Is QE2 A Stealthy $90 Billion Gifting Scheme To The Primary Dealers?

Tyler Durden's picture

We have previously discussed how due to the inability to know at what price (par or market) the Fed is buying back bonds from the Primary Dealers, there is a distinct possibility that due to the par-market difference, especially with many CUSIPs trading near record prices over par, the Fed may be implicitly letting PDs pocket the market-to-notional difference. The total, as shown below, could amount to over $40 billion. Furthermore, by avoiding the tight spread of on the run bonds, the Fed is effectively allowing PDs to pocket a huge bid/offer spread, which assuming a total size of ~$800 billion (low estimate) of all USTs bought over the (initial) life of QE2, aka QE2.5 and higher pre-extensions, amounts to $50 billion over the next 8 months. Since the money paid out is certainly not that of Brian Sack, but of the US taxpayers, to which the FRBNY has repeatedly demonstrated it has no fiduciary obligation, one can see why it is prudent to ask just how much leakage is occurring as the Fed is monetizing. Surely the Chairman can see why at a time when Wall Street is about to pocket $150 billion in bonuses, America can be a little concerned with the possibility that QE2 in addition to being a blatant debt monetization scheme, is also a direct taxpayer funding mechanism to the Primary Dealers. We hope Congressman Paul will demand an answer to the these questions at first opportunity.

John Lohman explains in detail.

When the Fed is finished playing 68 with the primary dealers (where the Fed blows the PDs and the PDs “owe ‘em one”), perhaps they can answer two quick questions.

According to the FRBNY’s website, prices for the securities purchased in today’s POMO will be released at 2:00 PM on December 10th.  In the meantime, an approximation of what was actually spent can be found by taking an average (using one minute intervals) of prices from 10:42 until 11:30.  As shown in the table below, almost a half billion dollars more was pumped into the market than was revealed in the par amount.  So, query number one: does the “$600 billion” refer to par or market value?  Since it’s not clear on their website, one is left to assume that they consider $40 billion  to be chump change.

Query number two:  why was the on-the-run 5 year (1 ¼ Oct 15) only 2% of the total operation?  It trades with a 1/64th bid/ask versus every other security purchased which is quoted with a 2/32nd bid/ask (per Bloomberg).  The result, when applied to the total operation of $800 billion, amounts to a transfer of roughly $50 billion dollars in commissions directly to the primary dealers (final table).  So, perhaps question two should be rephrased:  Why not just drop the pretense and absorb every Treasury auction directly for the next 8 months?