Another day, another story on rigged financial markets, with US Treasuries the latest as investor lawsuits focused on trading in the world’s largest bond market recite the familiar story of asset price manipulation that boosts bank profits at the expense of investors.

A number of institutional investors are crying foul over how Treasury debt is sold, marking the gravest allegation of US government bond trading chicanery since Salomon Brothers was fined for cornering the market in 1992.

Global banks that dominate trading in derivatives, bonds and currencies have been hit hard by the legal and reputational damage of manipulating various benchmarks in recent years. Many of these banks, along with smaller dealers, are US primary dealers, approved by the Federal Reserve Bank of New York to underwrite the sale of government debt, ensuring there is always enough demand for new securities.

Questions over the fairness of US Treasury auctions strike at the heart of the global financial system, given that half of this $13tn market is held by foreign investors, including central banks and sovereign wealth funds. As a benchmark for global asset prices, any manipulation of Treasuries ripples far and wide. The US Treasury, taxpayers, and investors of all stripes may well have been affected.

That is the contention from more than 20 private lawsuits filed in recent weeks claiming that dealers colluded to increase the price at which they sold Treasuries to investors, while seeking a lower price for the same bonds during auctions.

Both the Department of Justice and New York’s banking regulator are investigating any efforts at manipulation of the Treasury market by some banks. The New York Federal Bank, US Treasury and Treasury Market Practices Group all declined to comment.

“This would be such an egregious violation,” says a trading head at an investment manager. “It would be so hard to do. But if it’s proven true I would be very frustrated.”

The court cases differ in some details of their claims but are broadly similar, with the expectation that they will be consolidated into one overall case.

Chart: Treasury analysis - Auction yield v secondary market yield midpoint quote

The complaint from Cleveland Bakers and Teamsters Pension Fund, for example, analyses price data from auctions and compares it with the price of similar securities that are already trading. It claims that the price of the debt at auction should be the same as “basically the equivalent thing” already in the market.

On the day of a Treasury debt auction, banks submit bids through an electronic system run by the New York Fed, with the winning bid being the lowest single price at which all securities can be sold. Investors can also submit bids, circumventing the banks and going direct to the auction — a trend that has been growing in recent years.

Ahead of an auction, dealers buy and sell securities in the “when-issued” market, often assembling large promises to sell to investors once the auction finishes. Such activity informs primary dealers’ bidding before the actual auction deadline of 1pm and affects the number of securities they need to purchase to deliver to clients. Investors argue that the price in the “when issued” market was deliberately inflated, resulting in them paying over the odds.

The Treasury also holds reopened auctions twice every quarter for certain maturities, including the benchmark 10-year note and 30-year bonds

The analysis conducted by the plaintiffs claims that primary dealers suppressed the price of reissued Treasuries in 69 per cent of auctions. “It can only be explained by the consistent tipping of the playing field in defendants’ favour,” says the CBTP complaint.

All primary dealers contacted by the Financial Times declined to comment on the allegations. But Treasury traders at three primary dealers agreed to speak on the condition of anonymity, disputing the analysis.

The data in the court case uses the midpoint as the price of a security, halfway between the price to buy and the price to sell.

One trader says it is “very deceiving to use mid-market price” because the price a bank is prepared to sell at (the bid) will be lower than the price they are prepared to buy at (the offer). Using a mid-price between the two inflates the price the bank is prepared to sell at, says the trader.

Chart: Treasury analysis - Primary recovery  post-crisis

There are other factors too. Banks are not paid fees for facilitating auctions, unlike corporate bond issues, meaning their “fee” is factored into their price. There is also a risk that the market will move against the bank between the time the auction closes and when the auction result is announced — usually around one minute, the trader says.

“It’s a liquidity premium,” says Galen Simmons, who formerly traded Treasuries for Jefferies, a primary dealer. “You are taking the risk that at the moment there is an influx of securities, the price could be different than what it was before.”

The lawsuits also allude to communications among traders ahead of debt sales with fingers pointing to the Bloomberg Chat software notorious in other manipulation scandals for being traders’ meeting place.

“They will prove collusion because there will be finger prints all over chat,” says a former Treasury trader.

Additional reporting by Gina Chon

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