Wall Street thunderclap

The impact of the US government's enormous federal budget deficits hit Wall Street like a thunderclap last week with a default of a little-known trading firm. And by the time the American financial community finally put all the bits and pieces of the disturbing drama together it was too late to prevent calamity for Drysdale Government Securities Inc., an earnings loss for New York's Chase Manhattan Bank of $135 million, and the direct intervention of the Federal Reserve Bank of New York into credit markets.

For these reasons, Congress, the Federal Reserve Board, and the US Securities and Exchange Commission -- not to mention the private securities market itself -- have a special responsibility to take all appropriate steps to ensure that such a potentially far-reaching financial default does not occur again.

In one sense, the incredibly complicated transactions involved in the Drysdale case could only have come out of the Wall Street of the 1980s -- with its reliance on razzle-dazzle computer technology -- and the growth of the virtually unregulated $700 billion US government securities market. Since throwing open its offices last February, Drysdale was able to parlay an initial Drysdale bought and sold federal securities from other dealers. Chase was the firm's primary middleman, since it would sell Treasury issues from some 30 major brokerage firms to Drysdale. But then came the moment of reckoning on Sunday evening, May 16, when a Drysdale official told Chase that it could not meet $160 million in interest payments due on the issues.

A Senate subcommittee is now taking a hard look at the Drysdale case, as are federal investment and banking agencies. Such a probe is long overdue, given the very complexity of the securities market. Because deficits have become part of the fabric of US fiscal policy, there is justification for being wary about regulating government securities as tightly as stock trading. That is because the securities market, by necessity, involves an enormous volume of issues, and requires fast trading. Thus detailed regulation could perhaps hamper broker-dealers in the marketplace. That, however, is what Senate and federal probers must determine.

In the meantime, the Federal Reserve Board should go ahead with its proposal to broaden oversight of securities dealers. The Fed now monitors the 36 largest dealers.

Private trading firms and banks, for their part, must be far more cautious about whom they deal with. Chase, at first, denied that it was responsible for the $160 million in interest. Surely, in transactions as complicated as those involving government securities, the industry can more precisely define areas of financial responsibility.

Finally, the Drysdale case would seem to be a stark reminder that federal deficits are too high.

Reducing the deficits would likely cut down on the number of firms dealing in government securities -- which would facilitate tighter federal supervision.

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