Financial Markets and Institutions (2-downloads)

Treasury Bill Auctions Go Haywire

Every Thursday, the Treasury announces how many

28-day, 91-day, and 182-day Treasury bills it will

offer for sale. Buyers must submit bids by the follow-

ing Monday, and awards are made the next morn-

ing. The Treasury accepts the bids offering the

highest price.

The Treasury auction of securities is supposed to

be highly competitive and fair. To ensure proper levels

of competition, no one dealer is allowed to purchase

more than 35% of any one issue. About 40 primary

dealers regularly participate in the auction.

In 1991, the disclosure that Salomon Smith Barney

had broken the rules to corner the market cast the fair-

ness of the auction in doubt. Salomon Smith Barney

purchased 35% of the Treasury securities in its own

name by submitting a relatively high bid. It then

bought additional securities in the names of its cus-

tomers, often without their knowledge or consent.

Salomon then bought the securities from the customers.

As a result of these transactions, Salomon cornered the

market and was able to charge a monopoly-like pre-

mium. The investigation of Salomon Smith Barney

revealed that during one auction in May 1991, the

brokerage managed to gain control of 94% of an 

$11 billion issue. During the scandal that followed this

disclosure, John Gutfreund, the firm’s chairman, and

several other top executives with Salomon retired. The

Treasury has instituted new rules since then to ensure

that the market remains competitive.

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Chapter 11 The Money Markets

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