mmm.. I don't get your point. Even in an open auction, bidders in an auction could still collude to submit lower bids and divide their winnings.
Problem is that there are only a couple of large banks who control a large portion of money. If there were more banks, one bank will eventually break the collusion and offer a competitive bids, and other banks will follow.
Yeah, you nailed the core of the problem. Banks don't so much "control" the money (most of such bonds flow to mutual funds and ETFs), it's just hard for average citizens to participate in the process. Large issuers have set up direct shops like http://www.buycaliforniabonds.com/
Problem is that there are only a couple of large banks who control a large portion of money. If there were more banks, one bank will eventually break the collusion and offer a competitive bids, and other banks will follow.