The Department of the Treasury
To: Staff (All)
Reuters has painstakingly followed up on a rule change made in 2009 to how bidders in US debt auctions are classified, though there’s less to the story than Reuters implies.
But first some quick background. FT Alphaville’s Izabella Kaminska reported on this rule change in June 2009, and we recommend that you go back and read the whole thing. But if
you’re not a massive nerd Treasury auction minutiae isn’t your thing, here’s a very brief (and somewhat oversimplified) refresher.
The US Treasury department classifies bids to buy Treasuries at auction in one of two ways — direct and indirect. Direct bids are made by two kinds of interested buyers: investors who choose to bypass the primary dealer network, and by dealers themselves who are buying for their own balance sheets. Indirect bids are made by dealers on behalf of their clients. Changes in the amount of indirect bids for Treasuries are considered a proxy for interest in Treasuries from foreign central banks, who use the network of primary dealers to make their buys.
Prior to the rule change in 2009, there was a way for dealers to buy Treasuries on behalf of investors while still having the bid classified as direct (from the dealer) — thereby allowing the investors to evade the transparency requirements that applied to other bidders. The practice was called a “guaranteed” bid, whereby the investor had agreed to take the bonds from the dealer at a price immediately after the auction.
But as FT Alphaville wrote in June 2009:
The Treasury, with the change in procedure, is providing market transparency which was only available before to those who submitted those customer bids as direct bids. That dealer would know that a substantially larger amount of bonds had been “put away” or sold to end users than was actually being reported.
Under the old system the award to the dealers was larger as the customer bid was included in the dealers bid. In that way the total to dealers was misleading as it made it look as though dealers were buying more bonds than they truly were. This gave an unfair advantage to the dealer who submitted the investor bid.
In short, foreign or indirect bidders will no longer be allowed to place bids clandestinely via direct dealer bids. This in the first instance may boost the number of publicised indirect bids, making demand from foreign central banks appear stronger in the short run than it was before.
The practice of guaranteed bids was allowed previously because of an archaic rule that applied to an earlier way in which these auctions were conducted; we won’t get into the specifics again (it’s in the earlier post) but suffice to say for now that the auction method changed in 1998 and the rule also should have been changed with it.
The wonder is that it took the Treasury department so long to amend said rule, and this is where Thursday’s article by Reuters comes into play. The reporters have done quite a bit of legwork and seem to have figured it out (emphasis ours):
When the Treasury Department revamped its rules for participating in government bond auctions two years ago, officials said they were simply modernizing outdated procedures.
The real reason for the change, a Reuters investigation has found, was more serious: The Treasury had concluded that China was buying much more in U.S. government debt than was being disclosed, potentially in violation of auction rules, and it wanted to bring those purchases into the open – all without ruffling feathers in Beijing.
A couple of things to unpack here.
First, on the reason that the Treasury finally made the change — in addition to interviews with dealers who had brought the issue of Chinese purchases to the Treasury department, here’s the evidence:
One government official warned others in a written message “not to include the words ‘China’ or ‘SAFE’ in email subjects.” The Securities Industry and Financial Markets Association, the main trade organization for Treasury dealers, asked the Treasury in early June 2009 to explain the change. The Treasury’s response: It had found that a detail in its auction rules no longer applied to the way auctions were conducted, and so the rule was changed, according to an internal Treasury memo.
Separately, the Treasury’s acting assistant secretary for financial markets, Karthik Ramanathan, told subordinates in an email: “Please let’s stick to the ‘Modernization of Auction Rules’ when outside requests come in on the (rule) change. Please DO NOT emphasize the guaranteed bid portion, or mention any specific investors.“
Good find, and it makes sense both that Chinese buying would have finally been the precipitating factor that led to the change and also that the Treasury would have wanted to avoid discussing it, for diplomatic reasons. Nor are we dismissive of the technical explanation offered — again, it’s just odd that the department waited so long.
Second, on the issue of which rules were potentially violated, Reuters is referring to the Treasury’s policy of not allowing any single buyer to buy more than 35 per cent of the single auction’s batch. There’s no evidence that China ever did this (then again, it would have been harder to uncover then), though Reuters does find:
The Treasury department, too, came to believe that China was breaching the 35 percent limit, according to internal documents viewed by Reuters, though the documents do not indicate whether the Treasury was able to verify definitively that this occurred.
(By the way, before we move on, we’ll just note that this rule has been flexible in the recent past, though to a buyer that Treasury found more to its liking.)
Reuters also does a good job of following up with the dealers on what happened after the rule change, when investors who wanted to continue keeping their identities opaque tried to arrange secretly with the dealers to keep doing business as before, though it’s hard to say if any dealer agreed to it (and obviously they’re not going to admit to having done so).
All in all, a good piece of reporting and explanatory journalism, but we do wish the article hadn’t been dramatised to exaggerate its importance. This is something we see now and again in the media when it comes to China, and it’s unnecessary. This passage, for instance, is mostly nonsense:
China’s vast Treasury holdings are both a lifeline and a vulnerability for Washington – if the Chinese sold their Treasuries all at once, it could undermine U.S. markets and the economy by driving interest rates higher very quickly. Scenarios of this sort have been discussed in Washington defense-policy circles for at least a year now. Not knowing the full extent of these holdings would make it even more difficult to assess China’s political leverage over U.S. finances.
Look, China can’t sell all of its Treasuries “at once”, nor is it clear why it would wish to. The faintest signal that the country planned to unload even a sizable chunk would risk a big decline in the value of the rest of its dollar-denominated holdings.
China is ever-gingerly taking steps towards internationalising its currency and will have to manage an expected growth slowdown in the coming years. In the meantime, while it makes sense for the country to be diversifying slowly and steadily into assets denominated in Euro and other currencies, its options remain limited. And the idea that it would chance a big, self-wounding diplomatic row with the US over this just isn’t a serious possibility — whether or not it is “discussed in Washington defense-policy circles”. This applies whether we know “the full extent” of China’s holdings, or just most of the extent of its holdings (which we do, in fact, know).
That brings us to our final point. The results of this change in the rules, two years on, appear to be mixed. The change did lead instantly to a more accurate breakdown of direct vs indirect bidding, which is no bad thing. But as for identifying which buyers are doing the buying, well, it still takes time. As we’ve explained previously:
The US treasury department publishes monthly estimates of these numbers based on interviews with US financial institutions. But once a year, around now, the department also publishes the results of a time-consuming survey of the major foreign investors in Treasuries, including central banks…
The treasury then revises the numbers from the prior June — as we said, the survey is time-consuming and hence the big lag.
The revisions are considered more accurate than the monthly estimates, and are especially important in the case of China, which tends to buy a lot of its securities holdings through dealers in London. Countries in the Carribean and Luxembourg also act as dealers and normally have big downward revisions in the annual survey as well.
Recently, as FT Alphaville’s Tracy Alloway noted, some strategists have used clever data manipulation to arrive at estimates for how much China is buying month-to-month — but they’re still just estimates. So if the Treasury department wants to make less obscure the identities of foreign Treasury buyers in timely fashion, there is work left to be done.
HT John McDermott for spotting the Reuters article.
China is finally buying fewer US Treasuries, StanChart says – FT Alphaville
UpTIC in China’s treasury holdings? Sort of – FT Alphaville