Brokers' role in financing Uncle Sam's big deficits
Washington counts on Wall Street to help it fund its ballooning deficit. This is so because the vast majority of government securities - which represent the lion's share of all borrowing these days - are sold to the public through a network of 39 dealers in government securities. These dealers are Wall Street brokerage houses and banks. With the government deficit such a significant part of the debt markets, they are vital to the government's ability to float its debt; if customers can't be found to buy the securities, these dealers must bid on them. The following is the story of how one major dealer, Merrill Lynch & Co. , accomplishes the task of helping the government sell its debt to investorsm.
It was the moment of truth. The US Treasury was auctioning off $3.5 billion in 30-year bonds to the highest bidder last Thursday.
At 1:26 p.m., Merrill Lynch & Co. had four minutes to gets its bid - which it hoped would be accepted as sufficiently high - to the New York Federal Reserve Bank.
A messenger was sitting in a phone booth several blocks away in Chase Manhattan Plaza, ready to jot down how many millions or even billions of dollars of securities Merrill Lynch would buy for itself and its customers. From the phone booth, he would sprint to the Federal Reserve Bank and submit the bid that Merrill Lynch considered to be the proper value for the securities at that moment in time. All of the forces that were pushing and squeezing the economy were focused on this one effort, since the government-bond markets represent a mirror of what sophisticated investors are thinking about the economy.
At Merrill Lynch, in a room packed with blinking computer screens and banks of telephones, all trading stopped as the Merrill Lynch officials prepared to send their bid to the Treasury. The moment was electric as nearly 250 people suddenly focused on this one event. For many of them, it was the culmination of two weeks of effort as they tried to convince pension funds, banks, and other institutional investors this was the right moment to buy long-term government securities.
The moment was particularly tense because buying such securities is a risky proposition. Noted Daniel Napoli, managing director of Merrill Lynch Government Securities Inc. (MLGS), ''When you bid on long-term government bonds, you keep your resume in your pocket.'' The risk, as Mr. Napoli knew, was greater with long-term bonds, because they are more volatile than short-term bonds. And with inflation an unknown component in the future, buying long-term bonds can be a risky business. For example, if the bonds were to move from 11 percent to 11.20 percent, it could make a major impact on whoever owned them. Such a move - which could occur within as short a span as two weeks - would mean a $2 million loss on $100 million worth of bonds.
But the risk did not stop Merrill Lynch from putting its money on the line. Mr. Napoli, with 11 years of experience; Jack Kugler, the chairman of MLGS, with 25 years of experience; and Michael Boyd, the firm's national sales manager, with 10 years of experience, huddled around a phone bank. With Mr. Boyd reading off the orders rounded up from the broker's institutional customers, Mr. Napoli made the decision. He would make a bid to buy nearly 30 percent of the government's offering that day.
It was a gutsy decision, as it later turned out, because the Merrill Lynch optimism was not universally shared. The government on this particular day received bids for $6.2 billion of securities. It accepts only the highest bids. Sometimes the percentage of bids made but not accepted is greater. At any rate, the auction received mixed reviews. When Merrill Lynch found out at 5 p.m. that night that its bids had been accepted, the Dow Jones tape called the auction ''disappointing.'' But, the next day, the New York Times called it a ''fair auction.''
Before submitting its bid, Merrill Lynch goes through a complex effort to determine what its posture should be on any given day. Starting at 7:30 a.m., key Merrill Lynch traders report for work. They read the papers, and as Michael Kamins, vice-president and senior long-bond trader, says, they ''think through'' what they are going to do that day. They also begin phoning customers and other brokers and dealers to get a feel for the markets.
At 8:25 a.m., the entire trading and sales staff gather in a conference room. Mr. Napoli asks the traders and technicians for their opinions on the markets they follow. In all, about 20 people comment about everything from the latest statements by Paul Volcker to the minute differences in yields between different securities.
Mr. Napoli wraps up the meeting by noting that his intuitive feeling about the day was that ''a lot of people are afraid of making a bet.'' Translation: Selling the long-term government securities was going to be tough.
The effort to sell the bonds had begun about two weeks earlier. A major portion of the company's 200 institutional-account executives began to canvass their accounts to see how much interest there would be in the bonds. Since the long-term bonds would be the first such offering by the government since November of 1982, no one knew how much interest there would be. And in that period, there had been a fair amount of profit taking in other long-term bonds, so no one knew how much would be reinvested.
At 9 a.m. trading in the bond markets begins in earnest. The opening is critical, says Mr. Napoli, since it sets the tone for the day. On this particular day, the bond markets open without any significant change.
At this point at Merrill Lynch, the focus turns to Mr. Kamins, the senior long-term government-bond trader. He has been hired by the big broker, says Mr. Napoli, because he is highly disciplined, not allowing his emotions to influence his trading, and he is very good at executing transactions. On this day, he and his partner, William Plotch, will trade $1.8 billion in securities between them. Surrounded by traders shouting across the open room, they routinely make trades of up to $100 million.
Mr. Kamins, who seems to have a nickname for everyone, keeps Mr. Napoli appraised of the drift of the market. Finally, right before the auction, Mr. Napoli makes his move. He tells Mr. Kamins to ''soften up'' the markets. ''I don't want other dealers to jump in front of me,'' he says. And, with a grin on his face, Mr. Kamins, acting like Han Solo in ''Star Wars'' starts ''blasting'' other dealer's bids (Merrill Lynch fills other bond dealers' bids, hoping to drive down the price). It gets lively. And then, at 1:26 p.m., Merrill Lynch makes its own bid for the bonds.
It will take the company a week to know if it made a good buy. During that time it will be selling the government securities it bought for its own account.
The market traded in a narrow range last week, reflecting uncertainties about the future direction of interest rates. For the week, the Dow Jones industrial average closed at 1,077.91, up 13.16 points.