Solomon Fixed Income

. Why does the U.S. Treasury auction its securities rather than issue them using the underwriting process that corporations or municipal governments employ when issuing bonds? Hint: think about the economic benefits that underwriters provide to corporations or state and local governments that might not be applicable to the U.S. (federal) government.

The U.S. Treasury can transfer the treasury security price fluctuation risk to dealers by auctioning its securities. Under the underwriting process, the treasury securities are still owned by The U.S. Treasury and an investment bank is a broker acting as an intermediary. Hence, when the treasury security price increases, it is good for the U.S. Treasury that they receive more funding from external investors. However, it harms the U.S. Treasury when the treasury security price drops since the U.S. Treasury will not get much funding.

On the other hand, if the U.S. Treasury auctions its securities rather than issues them using the underwriting process, dealers will pay a fixed amount of money to the U.S. Treasury and the ownership of the securities are transferred to dealers. Therefore, the U.S. Treasury will not have to take the price fluctuation risk which may decrease the value of total treasury securities if the price drops dramatically.

2. Why did bidders in the Treasury’s multiple-price, sealed-bid auction try to bluff each other and sometimes start false rumors?

Some dealers wanted to manipulate the price of the bond and arbitrage in the bond market.

3. Explain the incentive for Paul Mozer to submit a bid in the name of Warburg when the bid was really intended to be Salomon’s.

Because the government has posted a limit that the bidder could not bid a price over 35% of the whole treasury securities’ value. Paul Mozer wanted to avoid this limit. By obtaining more securities, Salomon has a better idea on the price and demand of the market.

4. What are the origins of the problem faced by John Meriwether? How might he have better managed Paul Mozer and Salomon’s Treasury securities trading even before his meeting with Mozer on April 27, 1991?

The problem was directly generated by a mistake made by Mozer. He submitted a bid in the auction in the name of Warburg; however he didn't get the authorization from this customer. Mozer's transaction activity violated the "35%" rule of the Treasury. No doubt, we all should blame Mozer for his greedy. However, after a careful scrutiny, I firmly believe that the real origin of this problem is lacking of regulation from Treasury and SEC. In order to avoid pushing up the borrowing costs of the government, Treasury didn't wield its right to issue formal and codified rules, and SEC also didn't issue rules governing the auction and