The Fed Prepares For A Surge In New Primary Dealer Applications

These days Primary Dealers are the new black. Being a Primary Dealer is defacto insurance that one is Too Big To Fail, even if that is hardly the case. Having unfettered access to the discount window, to the Primary Dealer Credit Facility, to various repo facilities, and all other mechanisms that Liberty 33 has come up with to make goosing the market a formality, is a guaranteed way to achieve record profits and a wet dream for many a bank CEOs. In many ways this is comparable to the rush by everything with a heartbeat to purchase a home using New Century loans back in 2005, with the Fed of course in the role of the now bankrupt subprime lender.

Today, the Fed issued new guidelines for capital requirements for the line of banks that are willing and able to join the ranks of their infinitely bigger market monopolist brethren such as Goldman Sachs, on the receiving end of the taxpayer bailout trough. And because the Fed is certainly taking this risk "seriously" it has made becoming a PD ever so much more difficult: now instead having $50 million in net capital, PD wannabes will need to show $150 million of capital to the Fed kleptocrats. Prudence defined.

The full list of incremental requirements:

  • a more structured presentation of the business standards expected of a primary dealer;
  • a more formal application process for prospective primary dealers;
  • an increase in the minimum net capital requirement from $50 million to $150 million;
  • a seasoning requirement of one year of relevant operations before a prospective dealer may submit an application; and
  • a clear notice of actions the New York Fed may take against a noncompliant primary dealer.

Surely, the $100 million incremental capital requirement will be sure to prevent any and all future financial crises. Here is the justification for this joke of a risk-management move, direct from the Fed:

This change reflects the proportional increases in gross U.S. Treasury debt issuance and the size of the U.S. Treasury market, as well as the evolution of open market operations since the policy was last updated in 1992.  The New York Fed believes a minimum net capital requirement is a prudent element of its counterparty credit risk management.   In light of the significant business expectations of primary dealers and the meaningful securities positions that primary dealers may take as a consequence, the New York Fed retains flexibility to require higher capital where circumstances warrant (e.g., if a dealer has a riskier business model or does not have significant support from a parent or affiliate).

PDs, which are nothing but Fed proxies due to their requirement to bid for govvie auctions, have been instrumental in loading up with billions in new government debt in 2009. By the looks of things, their life will be even more interesting in 2010, now that the Fed is not directly monetizing debt: with $2 trillion of new Treasuries in the pipeline, the Fed will need any and every bank to be a Primary Dealer. We expect the list of 18 current primary dealers to balloon skyward in the coming months courtesy of this new directive.

And lest we be called biased, here is the politically correct definition of Primary Dealers, aka Massive bank failures in waiting, and soon to be TBTFs, direct from the Chairman (who will hopefully become so on a pro tempore basis in 3 weeks).

Primary dealers serve, first and foremost, as trading counterparties of the Federal Reserve Bank of New York.  This role includes the obligations: (i) to participate consistently as a counterparty to the New York Fed in its execution of open market operations as directed by the Federal Open Market Committee (FOMC), and (ii) to provide the New York Fed’s trading desk with market information and analysis helpful in the formulation and implementation of monetary policy.  Primary dealers are also required to participate meaningfully in all auctions of U.S. government debt, including an underwriting commitment, and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.

We are confident that the New York Fed's trading desk is sufficiently qualified to manipulated markets on its own. Yet with what will soon seem like an avalanche of Fed transparency demands, it just may become obvious with what liberties the fine young yield cannibals behind Bloomberg terminals at 33 Liberty have been transacting. Thus, the logical move is to spread the wealth: and if that means allowing soon to be FDIC bank failures to become Primary Dealers, well, so be it.


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