Photo: Campus Reporter
File this under “Paging Ron Paul’s Subpoena Committee” (applications being taken now).ZeroHedge comments and links to a NYT article offering a rare glimpse of the wizards operating the Federal Reserve Bank of New York’s massive and ongoing large scale asset purchases, and it’s every bit as instructive as Toto’s little curtain-pulling stunt: (emphasis and brackets ours)
But inside the Operations Room, on the ninth floor of the New York Fed’s fortresslike headquarters, there is no time for second-guessing. Here the second round of what is known as quantitative easing — QE2, as it is called on Wall Street — is being put into practice almost daily by the central bank’s powerful New York arm.
Each morning Mr. Frost and his team face a formidable task: they must try to buy Treasuries at the best possible price from the savviest bond traders in the business.
The smallest miscalculation, a few one-hundredths of a percentage point here or there, could unsettle the markets and cost taxpayers dearly. It could also embolden critics at home and abroad who say QE2 represents a dangerous expansion of the Fed’s role in the markets.
“We are looking to get the best price we can for the taxpayer,” said Mr. Frost, a buttoned-down 34-year-old in a striped suit and rimless glasses.
Louis V. Crandall, the chief economist at the research firm Wrightson ICAP, said Wall Street bond traders were driving hard bargains. The Fed has tipped its hand by laying out which Treasuries it intends to buy and when, giving the bond houses an edge.
“A buyer of $100 billion a month is always going to be paying top prices,” Mr. Crandall said of the Fed. “You can’t be a known buyer of $100 billion a month and get a good price.”
Nevertheless, Mr. Frost and his team have been praised on Wall Street for creating a simple, transparent program. Neither the Fed nor Wall Street want any surprises. The central bank is even disclosing the prices at which it buys [though, as ZeroHedge points out, not the prevailing bid/offers].
Mr. Frost and his team work out of a small, beige corner office with arched windows that used to be a library. There, at about 10:15 most workday mornings, one of them pushes a button on a computer. Across Wall Street, three musical notes — an F, an E and a D — sound on trading terminals, alerting traders that the Fed is in the market.
On one recent Tuesday morning, what Mr. Frost and his five young colleagues did over a 45-minute period might have unsettled even a seasoned Wall Street hand: they bought $7.8 billion of Treasuries.
Mr. Frost and his team drew up the daily schedule for what the Fed calls its Large-Scale Asset Purchase program. And that program is, by any measure, large scale: through next June, these traders will buy roughly $75 billion of Treasuries a month — on top of another $30 billion it is reinvesting in Treasuries from its mortgage-related holdings.
But depending on daily market conditions, Mr. Frost can decide not to buy certain bonds if they are already in short supply.
As offers to sell Treasuries flash on a bank of trading screens, a computer algorithm works out which ones to accept. The computer compares the offers from Wall Street against market prices and the Fed’s own calculation of what constitutes a “fair value” price. [Got that? There are three prices: Wall Street offers, market prices and some Fed black box algo’s interpretation of “fair value” which, according to the sentence structure, is distinct from market prices!]
The real work is done by three traders who are referred to during the operation as trader one, trader two and trader three. They sit at a long table against the wall, tapping at seven screens.
On one recent morning, trader one was [current NYU student] Tiffany Wilding, 26. While she reviewed [this is the “real work”?] the stream of offers and then the prices finally accepted by the algorithm, trader two, Blake Gwinn, 29, double-checked her decisions [these “decisions” were only the review of the algo’s decisions] and trader three, James White, 29, made a duplicate of everything in case the computers crashed [basically, a stenographer].
All the while, Mr. Frost stood behind his colleagues, ready to intervene — and even cancel the Fed’s purchases — at any sign of trouble.
With humans serving as mere spot checkers for the Fed’s trading robot, one wonders what trouble might be detected outside of the odd coffee spill on the keyboard. Certainly, we would not expect any alarm bells to sound regarding skewed bid/ask spreads or the like–what with the Fed’s own fair value engine cranking out non-market-based prices. Not even the mark-to-myth hallucinations of BlackRock (remember Maiden Lane?) are needed for this endeavour.
For the record, we would like to know just who programmed the Fed’s Treasury purchasing algo, their historical affiliations, along with details of [any] competitive bidding procedure used to source the contract for the programming work. If the job were sole sourced or sourced to an industry insider affiliated with any primary dealer, we would like to know on what basis the FRBNY’s office of General Counsel approved this.
For that matter, we’d like to know why BlackRock management of Maiden Lane I was sole sourced without a “clear reason”, as is implied by the below email to FRBNY [then] Senior VP, Sarah Dahlgren, which we excerpt from the below document presented to Congress, with emphasis and brackets ours:
To Sarah Dahlgren/NY/[email protected]
Re: Sole Source
Spent some time with him [Tom Baxter, Jr., FRBNY GC] tonight. (He doesn’t understand ML3, and I can’t begin explain it either — so don’t needle him! — and I am going to have [Paul] Whynott [FRBNY VP] spend some time with him tomorrow, BTW, you might touch base with Joyce [Hansen, FRBNY Deputy GC] about her reaction to Sunday’s briefing; I think she had some concerns about how ML3 was presented to Geithner, which she expressed to Paul.) He knew that Stephanie [Heller?, FRBNY Asst. GC] was handling the Blackrock contract — he didn’t express any concerns — and I explained that, in contrast to MLI, we had a clear reason to sole source it this time (that they had already modelled, etc.). So, although I have no worries, yes, probably worth reviewing it with him [Geithner] before taking it to Tom.”
For that matter, we’d still like to know why the Fed’s web page says, “Outright [MBS] purchases were conducted via competitive bidding to ensure that trades were executed at market rates” when a paper written in part by the manager of the FRBNY’s purchase operations, Brian Sack, says, “Because the MBS purchases were arranged with primary dealer counterparties directly, there was no auction mechanism to provide a measure of market supply”, as we pointed out in detail here.
Lots of unanswered questions…
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