Guest Post: How the NY Fed Gifted An Extra $15.7 Million To Wall Street Yesterday

Tyler Durden's picture

From Bob English

How the NY Fed Gifted an Extra $15.7 Million to Wall Street [Yesterday]

As part of the Federal Reserve's ongoing QE2 program, nearly each day,
the NY Fed purchases US Treasury securities from a select group of primary dealers
in what is called a permanent open market operation (POMO).
Ordinarily, the auction begins at 10:16 am and ends at 11:00 am Eastern.
While the exact mechanics of the operations are not public, the NY
Times published an article about the team that manages them here, divulging a few details, which we subsequently analyzed here.

minutes before [yesterday]'s auction was scheduled to complete (while most,
if not all, offers from the primarily dealers were presumably in), the
European Union’s energy commissioner warned of
‘further catastrophic events’ at Japan’s stricken nuclear power plant.
Shortly thereafter, the NY Fed cancelled the POMO--to our knowledge, an
unprecedented act. According to Tyler Durden of Zero Hedge, Reuters reported the cancellation at 10:57 or 10:58 am.
the minutes that followed, equities and other risk markets tumbled,
while the very 5 and 7 Year Treasury Notes the Fed would end up buying
surged in price over 50 bps (0.50%). At 11:24 am, after prices had
settled a bit (though were still materially higher than before), the NY
Fed restarted the POMO, which finally closed at 12:04 pm. It would end
up purchasing a total of $6.580 billion in Treasury securities (reported
at par), with a heavy concentration in the 5 Year tenor at $5.089
billion (of which $3.209 billion had been issued by the Treasury in the
last two months).
Using 5 Year Note futures as a
proxy, we have calculated the difference in average price between what
the NY Fed would have paid had it not cancelled the first auction versus
what it actually ended up paying: $15.7 million ($12.1 million for the
5's and $3.6 million for the 7's). This amount was simply pocketed by
the primary dealers and is now a liability of the Federal Reserve, and
putatively the US taxpayer.
The below chart illustrates the sequence of events with the 5 Year Note futures (click for large image).
is now incumbent upon the NY Fed to issue an explanation detailing its
decision making process [yesterday]. Just why did it cancel the auction when
prices were starting to move in its favor (against the dealers)? If Mr.
Frost, who supervises the purchase operations at the NY Fed, was telling
the truth when he told the NY Times, "We are looking to get the best
price we can for the taxpayer", then why did the opposite occur [yesterday]?
Zero Hedge has chronicled how the Fed serially purchases the richest
spline in its operations, to the benefit of the primary dealers (see here, here, here, here, here, and here). We also reiterate and incorporate herein our previously expressed concerns
regarding the NY Fed's black box computer program that virtually runs
the Fed's daily auctions. Just who programmed it, and how does it
assess "fair value"?
As is usually the case with the Federal Reserve, there are more questions than answers.
Update: Reuters has backtracked with the following:

EU Energy Commissioner did not say a catastrophe was going to happen, he just expressed his fear - spokesman