Zero Hedge: Fed's QE2 Giving Away $5 Billion a Month to Primary Dealers

From Zero Hedge:

The topic of how much money the Fed is gifting to the Primary Dealers via POMO commissions has to become front and center right now. While we appreciate fluff "profile" pieces in the NYT addressing the issue tangentially, and assuring us via worthless promises by people whose one purpose in life is to pad the pockets of their future employers in preparation for that inevitable day when said parasites move from faux public service to doing the hard core biddings of a vampire squid, the truth is that this is daylight robbery and it is happening in front of everyone's eyes. As a reminder, per the NYT: "As offers to sell Treasuries flash on a bank of trading screens, a computer algorithm works out which ones to accept." We contest that this algorithm is costing tapxayer billions each and every month and demand that Bill Dudley, Brian Sack, Josh Frost or one of the 20 year old henchmen traders immediately disclose just what the operatinal terms of the algorithm are, and what the slippage is. The reason: we have reason to believe that the Fed's slippage rate is up to 5%. On a monthly POMO notional total of over $100 billion, this means that the Fed hands out well over $5 billion each and every month to the Primary Dealers. This is an abortion of the Fed's fiduciary responsibility and should be criminal if proven to be in fact correct.

John Lohman explains:

If the Fed’s POMO desk had one single Bloomberg, they could compare their weighted average accepted prices with each cusip’s 10:59 price (one minute before the POMO closing) as a means of determining the efficiency of their “computer algorithm”. A sampling of about 30 issues from the latest report confirms an average of 5% slippage. This means the most recent month of POMOs gifted $5 billion in commissions directly to the PDs. If they won’t drop the charade and go directly to auction (where the $5 billion would at least be gifted indirectly to the taxpayer via lower auction yields), they should consider signing up for TradeWeb and buy anonymously like the rest of us. And send their “computer algorithm” back to Moody’s.

And who are the primary dealers? There are 18 of them, and 11 of them are foreign banks.

The Federal Reserve is simply doing the job, though - to do everything to ensure the welfare of its member banks.

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Federal Reserve Asks Primary Dealers How Much QE2 They Would Like

The Federal Reserve's claim of "independence" is sorely tested, I think, with the latest revelation by Bloomberg that the NY Fed sent a questionnaire to the primary dealers (including both domestic and foreign banks) asking how much QE2 they would like in the next 6 months.

From Bloomberg:

The Federal Reserve asked bond dealers and investors for projections of central bank asset purchases over the next six months, along with the likely effect on yields, as it seeks to gauge the possible impact of new efforts to spur growth.

...The New York Fed survey, obtained by Bloomberg News, asks about expectations for the initial size of any new program of debt purchases and the time over which it would be completed. It also asks firms how often they anticipate the Fed will re- evaluate the program, and to estimate its ultimate size.

...In the survey, dealers assigned percent chances to the Fed easing through communications changes in the FOMC statement, additional purchases, or some other means. They were also asked how communications might change, and how the Fed might carry out new purchases.

Another question asked dealers to estimate changes in nominal and real 10-year Treasury yields “if the purchases were announced and completed over a six-month period.” The amounts dealers chose from were zero, $250 billion, $500 billion and $1 trillion.

According to Zero Hedge, 4 dealers answered $1 trillion.

On an annual basis, that translates into $2 trillion, exactly the amount predicted by Goldman Sachs, as I reported on this blog.

So, the Federal Reserve will decide on probably the most important monetary policy that will affect not just the US but entire world with a handful of its member banks. It makes sense, doesn't it? It makes it clear whom the Federal Reserve serves.

Here's the list of the primary dealers (info from www.newyorkfed.org - notice it's not .gov):

BNP Paribas Securities Corp. (French)
Banc of America Securities LLC (USA)
Barclays Capital Inc. (UK)
Cantor Fitzgerald & Co. (USA)
Citigroup Global Markets Inc. (USA)
Credit Suisse Securities (USA) LLC (Parent is Swiss)
Daiwa Capital Markets America Inc. (Parent is Japanese)
Deutsche Bank Securities Inc. (Germany)
Goldman, Sachs & Co. (USA)
HSBC Securities (USA) Inc. (Parent is UK)
Jefferies & Company, Inc. (USA)
J.P. Morgan Securities LLC (USA)
Mizuho Securities USA Inc. (Japanese)
Morgan Stanley & Co. Incorporated (USA)
Nomura Securities International, Inc. (Japanese)
RBC Capital Markets Corporation (Canada)
RBS Securities Inc. (UK)
UBS Securities LLC. (Switzerland)

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Treasury Primary Dealers Under Pressure?

This week, the US Treasury Department is set to auction $157 billion worth of Treasury securities. There seems to be an increasing angst in the market: who is going to buy all these debts and how?

Primary Dealers are the banks, both US and foreign, who are required to bid at Treasury auctions. The current Primary Dealers, as released by the New York Fed, are as follows:

• BNP Paribas Securities Corp.
• Banc of America Securities LLC
• Barclays Capital Inc.
• Cantor Fitzgerald & Co.
• Citigroup Global Markets Inc.
• Credit Suisse Securities (USA) LLC
• Daiwa Securities America Inc.
• Deutsche Bank Securities Inc.
• Dresdner Kleinwort Securities LLC
• Goldman, Sachs & Co.
• HSBC Securities (USA) Inc.
• J. P. Morgan Securities Inc.
• Mizuho Securities USA Inc.
• Morgan Stanley & Co. Incorporated
• RBS Securities Inc.
• UBS Securities LLC.

In addition to weekly auctions of various Treasury bills (4 to 52-week), longer-term Treasury notes and bonds are sold every 2 weeks. 3-year note, 10-year note and 30-year bond are usually sold in the same week, so are 2-year note, 5-year note and 7-year note. This week, it is 3-year, 10-year, 30-year combo.

Just to give you an idea of how much debt is being issued, take 3-year note as an example:

In 2009, 5 auctions have been completed; there are 7 more to go. Each auction sells between $32 to 35 billion worth of 3-year note. So, by the end of this year Treasury will have sold between $384 and 420 billion. In 2008 there were two 3-year note auctions that sold $53 billion total.

How about 5-year note?

Treasury auctions 5-year note every month. This year, the size of each auction is well over $30 billion. In 2008, it was between $15 and 28 billion. In 2007 it was between $14 and 16 billion. In two years, the size of each auction doubled.

Or 7-year note, which is offered for the first time this year:

So far this year 4 auctions have been completed, with each auction selling $26 billion. There are at least 5 more auctions scheduled.

Or 10-year note:

Treasury is set to auction 10-year note every month this year. 10-year note was auctioned every month also in 2008, but prior to 2008 it was auctioned only 8 times a year. This year's auction size is between $16 and 22 billion. In 2008 it was between $10 and 20 billion. In 2006 it was between $9 and 15 billion. In 2000, there were only 4 auctions, in which $46 billion total was auctioned.

In May alone, Treasury auctioned $172 billion worth of Treasury note and bond. $172 billion times 12 months equals $2 trillion. And this is not counting Treasury bills (4-week, 13-week, 26-week sold every week - about $30 billion each, 52-week once a month, about $25 billion).

So who has the money to buy all these debts? Or who wants to buy them? Foreigners are dropping out of longer-dated Treasuries. Will the primary dealers be able to continue buying them and selling to someone else, without becoming insolvent themselves? (Some say these banks are already insolvent.) Or will we start to see the primary dealers refuse to buy Treasuries? The Federal Reserve's $300 billion pledge to purchase Treasuries over the 6-month period (starting March) won't be anywhere near sufficient, I'm afraid.

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