Stuck in the middle with debt

European bond auctions are crying out for change

Germany and Britain should find it child's play to sell their relatively safe bonds when markets are volatile and economic uncertainty is high. Not so.

Bids have fallen short of the amount Germany planned to sell at several auctions. And while Britain hasn't suffered this particular embarrassment since 2009, the average of these so-called bid-to-cover ratios so far this year is a fifth less than a decade ago.

The problem is not demand from final investors. UK and German bond yields are hardly shooting up. The bottleneck involves primary dealers - banks which have the privilege of buying bonds directly from government debt management offices in return for acting as a market maker in secondary trading.

For the market makers, a once fairly lucrative privilege is becoming something of a burden. New regulations have made it more expensive for them to hold onto debt. Wary of being lumbered with unwanted inventories, they may be less willing to scoop up everything on offer at primary auctions. Even without regulation, huge gyrations in the safest, most liquid government bond markets over the past year inspire caution.

Reform is needed. One possibility might be to issue smaller amounts of debt at more frequent auctions. This would reduce the risk of primary dealers being left with too much unsold inventory.

Another idea is to start reducing the role of these middlemen. Some countries have already started down this road. US retail investors can buy bonds directly from the Treasury online, albeit on a slightly different basis than the bigger players. And Italian bonds tailored for smaller investors typically sell like hotcakes.

Granted, each country has its peculiarities. The US Treasury already issues a lot and often, in the global reserve currency. Italians have a historical bias towards fixed income. Besides, government debt offices still need to keep market makers sweet for the time being.

Eventually, central banks may take the role of "market makers of last resort" during volatile bond selloffs, as a senior International Monetary Fund official suggested in June. All the more reason to reconsider the need for middlemen to sell government debt.