Meltdown 101: Treasury auctions, without the gavel

[December 16, 2008]  WASHINGTON (AP) -- Auctions of Treasury bills have played an important role in the ongoing financial crisis, as institutions flock to the relatively safe investment during a time of market uncertainty.

How exactly do these auctions work? Do they -- or did they ever -- involve a guy with a gavel shouting, "Sold, to the central banker in the blue suit"?

Here are some questions and answers about Treasury auctions conducted to finance the nation's $10.5 trillion national debt.

Q: The sale of Treasury securities -- investments in government debt -- doesn't happen in a room with an auctioneer in the front, does it?

A: No, it's all done by computers these days. Although up until about three decades ago, the process did involve bond dealers dropping their bids in a box at the Federal Reserve's New York regional branch. Those bids were then reviewed by hand in a process that could take several hours.

Q: So, no more boxes and paper bids these days?

A: No. The big primary bond dealers do business through a computer system run by the Treasury Department's Bureau of Public Debt. Instead of hours, the whole auction process now takes place in minutes.

Q: How does that happen?

A: The bond firms usually wait until just minutes before bidding is closed and then submit their bid, using as a guide the prices on a separate market where bonds are traded throughout the day. After bidding ends, say 1 p.m. EST, the Bureau of Public debt can review all the bids and make announcements on what the bills, notes and bonds will be sold for -- usually just two minutes after the auction closes.

Q: How can they do it that quickly?

A: The power of computers, helped along by a strong push by government officials. Back in 2003, the Treasury Department reached its goal of announcing the auction results in most cases within two minutes. The feeling was that the fast turnaround between when bids are submitted and results are known would help improve the transparency and functioning of the Treasury security markets.

Q: So how does a bid get made?

A: The Treasury announces before the day of the auction the amount it wants to raise in that particular debt sale. For example, the government sold $27 billion in three-month Treasury securities on Monday and another $27 billion in six-month securities. It had told bond traders last Thursday that these would be the amounts.

The bond traders often submit multiple bids, based on how much of the new debt offering they need to buy to meet their clients' needs.

Q: Does the debt get sold at different interest rates?

A: No. All the debt at a single auction is sold at one interest rate -- the lowest rate the government has to pay to meet its debt requirement. For the $27 billion in six-month Treasury bills that were sold on Monday, that rate -- called a "high rate" -- was 0.270 percent, the lowest on record.

Q: A "high rate"? What does that mean?

A: That's the rate at which all securities at a particular auction can be sold, based on the various bids that come in. Some bond dealers may have offered to take a lower interest rate for their bonds, but they get to benefit from the higher rate too.

Q: How many primary dealers are there?

A: That number has been changing, given that Wall Street is going through its biggest upheavals since the Great Depression. The number of primary dealers now stands at 17 since Oct. 1 of this year when Bear Sterns and Co. was removed from the list, reflecting its acquisition by JP Morgan Chase & Co.

Other primary dealers include big names such as Banc of America Securities LLC, Barclays Capital Inc., Citigroup Global Markets Inc. Deutsche Bank Securities Inc. and Goldman Sachs & Co.

Q: What happens after the Treasury auctions off the securities?

A: The institutions turn around and begin selling many of the notes, bills and bonds in the secondary market to individual investors.

That market has been very active in recent months as investors in the United States and around the world have flocked to the safety of Treasury securities. Many investors have been spooked by billions of dollars in losses in stocks and other investments -- like securities backed by mortgages that have gone bad.

Q: How has the increased demand been reflected at the auctions?

A: It has driven interest rates on the government's debt down to record low levels. That is a good thing for taxpayers, who could end up financing more than $1 trillion in extra debt this year, between the government's $700 billion financial rescue program and additional stimulus efforts being contemplated by President-elect Barack Obama.

[Associated Press]

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