providedire ct con tact w ith custom ers seeking to bu y or sel l securi t ies. Sa leor purc ha se ord ers received at bra nc h offices are proc essed.Co ntra s t to th i s the t r ad in g room of a sm al l dealer . O ne, tw o, o rpe rh ap s four or five me n are qu iet ly buy ing , se l l ing , o r quo t ing secur i t ies on the te lephone or record ing thei r posi t ion on thei r ta l ly sheets .Th ere i s m uch l ess ap pa ren t ac t iv i ty . A nd the re a re im po r tan t d if fe rences in funct ions per form ed.The large dealer i s much more l ikely to be operat ing in a nat ionalm ar ke t . H e freq uen tly h as la rg e br an ch offices in va rio us sect ions ofthe cou ntry . A nd h e i s a l so mo re l ikely to hav e bo th te lepho ne andouts ide sa lesmen cal l ing on banks , insurance companies and the t reasure rs o f larg e nonf inancial corp orat ion s ou ts ide New Yo rk . M oreover , the larg e deale r wi l l gen eral ly hav e an a ct ive and wel l-s taf feds ta t i s t i ca l depar tmen t to ana lyze the changes t ak ing p lace in the var ious pa r ts o f the cou ntry , thei r impa ct on the reserve posi t ions of ba nks ,on in teres t ra te s an d the pr ice of Go vern me nt bon ds . I n add i t ion , h isstaff p eop le col lect i temize d po rtfol io s for act iv e pa rt ic ip an ts in them ark et . H e i s thu s aw are of factors af fect ing the dem and for secur i t i es in pa r t i c u la r com muni t i es .The in format ion and contacts ob tained in these ways no t on ly d i rect ly ass is t the larger dealer to main ta in a greater vo lume, they a lsop rov ide in fo rm at ion w h ich i s u se fu l fo r two im po r tan t pu rpose s .


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14 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERSFirs t , when a cus tomer i s seek ing to purchase or se l l a par t icu lar long-term issue which i s no t act ively t raded , knowledge of the presen tholde rs of the i ssue and an awaren ess of the i r por t fo l io requ i rem entsis a p rere quis i te to serv ic ing the orde r . I n the pres en t long - term m arket , many i ssues are no t act ively t raded for reasons d iscussed in moredeta i l below. Ea sie r access to in form at ion p erm i ts the lar ge r dealerto serv ice the order by offer ing to exchange secur i t ies wi th some o thercustomer , borrow the secur i t ies which a par t icu lar cus tomer des i res ,or o therwise ar ra ng e to fill th e order . T hr ou gh these m ean s some ofthe d i sadvan tages o f a " th in" long t e rm bond marke t a re overcome.D eale r in fo rm at ion on customer por t fo l ios e l im inates some of ther isk involved in ho ld ing " th in" i ssues and helps to prevent in f requent ly t raded i ssues f rom sel l ing a t a p r ice which i s low rela t ive toco m p ar ab l e m a t u r i t i e s .Second , g rea te r access to m ark e t in fo rm at ion perm i t s the l a rge dea le rto t ake ad van tage o f t em por ary s i tua t ions wh ich a r i se in o ther pa r t s o fthe cou ntry . T hr ou gh h is b ra nc h qfEces an d h is m ore f requ ent cont ac t s wi th f i rms th roughou t the coun t ry the l a rge dea le r i s made morequ ick ly aware o f mino r bu t impor tan t changes in loca l o r na t iona lcond i t ions . F o r exam ple , the fo r thcom ing l a rge sa l e o f a p ar t i c u la ri ssue by a pension fund w ould temp ora r i ly reduce th e pr ic e for th a ti ssue. T he dealer m ay therefo re wish to d ispose of h is posi t ion inadva nce. A re su l t of th i s has been a redu ct ion in the nu m be r of dealerswho ac t ive ly t r ade longer t e rm secu r i t i es fo r wh ich marke t s a re" th in" and the r i sk involved in ho ld ing a g iven dol lar amount of secur i t ies i s g reat .One smal l dea le r summar ized h i s ro le in the marke t by s t a t ing tha the was gen eral ly una ble to assume the r i sks of a long - term posi t ion . I fhe t r ied , he fe l t sure that he "would end up 'ho ld ing the bag ' fo r oneof the b igg er dealers . H e [ th e larg e dea ler ] can f ind ou t w ha t ' s ha ppening in Cleveland , Det ro i t , o r on the west coas t and unload h isposi t ion on me long before I know w ha t i s go in g on ." A s a resu l t ,some smal ler dealers operate much less or no t a t a l l in long- termm at u r i t i e s .More impor tan t i s the f ac t tha t the smal l dea le r t ends to th inkof h is operat ion as concent ra ted pr incipal ly bu t no t exclus ively inNew Y ork . Th e l a rge dea le r i s more l ike ly to r eg ard h i s opera t ionas na t ion al in scope. T he re i s no ru le which c lear ly del ineates th e two .Even smal l dea le r s were anx ious to po in t ou t in in t e rv iews tha t theyhad long es t ab l i shed bo r rowing a r rangemen t s wi th the X Bank inSea t t l e o r San F ranc i sco . Bu t , i n d i scussing the i r t r a d i ng ac t iv i ti esthey were much more l ikely to choose examples based on in terdealert r a d i ng o r sa les to and f rom New Y ork money m ark e t ban ks a ndfinancial ins t i tu t ion s. M oreo ver, quest ion s ab ou t th e scope of act ivi ti es genera l ly ind ica ted th a t the New Yo rk ma rk e t was re l a t ive lymore impor tan t fo r smal l t han fo r l a rge dea le r s .

The fo rego ing does no t imp ly tha t the marke t i s "domina ted" bythe larg e firms or th a t the smal l firms are w i tho ut im po r ta n t funct ions .T he role of sm aller f irms in th is m ar ke t is discussed lat er . How ever , we wish to suggest here that : (1 ) the funct ions performed byde ale r firms differ, (2) size of firm is a ro ug h in di ca to r of th is difference, an d (3) larg e firms incu r ad di t io na l cos ts an d u nd er tak eadd i t iona l r i sk s in the in t e res t o f inc reas ing the i r t r ad ing vo lume,prof i ts an d serv ice to cus tom ers .


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STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERS 15D E A L E R V I E W S OF D E A L E R F U N C T I O N S

Making marketsConversa t ions wi th dea le r s and wr i t t en mate r i a l abou t the Govern ment secur i t ies market are rep le te wi th references to the dealer funct ion o f "m ak ing m ark e t s . " Us ua l ly th i s r e fe r s to the wel l -known fac ttha t the m ark et for G ove rnm ent secur i t ies i s an over- the-coun terma rket , and th a t secur it ies dealers c lear the m ark et by bu yin g (absorbing secur i t ies in to thei r posi t ion) or se l l ing (e l iminat ing secur i t iesf rom pos i tion o r , a l t e rna t ive ly , sho r t ing the m ar ke t ) . W he n in te r v iewed many dealers seemed proud of the way in which th is funct ionis perfo rme d. De scr ip t ion s of the i r re la t io nsh ip s w i th cus tomersof ten refered to the a lleged fact th at "w e m ake good m ar ke ts" or "weare w i l l ing to s tan d on our m ar ke t ." Ca re wa s tak en to m ake a d is t inct ion between dealers who as pr in cip als buy and sell secur i t ies for the i rown account and " take posi t ions" (ho ld an inventory of Governmentsecur i t ies) and brokers who ar range t ransfers between buyers andsel lers but do not take posi t ions.B u t the rep et i t ion of such phra ses as ide , the re was mu ch d isag reement about the funct ion of making markets when dealers were askedto descr ibe the i r funct ion in deta i l . A t one ex t rem e the re was a grou pof f i rms, general ly the larger f i rms, who asser ted that markets werem ad e alm ost exclusively for custom ers. If a secu ri ty is quoted to acustomer, the dealer wil l be wil l ing to buy or sel l at the given "bid"and "aske d" pr ices . H ow eve r , the ex ten t to wh ich these quotat ionsmay be regarded as f i rm commitments appears to depend d i rect ly onthe dealer ' s p resen t o r des i red inventory posi t ion and inversely onthe yea rs to m atu r i t y of the i ssue. I n the case of sho r t - term secur i tiesmost large dealers descr ibe themselves as wi l l ing to "s tand on thei rm ar ke t" for a lmost any am oun t th at a cus tom er offers. B ut , inthe event that a cus tomer des i res to se l l a re la t ively large amountof a long or medium-term issue, e.g . , $5 mil l ion, a large dealer wil lnormally buy some proport ion of the offer , say $y2 or $1 mill ion . H e wi l l then t ry to d ispose of the rem ain ing am oun t th ro ug hin te rdea le r t r ad ing o r a f t e r inqu i ry , among those cus tomers whoare likely to hav e a por t fo l io need for the i ssue or ma tu r i ty ran ge .The dea le r wi l l no rmal ly no t t ake the r emain ing $4 mi l l ion o r$414 mil l ion into posi t ion unti l he is able to arrange for the sale ofthese secur i t ies to a cus tomer . O n occas ion an in f requ ent ly t ra de dissue is offered. E ve n th e larg es t dea lers ind ica te an un w il l ing ne ssto take such "thin" issues into posi t ion unti l an offset t ing sale hasbeen a r ranged .Large dealers a lso emphasize what they descr ibe as a serv icefunct ion . I f a cus tomer des i res a pa r t ic u la r issue, the dealer wi l lscour the known holders of the i ssue and t ry to ar range for an exchange or "swap" wi th a ho lder in order to re lease the secur i t iesdesired by the customer . O r if the secur i ty is act ively t rad ed , thedealer wi l l se ll the secur i ty shor t o r hed ge the t ran sac t ion . To dot h i s , he borrow s the secur i ty and "goes sh or t" to h is cus tomer . H eres tores h is inventory wi th an avai lab le i ssue in the same matur i tyran ge . T hu s the dealer services the cus tom er by tem po rar i ly furn ishing the market wi th a secur i ty which i s in shor t supply a t the ex is t ingm ark et p r ice . A t a la te r date , the hedge t ran sac t ion i s reversed . Th e


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16 STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERSdealer purchases the secur i ty which was so ld shor t and sel l s thesecu r i ty wh ich was pu rchased .Whi le there was some consis tency in the v iews expressed by thelar ge dealers , the re wa s fa r less un an im i ty of op in io n amo ng t hesmal ler dealers wi th respect to the dealer ' s funct ion in the marketan d the def in it ion of "m ak ing a m ark et ." T hr ee po in ts o f v iew coverthe ra ng e of expressed opin ions . T w o of them reveal a g r ea ter o r ienta t ion toward the dealer market than to the serv ice of cus tomers .On e dealer descr ibed h imsel f as " th e dealer ' s deale r ." T hi s does no tmean that he refuses to se l l to nondealers bu t he was qu i te expl ic i tth a t he v iews h imsel f as a specia li s t w ho ma kes a m ar ke t for o th erdea le r s . H i s me thod of opera t ion cons is ts p r im ar i ly in b id d in g fo rb i l l s a t the weekly Treasury auct ion , tak ing them in to posi t ion anddispos ing of h is aw ar d du r in g the week . On occas ion he buy s b i ll sf rom o the r dealers an d sel ls the m to cus tome rs or v ice versa . B u t h ispr incipal occupat ion seems to be winning an award of longer term180 da ys or 1 yea r bil ls an d sel l ing th em off d ur in g the course of th eweek to o the r dealers . H e v iews h is funct ion as a me ans of p ro vid inga por t fo l io of b i l l s avai lab le to o ther dealers who are more d i rect lyengaged in serv ic ing customers .One long es tab l i shed dealer descr ibes h is p r imary funct ion as making mark e t s fo r o ther dea le r s . H e den ied em phat i ca l ly th a t he " s t and son m ar ke ts" for cus tomers . M oreover , he does no t v iew the ba nk dea l ers as an in teg ral p a r t o f th e ma rke t an d does no t feel i t necessary tom ake m ark e t s to them . H e ind ica ted tha t in h i s firm genera l ly thecustomer i s asked about the do l lar amount of secur i t ies which thecustom er wishes to purc has e or se ll . T he t ra de r then decides w he the ror no t to quote a pr ice . T h e decis ion seems to be based pr inc ipa l lyon the dealer ' s curren t and des i red inventory .A th i rd smal l dealer descr ibes h imsel f as a "merchant o f secur i t ies ."In general , he does no t take very large posi t ions in Government secu r i t ies . P ra c t i ca l ly a l l o f h i s t r a d i ng is wi th cus tomers r a the r tha nw i th o the r dealers an d mo st o f th is is done in b i l l s . Lik e the la rg erdeale rs , he v iews h is firm as a serv ice orga niza t ion . B ut un l ik e them ,the process of "making a market" i s descr ibed as one in which customers are contacted , thei r needs are d iscovered , and secur i t ies arepur cha sed to f ill the i r dem and . A side f rom the sma l l posi t ion whic his no rm al ly car r ied by the f irm a nd the a l leged fact th at the f irm ne vercharges commission or other fees, there is l i t t le difference betweenthe "m erch an t o f secu r i t i es" and a b roker .The bank dealers do no t d i f fer substan t ia l ly in thei r operat ionsf rom o ther dea le r s . B ank s w i th l a rge dea le r dep ar tm en t s t end toho ld l a rge r po r t fo lio s in med ium- an d long - t e rm se cu r i t i es ; t he smal l e rdepar tmen t s a re concerned more d i rec t ly on the average wi th b i l l s ,cer t if icates , an d o the r sho r t m atu r i t ies . Ho w eve r , i t i s l ikely th att r ansac t ions wi th commerc ia l banks a re a l a rger par t o f to t a l t r ad ingfor ba nk dealers th an for non ban k dealers . F o r some of th e ban kdea le r s , t he opp or tu n i ty to a t t r a c t funds f rom ba nk ing co r respon den t sou t s ide New York o r Ch icago makes the i r dea le r opera t ion a t t r ac t ive even du r ing per iods o f " t igh t money" when numerous a l t e rna t iveuses of th ei r reserv e pos i t ions are ava i lable . M oreove r, some of th ebank dealers seem convinced that thei r dealer operat ion a t t ractsl a rge co rpo ra te depos i to r s s ince the depar tmen t enab les the bank to


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STUDY OF FEDERAL GOVERNMENT SECURITIES DEALERS 17effect secur i t ies t ransact ions for corporat ions more rap id ly than canban ks wh ich do no t have dea le r d epa r tme n t s .Smal l e r f i rms t end to concen t ra t e on a par t i cu la r r ange o f matu r i t i e s ; larger f i rms are more l ikely to take posi t ions over the wholeran ge of ma tur i t i es . Som e of the smal l f irms hav e become b i l l specia l i s t s , o thers have concent ra ted on in termediate and long- term secur i t ies o r agency and gu ara n te ed obl igat ions . I n pa r t , th is ref lectsthe problem, d iscussed in greater deta i l in chapter I I I below, ofmain ta in ing a posi t ion in a wide var ie ty of i ssues when cap i ta l i sl imi ted . I n pa r t , i t i s a react ion to a prev iou sly unprof i tab le o perat ion over the who le ra ng e of the G ove rnm ent secur i ties m ark et . Ava r ie ty of o ther reasons could be c i ted . I n general they fa l l in toth ree main c l asses :1. Information. Large dealers have larg e sales orga nizat io ns , f requent ly have branch off ices th roughout the country , and are gene ra l ly much more aware o f the cond i t ions and opera t ions th roughout the country . T hi s po in t was d iscussed above an d need not bee labo ra ted fu r ther .2. Risk. The ex is tence of long bonds in the por t fo l io mean s tha tthe dealer i s ca r ry ing a gre ate r r i sk pe r do l la r o f por t fo l io . Th ispoin t wi l l be d iscussed in more deta i l in chapter I I I .3. Cost. Average size of t ra ns ac