Stay 
Trading Conditions
Products
Tools
The Masters of the Universe immortalized by Tom Wolfe in his 1987 novel “The Bonfire of the Vanities” are feeling like mere mortals.
The Wall Street banks known as main dealers because they get to exchange with the Federal Reserve and provides the money that the U.S. government needs to manage are concerned that they are being marginalized because of advances in technology. So worried are they that the group wants the Treasury Department to curb the increasingly popular practice by investors of purchasing bonds directly from the government without their involvement.
In many ways, the request underscores the changing nature of the business, where a wide access to data has leveled the playing field between banks and investors, and turned telephones into little more than paperweights. A record 49 percent of Treasury trading was done electronically in 2013 and the amount of debt merchandised straight to investors at auction bolster to 17.7 percent of issuance from 2.5 percent in 2008. The number of primary dealers has sagged down to 22 from the topmost mark of 46 in 1988.
“The Treasury needed the dealer community for its information, for its distribution,” saidE. Craig Coats Jr., who was the co-head of the government bond trading desk at Salomon Brothers in the 1980s, when the partnership was Wall Street’s biggest bond trading firm. “Today there’s so many different sources of liquidity and information and distribution that the dealers become less important to the Treasury.”
‘Breaking Down’
Primary dealers, which include JPMorgan Chase & Co., Goldman Sachs Group Inc., Bank of America Corp. and Citigroup Inc., are seeing their roles diminished just as the Fed begins to unwind the extraordinary monetary stimulus measures put in place after the 2008 financial crisis. That includes bond purchases that swelled the assets on the central bank’s balance sheet to a record $4.15 trillion from less than $1 trillion.
At the same time, government borrowing has more than doubled the amount of tradable U.S. government debt to $11.8 trillion. That combination has dealers concerned that there’s an increased chance of disorder in markets if demand for Treasuries declines. Forecasters predict higher yields, which would reduce the value of existing bonds.
“This is an oligopoly that’s breaking down and the oligopolists are concerned,” said Robert Eisenbeis, a former director of research at the Federal Reserve Bank of Atlanta and vice chairman and chief monetary economist for money-management firm Cumberland Advisors in Sarasota, Florida.
Influential Membership
The request by the dealers was revealed on page 58 of a 74-page chart presentation accompanying the report that the Treasury Borrowing Advisory Committee, or TBAC, presented to the government this month and made public. The 15-member group is made up of the world’s most powerful and influential banks and investment firms.
The committee, which makes recommendations to the Treasury on its borrowings and briefs it on market conditions, suggested setting curbs on investors’ ability to circumvent the dealers and buy bonds directly from the government because the unpredictable nature of that demand “could potentially lead to increased debt funding costs” for the government.
They also suggested the U.S. consider the potential for syndicated sales of securities such as ultra-long maturity bonds due in more than 30 years and granting underwriters the option to buy additional debt at the Treasury offerings. Those measures would tighten their grip on the sales process.
Taking Stock
TBAC Chairwoman Dana Emery, the chief executive officer of mutual-fund firm Dodge & Cox Inc. in San Francisco, declined to comment, said her spokesman, Steve Gorski. All of the 14 other members either declined to comment or didn’t return calls.
“We’re always trying to take stock of where we’re at and make sure we understand how new developments in the marketplace are impacting our ability to finance ourselves,” Matthew Rutherford, the Treasury’s assistant secretary for financial markets, said in a February 20 telephone interview.
Ensuring that the government is getting the best rates possible on its borrowings is no small matter with the Treasury selling more than $2 trillion of notes and bonds a year. That’s up from an average of $659 billion in the five years before the 2008 financial crisis.
Unlike dealers, direct bidders aren’t required to bid at every Treasury auction. That means their decision to participate makes government debt sales less predictable, the TBAC has said in its reports. As a result, dealers may need to reduce their bids to compensate for the added risk.
Increasing Share
Direct bidders submitted $829.2 billion in bids last year, and were awarded $351.1 billion, or 17.7 percent of the $1.99 trillion in competitively sold U.S. debt, according to Treasury data compiled by Bloomberg. All were record amounts.
In 2008, direct bidders tendered $25.4 billion and were awarded $20.2 billion, or 2.5 percent, while dealers submitted $1.47 trillion of bids for $809 billion of competitively sold securities, winning $554.7 billion, or 68.6 percent.
The increased availability of data and the advancements in trading technology have leveled the playing field, giving investors access once enjoyed only by the dealers.
“I can enjoy a primary dealer level of access to both the primary and secondary markets,” Jason Evans, co-founder of hedge fund NineAlpha Capital LP in New York and the former head of U.S. government bond trading at Deutsche Bank AG, said in a telephone interview.
Trading Slump
Trading in fixed-income, currencies and commodities at the 10 largest global investment banks declined 19.4 percent in 2013 to $73.9 billion, according to research firm Coalition Ltd. The “anticipation of rising interest rates, tougher capital adequacy regulations and concerns over the U.S. Fed ‘tapering’ weighed on the business,” Coalition said in report last week.
Increased regulations after the financial crisis to limit banks’ risk-taking “is increasingly stifling for the dealers,” Evans said last week. “Primary dealers have seen the true value proposition in being a primary dealer eroded over time.”
Even though the amount of debt has expanded, trading activity is stagnant, with $544 billion of Treasuries on average changing hands each day in 2013, down from $553 billion in 2008, Fed data show. Electronic trading has increased from 31 percent in 2012, according to a survey of institutional money managers by Greenwich Associates.
Coats, who worked at Salomon when its influence was caricatured in “Bonfire of the Vanities,” said he trades Treasuries via exchange-traded funds. The 66-year-old retired in 2009 as co-head of fixed income at Keefe, Bruyette & Woods Inc.
Bond Decline
Treasuries in 2013 suffered their first losing year since 2009, dropping 3.35 percent in value as yields rose, according to Bank of America Merrill Lynch index data.
Yields on 10-year notes are forecast to climb again this year, to 3.37 percent, according to the weighted average in a Bloomberg survey of 74 participants. Last week, the yield on the benchmark 2.75 percent note due in February 2024 was little changed at 2.73 percent, Bloomberg Bond Trader prices show. The yield was 2.72 percent at 11:42 a.m. in Tokyo.
Banks began to exit the dealership business in the 1990s as the large number of firms and the increased transparency of electronic trading cut the spread between offers to buy and sell debt, making activity less profitable.
“It’s a tricky balancing act about keeping costs as low as you can but at the same time not disenfranchising dealers,” said John Fath, a former head Treasury trader at Zurich-based primary dealer UBS AG. He’s now a principal at investment firm BTG Pactual in New York, which manages $2.5 billion.
‘Meaningful Intermediary’
Treasury officials understand the difficulty posed for dealers by the erosion of their dominance at the auctions and as new regulations limit their ability to commit capital to their bond businesses, according to Karthik Ramanathan, a former Treasury debt management director
Dealers still “offer a meaningful intermediary” between the market and the Treasury, Ramanathan, who is now a senior vice president at Fidelity Investments, said in a telephone interview from Merrimack, New Hampshire. “I do not believe at this point direct bidding or technology is going to completely disintermediate the primary dealer structure.”
A primary dealership still carries some allure. Toronto-Dominion Bank’s TD Securities was named one by the Fed on February 12, the first new dealer in more than two years. Stamford, Connecticut-based Pierpont Securities LLC is interested in becoming one, according to Mark Werner, its chief executive officer.
‘Certain Distinction’
“Typically, central banks and sovereign funds, the biggest holders of U.S. Treasuries, will only deal with primary dealers,” Werner said in a telephone interview. “There’s a certain distinction that comes with being a primary dealer.”
Werner, who worked at JPMorgan Chase for 22 years, where he rose to vice chairman before co-founding Pierpont in 2009, and in 2010 was a member of the TBAC, acknowledges the challenges.
“You’re in a low rate environment, with relatively low volatility and low turnover in the asset class,” he said. “The result is a somewhat less profitable environment for dealers.”
The Treasury may face “perception issues” if it adopts the TBAC’s recommendations, said Dean Baker, co-director of the Center for Economic and Policy Research, a Washington-based group funded by labor unions and private foundations.
“The idea that somehow the Treasury would get a higher price for its bonds with fewer people bidding, that’s not the economics I learned in school,” Baker said in a telephone interview.
The Treasury’s bailout of the banks during the financial crisis created the notion that the biggest lenders were too big to fail and created “implicit subsidies” for them, according to Cumberland’s Eisenbeis.
“It’s no wonder they’re going to say they’re concerned about their profitability,” he said. “That’s pure self-interest and has nothing to do with the efficacy or the functioning of that market.”
