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An analysis of potential Treasury auction techniques.

Last summer's revelation of abuses of the rules governing the primary market for government securities spurred a comprehensive review of all aspects of market activity. Some of that work appeared in the Joint Report on the Government Securities Market, which the U.S. Department of the Treasury, the U.S. Securities and Exchange Commission, and the Board of Governors of the Federal Reserve System transmitted to the Congress in January 1992. While the Joint Report addressed many issues, its advocacy of experimentation with alternative auction designs for selling Treasury securities in particular attracted considerable attention. This attention likely owed to the sizable stakes. With the outstanding federal debt totaling $2.8 trillion and mounting with each year's fiscal deficit, the gain to the Treasury from even a modest improvement in selling technique could be substantial. In fiscal year 1991, for example, gross issuance by the federal government exceeded $1.7 trillion. Given that scale of borrowing, a reduction of one basis point in the average annual issuing rate at Treasury auctions would trim more than $200 million from the federal deficit each year. At the same time, the Treasury must maintain the integrity of the auction process by ensuring that no illicit activity is hidden by the sheer volume of transactions. A concern by investors that the market was not open and fair would be translated into lessened demands for Treasury debt and higher costs of borrowing.

By reviewing the academic literature on auctions, this article puts current Treasury practice and a popular proposal for reform in critical perspective. It also examines the alternative scheme embraced in the Joint Report that uses technology to give better protection against certain kinds of manipulative behavior and that has a potential for lowering borrowing costs.


There is a large academic literature on auctions, with important early contributions by William Vickrey and Milton Friedman and significant later work by Paul Milgrom, among others (see the references at the end of the article). This research has classified the types of auctions, rigorously modeled the bidding strategies, and ranked auctions by various criteria regarding efficiency. Unfortunately, this literature has a language all its own that differs from the terms that the financial press uses. To avoid confusion, this article will use explicit, if somewhat unwieldy, names for each auction.

William Vickrey established the basic taxonomy of auctions by classifying them based on the order in which prices are quoted and the way in which bids are entered.| First, securities can be awarded at prices that are progressively lowered until the entire issue is sold; alternatively, the auctioneer can arrange the bids in ascending order by their price and decide on a single price that places the total issue. By the second measure, the auction can be a private affair with sealed bids opened by the auctioneer, or it can be conducted in real time, with participants in a single room or connected by phone bidding in public. This two-by-two classification yields four auction types: the first-price sealed-bid auction, the second-price sealed-bid auction, the descending-price open-outcry auction, and the ascending-price open-outcry auction.

Complicating matters, researchers after Vickrey further classified models by an assumption about the information that bidders have regarding the value of the auctioned object. One such model is the private-values case, in which bidders' valuations are subjective decisions, independent of each other. Another is the common-values case, in which each participant attempts to measure the value of the item by the same objective yardstick. The auction of a unique work of art not for resale is the prototypical private-values model, whereas a Treasury auction--with each bidder guessing at the security's value at the end of the day--is an example of a common-values model. This article concentrates on the common-values case, which is applicable to the sale of Treasury securities, and also assumes that agents care only about maximizing profit.

In general terms, the expected profit from winning an auction for bidder 1, [Pi.sub.1], depends on the expected value of the security in secondary market trading, [v.sub.1], less the awarded price, [b.sub.1], times the probability of winning the auction, Pr(*}. In more formal terms and using i as an index to represent the bidders in the auction,

[Pi.sub.1] = ([v.sub.1] - [b.sub.1]) *

Pr{b.sub.1 > b.sub.i, for all other i}.

The format of the auction determines how the bid price affects the probability of winning and the profit from acquiring the security, as well as what information is revealed about the security's value through the auction process.

First-Price Sealed-Bid Auction

The current practice of auctioning government securities falls into the first-price sealed-bid category, which in the financial community is termed an English auction (except by the English, who call it an American auction). Bidding takes place in private and, as diagram 1 shows, awards are made at the highest priced bids covering the total auction size. It is termed a first-price auction because in the sale of one unit of good or security the award is made at the highest bid. In the figure, the horizontal bars measure the cumulative amount of bids at the given price or higher.2 Thus, participants pay differing prices reflecting the strength of their bids.

In terms of the expected return from winning the auction, a high bid lowers the profit from victory and raises the probability of winning. The strategic bidder trades between the two: He or she lowers the bid relative to valuation in order to profit more from winning and accepts the risk of lowering the probability of winning. The optimal strategy is to shade a bid toward the perceived market consensus; the more certain that consensus is (in terms of lower variability), the more the strategic investor will shade his or her bid.3

Another factor comes into play in the commonvalues case: Since all participants guess about the price--where the security will trade after the auction--a high bid signals a heightened probability of subsequent loss of profit for that bidder. In that sense, winning is losing, as entering the highest bid signals that one's valuation exceeds that of all other interested parties. This is the "winner's curse" and gives aggressive bidders an additional reason to rein in their enthusiasm. Avoiding the winner's curse may lead to the pooling of bids, as a group of investors is more likely to have a clearer view of the market consensus and is less likely to be in the far end of the bid-price distribution. The pooling of bids is a service provided by dealers, who collect customer business and place largescale orders.

Second-Price Sealed-Bid Auction

The Treasury could collect sealed bids, arrange them by price, and award all the securities at a single price that just places the entire issue (diagram 2). This auction is termed second-price because, when a single unit is on the block, the price charged would be that of the highest bid below the price that places the issue, or the second-best price. The second-price auction, called a Dutch auction in the financial press, has been proposed as a simple alternative to current Treasury practice that would prevent the type of abuses witnessed last year while lowering average borrowing costs.4

A second-price auction, in which the winner pays, not his or her bid, but only the second-best bid, severs the gain in winning from the probability of winning. An aggressive bidder can receive a sure award but pay a price closer to the market consensus. As a result, less of the shading that marks the response to the winner's curse should occur. Accordingly, customers may be more willing to place their business directly by bidding at the auction than to go through a dealer.

Descending-Price Open-Outcry Auction

This procedure is used to auction flowers in the Netherlands, hence it is referred to by academics as a Dutch auction. Bidders congregate in one room, or plug into its electronic equivalent, and wait as the auctioneer calls out a sequence of decreasing prices. In an auction of one unit of a good or security (diagram 3), the auction stops when one bidder is willing to pay the price called out. For multiple units, the eager bidder is awarded the security, and the auction continues, with the auctioneer selling the remaining securities at progressively lower prices. The strategic decision is identical to that of the first-price sealed-bid auction: The optimal bidder does not want to be too aggressive and stop the auction well above the likely market consensus, but will shade his or her bid to avoid the winner's curse. In other words, what market participants refer to as an English auction is strategically identical to what academics refer to as a Dutch auction. As a result, investors have the same incentive to pool bids and place customer orders at dealers.

Ascending-Price Open-Outcry Auction

The auctioneer can just as well cry out an ascending sequence of prices to the gathered bidders, stopping the auction when enough are willing to take down the total issue. Such a price sequence is plotted in diagram 4 for the auction of a single good or security. In keeping with the mirror imaging, academics term this an English auction.5

The auction of multiple units of a security begins as a price is called out and all interested parties submit their quantities demanded. The volume of bids at that price is announced and, in successive rounds, the price is raised until the volume demanded is smaller than the issue. When that point is reached, the seller knows that the price just previously called out is the highest price consistent with placing the entire issue--that is, it clears the primary market. Everyone who bids at the top price and some fraction of the bidders at the previous price not in the top group receive awards at that lower price.6 As the auctioneer calls out an increasing price list, bidders receive news that participants prize the security more highly than those low quotes. In effect, the auctioneer's initial announcements role out low-price outcomes, revealing that the true market value is probably higher. This increasing sequence of prices lessens the winner's curse. Besides, if an investor is truly alone in valuing the security highly, the auction stops before the price is pushed too far up when the other bidders drop out.

In 1961, Vickrey established that the four major auction formats provide equal proceeds to the seller when individual valuations are independent. Obviously, the Treasury market violates this assumption, as the value that bidders place on the security reflects an imperfect estimate of the price in subsequent market trading--that is, bidders in a Treasury auction care about the common value of the security. In the common-values case, as later researchers showed, an ascending-price open-outcry delivers the greatest proceeds to the seller under many clrcumstances.7 Essentially, in such an auction, bidders condition their behavior on the highest expected value of the security and shade their bids the least relative to the other formats.


The current auction format elicits one form of strategic behavior: Because awards are priced at the bid, the participants have incentives to shade their bids to avoid the winner's curse. As a result, customers have an incentive to pool their bids with dealers so that a combination of bids can, by a law of large numbers, be appropriately cast. The auction format may encourage two other types of strategic behavior as well. First, a dealer may combine with a customer to comer a significant portion of one auction--70 percent under the current rules. This strategy is called single-dealer cornering. Second, a group of dealers can conspire to accomplish the same end; this strategy is called collusive combining. In a sealed-bid auction, to garner the lion's share of awards, the single strategist or the group need make only a slightly more aggressive bid than the other participants expect. Indeed, the second-price auction, a popular candidate to replace the current format, may make these strategies less expensive for the purchasers than they would be under current practice. The strategic purchaser could corner the issue by bidding substantially more than the market consensus but pay a price closer to the mass of the distribution that marks the other bids.

Clearly, single-dealer cornering and collusive combining are similar. However, the informational requirements and incentives for these two types of strategic behavior vary across auction type, and actions taken to combat one might make the other more likely. To analyze the collusive potential in auctions, one must first understand the incentive behind cornering an auction-or the way in which one variety of squeeze can work.

How a Corner Works

The potential for profit in a comer, or squeeze, lies in the interaction of the three main trading forums for Treasury securities: the when-issued market, the Treasury auction, and the secondary market. Those markets are represented by the three panels of diagram 5, arrayed by time---before, at, and after the auction. As the right panel shows, the price of a Treasury security must satisfy the ultimate holders of securities (pension funds, insurance companies, mutual funds, and the general investing public), seen as the intersection of their downwardly sloped demand schedule with the vertical Treasury supply schedule.

Current auction procedures, however, get securities to those holders indirectly, through the intermediation of dealers. As the middle panel shows, the demand derived from current and anticipated customer orders produces a flatter and more inward schedule at the auction as a result of the shading of bids in the attempt to avoid the winner's curse.

An investor can purchase the security before the auction, as long as he or she can find someone wilting to sell it short. The when-issued market, shown in the left panel, matches those parties. Those seeking secure ownership rights trace a downwardly sloped demand schedule, while those willing to sell what they do not yet have make up the short-sale schedule. Selling a security before the auction involves a risk, as short sellers may not win awards at the auction to cover their open positions and so will have to bonow or buy the security after the auction settles to make delivery. Accordingly, the when-issued price should clear above the expected auction price.

The cornering of an auction is depicted in diagram 6. Short sales are made at a price just enough above the anticipated auction price to pay the sellers for exposing themselves to the likely risk at the auction. Those sellers, however, turn out to be wrong about the auction for, while the market consensus coalesces around bids consistent with the Demand schedule in the middle panel, one party comes in with bids that shift the actual schedule to Demand'. The cornerer exploits the sealedbid nature of the auction: By bettering the market consensus, the schemer wins the bulk of the awards (measured by the horizontal distance between the two demand schedules).

Since other parties cannot react, the Treasury receives only a modestly higher price for its auctioned securities, but the major price action awaits secondary market trading. The cornerer restricts the supply of the security in the secondary market (seen as the inward shift in the vertical supply schedule in the right panel), so that the price that clears that market is well above the auction price. From there, the cornerer slowly unwinds that position, expanding market supply to sell at prices above the ultimate level determined by the final owners of Treasuries. In effect, the cornerer acts as a discriminating monopolist, carefully regulating secondary market sales to earn all the revenue given by the area under the demand schedule. The cornerer's cost is given by the unshaded rectangle, leading to the profit given by the shaded area.

Indeed, the profit from a market squeeze may come by other means. While the issue remains in the cornerer's control during secondary trading, short sellers must borrow the security to make delivery. That transaction is one side of a repurchase agreement in which the owner of the desirable security--the cornerer--lends it to a short seller in return for cash at a preferential bonowing rate. In effect, by creating a demand for the issue, the cornerer can finance his or her position at a below-market bonowing rate.

The when-issued market plays two important roles in cornering strategy. First, early trading allows the market consensus to coalesce quickly and thus provides a usually accurate forecast of the auction price. By aiding in the "price discovery" of the appropriate price on the security to be auctioned, the when-issued market serves in tightening the spread of bids; thus, the cornerer needs to bid only slightly higher than that consensus to be assured awards. Second, a group of thwarted bidders--those who shorted in the when-issued market--are forced to the secondary market to close their positions. Their surprising presence makes the demand schedule less price sensitive, as no substitute exists for the security that they promised to deliver. As a result, as long as they keep their positions open, short sellers will need to borrow the desirable security and thus provide the cornerer favorable financing in the repurchase market.

The successful cornerer makes use of three elements of the current practice:

* When-issued trading creates a core of reliable demanders for the auctioned security (those who sold short).

* The first-price method of allocating awards reduces demand at the auction and makes that demand more price sensitive.

* Sealed bids allow a cornerer to place bids only marginally better than the consensus to win all the awards.

These characteristics of current procedures promise profit in successfully cornering a Treasury auction, although such trades are not without considerable risk. Even slight shifts in the prevailing level of interest rates could more than wipe out the profit from controlling a significant portion of an outstanding issue.

The Potential for Collusion

One dealer with adequate capital and the willingness to be exposed to substantial risk can possibly take advantage in the current market. A harder problem to assess is whether or not an auction's design may entice a group of dealers to conspire in an attempt to corner. The theoretical analysis of the incentives for collusion in auctions proceeds as follows.

Let us suppose that a few dealers, intent on extracting profit from those not in the ting, willfully plan together to purchase all that is sold at an auction. They agree on a price just above the market consensus that is sure to win all the awards. A sealed-bid auction, however, tempts each of the conspirators to move just above the agreed-upon price and to steal awards; as a result, the cartel likely will not hold.9 Hence, on the one hand, incentives in the classic first-price sealed-bid auction are structured so as to make collusion unlikely. On the other hand, in an ascending-price openoutcry auction, such a conniver among conspirators has to show his or her hand, making such manipulation less likely. Even if bidding is secret, the other members of the cartel will know by the price movement that someone has cheated. The cartel will hold.

By this theoretical argument, one might surmise that the current first-price sealed-bid auction protects, at least, against the willful joining of dealers to exploit the Treasury and other dealers. Unfortunately, a gap exists between models and reality, as the rule limiting awards to 35 percent of the issue paradoxically turns incentives back toward collusion. If a conniver plays within the lines of the 35 percent rule, he or she will not win enough securities at the auction to control the secondary market. Consequently, tough enforcement of quantity limits more strongly binds conspirators together.

More to the point, theoretical analyses of collusion assume that a small number of colluding parties share information, an assumption that ignores the multiple arenas in which dealers compete. Dealers will not cooperate in auctions if such cooperation jeopardizes their trading in the secondary market. Given the large number of participants and the apparent mistrust among dealers, auction format is unlikely to bring them together.10 Thus, from the standpoint of public policy, the chief risk seems to lie in the manipulative actions of a single dealer, the rogue with capital, which threaten the integrity of the market.


The abuses of the auction rules last summer rekindled enthusiasm for a simple alternative, the second-price sealed-bid auction, to the current discriminatory pricing practice. Proponents argue that awarding securities at a uniform price rather than at the bid prices would end cornering attempts by eliminating the profit potential in market manipulation. And in a way that sounds contradictory, they argue that total revenue would increase by the surrender of the ability to discriminate across bids.

The Consequences for Revenue

The algebra required to calculate an optimal bidding plan in a multiple-unit auction quickly becomes intractable. No analyst yet has worked through the strategic implications of a large core of bidders carving up a block of securities. The logic of the single-unit case, however, suggests that the extent of bid shading can be extreme. In a firstprice auction of multiple units, a strategic bidder does not have to beat the participant with the next highest valuation to win but must better only the middle of the pack of bidders.

If one steps away from the explicit modeling of bidder behavior, the implications for revenue can be spelled out in terms of shifts in the demand schedule for the auctioned security.[1] As shown in diagram 7 (which repeats the middle panel of the three-figured determination of market prices), part of the Treasury's total revenue results from its charging winners the price that they bid, which for its current practice is measured by the area under the demand schedule labeled "First price." That price discrimination, however, discourages some demand, as investors shade their bids for fear of the winner's curse. Adopting a second-price system turns part of that surplus back to the bidders, shifting out the demand schedule to the position labeled "Second price." Under a first-price scheme, the Treasury would have to work down the left demand schedule and award securities at lower prices to place the total issue (marked by the vertical dashed line). Under the second-price scheme, one price, depicted by the horizontal line drawn to intersect the right demand schedule at the issuance size, exhausts the issue. The consequences for revenue depend on whether or not the loss from the inability to price discriminate (left triangle) is greater than the gain from added demand (right triangle).

Support for the second-price scheme is stronger than the balancing of these welfare triangles would suggest. Those analysts working with explicit models of bidder behavior in a Treasury-like format, rather than with reduced-form demand schedules, typically find that a second-price scheme does produce higher revenue for the seller. Further, in 1962 Milton Friedman made a persuasive argument that revenue would increase.[12] Dealers devote considerable energy to the auction only to sell those securities almost immediately to customers--and most profit from doing so. Part of the resources devoted to that distribution could be appropriated by the Treasury if it could directly deal with those customers. A second-price auction, because it is less penalizing to the aggressive or the uninformed, may be the best vehicle to attract those people.

The Consequences for Cornering

As seen previously, the current format reduces demand at auctions and makes it more sensitive to price in relation to the demand determined by the buy-and-hold ownership of the long-time investor. This reduction is the rational response to the Treasury's discriminating pricing: The investor shows less of his true consumer surplus to a seller whose stated intention is to seize it.

Moving to a common-price format permits demand at the auction to reflect the true nature of investor preference. With no friction, investors can bypass the dealer intermediaries and bid directly, sharing the resulting savings with the Treasury. Viewed in terms of the three-figured determination of Treasury prices, second-price awards would make the auction demand curve identical to the secondary market demand curve (diagram 8). Against this backdrop, the cornerer of an auction would place surprising bids that shift the demand schedule from Demand to Demand'. The horizontal distance of that shift represents the cornerer's awards, or the extent to which secondary market supply can be restricted. As seen in the tight panel of the figure, however, the investors who are unwilling to pay the auction price will be unwilling to pay the secondary market price. Now the cornerer acting as a discriminating monopolist, rather than maximizing profit, minimizes loss (the shaded triangle). Clearly, one cannot profit from cornering a market with invariant demand, because one ultimately must sell the security to those from whom it was bid away. In this simple world, cometing would be eliminated by the removal of the potential for profit.

This result, however, requires that the switch in auction technique completely unify the primary and secondary markets. Even after the adoption of common-price awards, presence at auctions may still be limited to a segment of the investor populace, perhaps to those who are more sensitive to price. Those who sold short in the when-issued market want quickly to cover their positions at the auction. Also, participants at an auction face uncertain outcomes, since they may not be awarded securities if they have not cast their bids appropriately. Those particularly averse to this quantity risk may well delay purchase to secondary trading. Most important, direct bidding requires incurnng the fixed costs of ensuring payment and arranging for the placement of bids--the prospects for which depend on the pace of automation and the nature of regulation. As a result, the infrequent purchaser may remain in the secondary market. In other words, advocates of this format assume that dealers exist solely to shade bids because of the Treasury's discriminatory pricing. If, however, dealers provide any other service in the distribution of securities, then a gap remains between the demand schedules of the auction and the secondary market. A sufficiently large gap represents an opportunity for manipulation. Indeed, second-price awards might encourage strategems should differences between primary and secondary markets remain. A would-be manipulator could place bids for a substantial fraction of an issue well above the market consensus, and thus ensure awards, but pay only that price required to allocate the remaining portion of securities to his or her unsuspecting competitors.


On balance, the switch to single-price awards likely represents an improvement on current Treasury practice; however, the Joint Report recommended the study of a more radical change. Collusive behavior relies on the closed nature of sealed bids-- whether in the current first-price procedure or in the second-price alternative. A schemer needs only to beat the market's best guess formed moments before bidding closes in order to leave his or her competitors no chance to react.

An open-outcry system lets other market participants react to any surprise. Technologically, pieces of paper are not needed for the expression of the intent to purchase Treasury securities. As an alternative, registered dealers could connect by phone (with appropriately designed security) to a central computer; those not preregistered could appear at their local Reserve Bank with sufficient documentation to be included as a serious bidder. The scenario might unfold as follows. The auction begins as the Treasury calls out a price and all interested parties submit their quantity demanded. With quick tabulation, the volume of bids at that price is announced and, in successive rounds, the price is raised until the volume demanded is smaller than the size of the issuance. The next-to-last price called out clears the auction market because it is the highest price consistent with selling the entire issue. Everyone who bid at the top price would be guaranteed awards at the lower, market-clearing price. Those who bid at the next-to-last price but who did not move up into the top group receive the remaining securities at that lower price. Since bids from that group would exceed the remaining securities, some scheme for partial awards would be required.

Strategically, a dealer attempting to comer this auction must show his or her hand to the competition as the Treasury auctioneer raises the price. But the public exposure of the manipulator's addition to the volume of bids warns other participants-- particularly those short the wben-issued security-- that they must raise their own bids if they want to receive awards. That opportunity for others to react should narrow the potential for profit in a comer attempt. To the extent that the average issuing price is raised in the attempt, the Treasury garners part of the profits. In contrast, in a sealed-bid auction, the bulk of the price action comes at the announcement of surprising awards, when other dealers realize that they are short and then react. In a real-time auction, that reaction occurs during the bidding. Also, the positive information revealed by the ascending-price nature of this auction format, on average, should benefit Treasury revenue.

A real-time auction may pose a daunting technical challenge. The goal of equal access requires that every effort be made to decentralize the system: Anyone willing to pay the fixed cost of a properly configured terminal should be allowed to enter. At the same time, all bidders must be screened to ensure payment if their bids are successful. If the fixed cost of entry is too large, participation at the auction will be limited and a two-tiered distribution of securities and all the attendant risks may be perpetuated. If access is too free, the physical demands of directing a large volume of messages in a narrow span of time may prove taxing to any computer network. The private sector provides some precedent, but those efforts are small relative to the scale of operation required to sell Treasury securities.

Opening the auction might create new opportunities for large traders to move prices. For example, the surprising presence of a large trader elevating demand during the early stages of an auction might lead to a groundswell of enthusiasm that would push up the market-clearing price.|3 Similarly, the sudden dropping out by a large trader at a low price might dampen spirits enough to lower the marketclearing price. Either action might present the potential for profit. Also, as long as the three trading forums in Treasury securities are imperfectly integrated, the possibility of a market squeeze remains. At the least, an open-outcry auction does not abet a squeeze attempt by facilitating the bidding away of securities by surprise, as both types of sealed-bid auctions do. Thus, the Treasury would be less likely to be the counterparty from which a manipulator amassed a controlling position. Further, with easy entry, large traders would be pitted against each other in their pursuit of trading profits, as an open-outcry system turns market forces against market manipulation. As an added benefit, the technical sophistication required to conduct an automated open-outcry system could also be made available for surveillance regarding compliance with the auction rules.


While the academic literature suggests that the current Treasury procedure has drawbacks, it does not readily identify the best way to auction government securities. Individual elements of the problem are addressed, but other considerations do not fit nicely into the theoretical models. The Treasury is obliged to provide easy entry into the auctions, broadening, where possible, the ownership of the public debt; and it must adhere closely to a crowded schedule of borrowing. Also, while the Treasury may not always get top dollar for its issues, the present auction system may ease the conduct of monetary policy and ensure a deep and active secondary market in government obligations.

The shift to single-price awards may mark an improvement over the current technique, but it may not avoid the repetition of recent experience. No matter how rigidly rules are enforced, the incentive to manipulate the market remains.

This reading of the literature suggests that the optimal Treasury auction would have the following attributes (in order of decreasing importance):

* Second price. If all securities are awarded at the lowest price of an accepted bid, investors wary of the winner's curse may enter the auction directly. Such entrance raises total demand because bidders no longer feel the need to shade their bids. Also, by making direct bidding more attractive, individual dealers will no longer have as much access to customer business in attempts to swing the market.

* Real time. Auctions involving many participants that are conducted on an open-outcry basis are less susceptible to corners, which rely on surprise. In a sealed-bid auction, such surprise requires only stepping above the market consensus. That surprise is lost if market participants can react during the bidding.

* Ascending price. If the auctioneer calls out an ascending list of prices until the issue is sold, the surprise of a cornering attempt is further eroded. Simply, other participants remain in the bidding. Also, an ascending-price auction produces the highest expected revenue to the seller.

In this regard, the open outcry of bids is a form of insurance against threats to the integrity of trading: An auction in real time makes active manipulation more difficult. As a side benefit, an open-outcry auction returns some of the potential profit from collusion to the Treasury in the form of higher prices.

There are no guarantees that any system will prevent manipulation. Any new system, however, should be flexible enough to permit experimentation with auction design. Planning for an openoutcry system may provide the requisite flexibility.

A transition to a new auction system has potential problems, as any reform is likely to be designed to entice investors to bid directly. Investors, however, may be hesitant at first to step in, preferring to observe before acting, especially if bidding has a substantial fixed cost. In the interim between the change in format and direct participation by investors, the auction would rely on dealers for their usual role--buying a large share of issuance-even though the reforms would ultimately erode their customer base and lessen their market power. If dealers left the market before final investors appeared, experimentation with alternative auction techniques might prove expensive. However, if access to the auction were kept as open as possible, scores of price-sensitive investors in the Treasury market might step in should auction prices differ markedly from those in secondary trading. Indeed, the threat of entry in itself might be sufficient to lessen the risk of an adverse reaction.


Bikhchandani, Sushil, and Chi-fu Huang. "Auctions with Resale Markets: An Exploratory Model of Treasury Bill Markets," Review of Financial Studies, vol. 2 (1989), pp. 311-39.

Eatwell, John, Murray Milgate, and Peter Newman, eds. The New Palgrave: A Dictionary of Economics. New York: Macmillan Press, 1987.

Friedman, Milton. "Comment on 'Collusion in the Auction Market for Treasury Bills,'" Journal of Political Economy, vol. 72 (October 1964), pp. 513-14.

"How to Sell Government Securities," Wail Street Journal, August 28, 1991.

Gastineau, Gary L., and Robert A Jarrow. "LargeTrader Impact and Market Regulation," Financial Analysts Journal (July/August 1991), pp. 40-51.

Goldstein, Henry. "The Friedman Proposal for Auctioning Treasury Bills," Journal of Political Economy, vol. 70 (August 1962), pp. 386-92.

Graham, Daniel A., and Robert C. Marshall. "Collusive Bidder Behavior at Single-Object Second-price and English Auctions," Journal of Political Economy, vol. 95 (December 1987), pp. 1217-39.

Henriques, Diana B. "Treasury's Troubled Auctions," New York Times, September 15, 1991.

McAfee, R. Preston, and John McMillan. "Auctions and Bidding," Journal of Economic Literature, vol. 25 (June 1987), pp. 699-738.

Mester, Loretta J. "Going, Going, Gone: Setting Prices with Auctions," Federal Reserve Bank of Philadelphia Business Review (March/April 1988), pp. 3-13.

Milgrom, Paul. "Auctions and Bidders: A Primer," Journal of Economic Perspectives, vol. 3 (Summer 1989), pp. 3-22.

____________, and Robert J. Weber. "A Theory of

Auctions and Competitive Bidding," Econometrica, vol. 50 (September 1982), pp. 1089-122.

Robinson, Marc S. "Collusion and the Choice of Auction," The Rand Journal of Economics, vol. 16 (Spring 1985), pp. 141-45.

Smith, James L. "Non-Aggressive Bidding Behavior and the 'Winner's Curse,"' Economic Inquiry, vol. 19 (July 1981), pp. 380-88.

Smith, Vernon L. "Bidding Theory and the Treasury Bill Auction: Does Price Discrimination Increase Bill Prices?" Review of Economics and Statistics, vol. 48 (May 1966), pp. 141-46.

U.S. Department of the Treasury, U.S. Securities and Exchange Commission, and Board of Governors of the Federal Reserve System, Joint Report on the Government Securities Market. Washington, D.C.: Government Printing Office, 1992.

Vickrey, William. "Counterspeculation, Auctions, and Competitive Sealed Tenders," Journal of Finance, vol. 16 (March 1961), pp. 8-37.

Weber, Robert J. "Multiple-Object Auctions," in Englebrecht-Wiggans, Richard, Martin Shubik, and Robert M. Stark, eds. Auctions, Bidding, and Contracting: Uses and Theory. New York: New York University Press, 1983, pp. 165-91.
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Author:Reinhart, Vincent
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Date:Jun 1, 1992
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Statements to the Congress.
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Statement by Peter D. Sternlight, Executive Vice President, Federal Reserve Bank of New York, before the Subcommittee on Domestic Monetary Policy of...
Statement by David W. Mullins, Jr., Vice Chairman, Board of Governors of the Federal Reserve System, before the Subcommittee on Telecommunications...

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