The U.S. Treasury changed the rules in 2009 concerning how it conducts its auctions, and the reason was the stockpiling of U.S. debt by China, according to a report that says that rule change substantially altered the configuration and bidding of the auctions.
Reuters reported Thursday that the rule change to the Uniform Offering Circular, published on June 1, 2009, eliminated the provision that allowed guaranteed bidding. Prior to the rule change, during weekly auctions by the Treasury's Bureau of the Public Debt, Treasuries sold in quantities ranging from $13 billion to $35 billion at a time were being purchased quietly and anonymously by China in sufficient amounts to affect the bidding on lots sold.
While investors can buy bonds directly from the Treasury at auctions, or through any of 20 elite "primary dealers," Wall Street firms authorized to bid on behalf of customers, China was cutting secret "gentlemen's agreements" with primary dealers through guaranteed bidding in which it would buy substantial quantities of Treasuries without being reported as the buyer. The primary dealers would purchase the securities, ostensibly for themselves, and then pass them on to the actual bidder upon issue.
Treasury rules limit how much any one investor can buy at an auction to 35% of the bonds on offer. Through these secret deals, China was buying Treasuries in sufficient quantities to influence the auctions, and at the same time the amount of debt it purchased was being hidden from Treasury officials.
While guaranteed bidding was not illegal, purchasing more than 35% at a time was, and the buyer could be subject to penalties that included being barred from future auctions. According to the report, China was not the only country to execute these "gentlemen's agreements"—Russia did as well, for instance—but Russia only holds 2.8% of outstanding U.S. debt. China entities hold about 26%, at least $1.115 trillion in U.S. government debt. Such an amount could, if released onto the market in large quantities, undermine U.S. markets, said the report, and while officials wanted to stop the practice, they also didn’t want to upset China.
The rule change, according to the report, was issued as a "technical modernization," and there was no mention of China. However, the change had an immediate effect on auctions. Prior to the rule change, indirect bidders, those who bought through primary dealers, amounted to 33% between February and May of 2009 for 7-year U.S. Treasury notes. After the rule change, from June to September, the percentage of indirect bidders rose to 63%.