WASHINGTON - The Treasury Department's plan to experiment with single-price auctions of two-year and five-year notes drew mixed reaction from government securities dealers yesterday, but on balance traders seemed to agree the idea is worth trying.
Details of the plan, announced by Undersecretary Jerome Powell, call for the Treasury to begin awarding all two-year and five-year notes that are sold at the government's monthly auctions at one market-clearing price.
The experiment, which win last one year, is intended to lure more investors into the government market and promote more aggressive bidding that trims government borrowing costs. The new procedures win begin with a sale of two-year notes on Sept. 25 followed by a sale of five-year notes on Sept. 26.
"People have been expecting some sort of an experiment like this, and it's not going to have any major impact on how we do business or bid in the auctions," said Ronald C. Brienza, managing director of Smith Barney, Harris Upham & Co. "In a highly efficient market there shouldn't be any difference. "
Other dealers, especially at smaller firms outside the primary dealer network, were more enthusiastic. "The government will hopefully be saving money and straightening out the bidding system," saud Dennis M. Galle, managing director of the trading department for Lebenthal & Co.
The Public Securities Association, in a statement, said the new system could end up being fairer to successful smaller bidders who will pay the same price as larger firms.
Implementation of the new auction procedures caps more than a year-long effort by Treasury officials to reform the government securities market and to broaden participation by investors.
Under the new system, the Treasury will sell all of the two-year and five-year notes that are auctioned each month at a single market-clearing price. The price will be determined y taking all of the bids, starting with the lowest yield, and awarding bidders at successively higher yields until the issue is filled.
Bidders at the highest yield would get the security on a pro-rated basis, assuming the issue is overbid.
For example, if the Treasury seeks to auction $9 billion of five-year notes, it may find it takes a market-clearing price of 5.03% to sell the issue. Dealers offering $3 billion at 5.01% and $3 billion at 5.02% would be awarded the amounts tendered, and dealers offering $2 billion at 5.03% would get two-thirds of the volume offered.
The Treasury said it will continue to sell other maturities using the current multiprice system that awards issues to dealers at different yields and prices.
Mr. Powell said it remains to be seen if the new method brings any savings to the government.
He stressed that the Treasury is determined to continue the experiment for the full year. While the government reserves the right to revoke the new procedures, he said, "no one should expect us to back away if we have a couple of bad auctions."
Some dealers warned that the Treasury may end up paying more for government debt.
"You've taken away that incentive to step up and take down a large portion of the issue," said James Sickling, head of institutional government trading for Kemper Securities Group. "I understand what the Treasury is doing. They're saying that it's going to lower their financing costs. I actually think it might raise the costs of their financing."
Mr. Sickling was also skeptical whether there will be more market participants. "I don't know if it increases the number," he said. "You're still distributing the same number of bonds. Does it matter whether five guys take down $2 billion each or whether 10 guys take down a billion each? I think you've reallocated the distribution, but I'm not sure you've lowered the cost. "
Other dealers reacted more favorably.
"As a desk, we are looking forward to this," said a trader at one primary dealer who did not wish to be identified. "We think there are going to be a variety of opportunities, one result of which win hopefully be that the Treasury will be able to issue securities at a lower rate than they would otherwise.
"I think what's going to happen is we're going to find that those who do want the securities will bid aggressively for them and that the auctions will come at levels that are relatively aggressive compared to where the secondary market is trading for the day. "
Mr. Powell said officials will be witching the number of participants in the auctions, the concentration of awards, and the dispersion of accepted yields. The new system is expected to discourage bidders from seeking to shave their bids to fall in line with the market consensus, he said.
Mr. Powell also said officials will be keeping an eye on the bid-to-cover ratio at the auctions, or the volume of total bids compared to the total issue, and on the spread between the yields on a given security in the when-issued market and the auction market. In when-issued trading, investors buy and sell a security that has been announced for sale but not yet gone to settlement.
Some said they expect the primary dealers, which generally take 90% or more of each Treasury auction, to continue to dominate the government market, with few new players.