Buyer Of Last Resort

Yet another back-door bank bailout program dumping billions in the laps of the megabanks, this time it's the Fed buying securities and the banks are getting the best price they can for selling them to the Fed, not the taxpayer getting the best price for buying them from the banks.

Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say.

The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.

However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.

The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage. Barclays, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.

“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”

A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”

So how did this happen? It is design, or incompetence? There are serious arguments here for both: the program wasn't thought through all the way, nobody seemed to realize that all of the Wall Street banks would collude on the Fed for the best prices they could get, of course the Fed was going to get ripped off when they announced ahead of time they were going to be buying ahead of time (causing the price to go up), nobody could have predicted, etc.

Of course, given the billions in cash and trillions in loan guarantees (latest price tag, $26 trillion) you'd probably have to go with "they did it on purpose". It's a near-perfect way to funnel cash to all the banks without Congressional oversight or angry voters noticing.

So, if you're looking for a way to understand how these banks that eight months ago needed hundreds of billions to stay alive and are now making record profits and giving out record bonuses, well there you are. It's miraculous how that works.

Yves Smith at nakedcap has more, it turns out that "paying back the TARP money" was just as much of a scam.

There is not a Wall Street derivatives trader on the planet that would have done the US Government deal on an arms-length basis. Nothing remotely close. Goldman's equity could have done a digital, dis-continuous move towards zero if it couldn't finance its balance sheet overnight. Remember Bear Stearns? Lehman Brothers? These things happened. Goldman, though clearly a stronger institution, was facing a crisis of confidence that pervaded the market. Lenders weren't discriminating back in November 2008. If you didn't have term credit, you certainly weren't getting any new lines or getting any rolls, either. So what is the cost of an option to insure a $1 trillion balance sheet and hundreds of billions in off-balance sheet liabilities teetering on the brink? Let's just say that it is a tad north of $1.1 billion in premium. And the $10 billion TARP figure? It's a joke. Take into account the AIG payments, the FDIC guarantees and the value of the markets knowing that the US Government won't let you go down under any circumstances. $1.1 billion in option premium? How about 20x that, perhaps more. But no, this is not the way it went down....

Of course we were played for fools. We were played for fools from the beginning. We've spent our entire economy saving the banks and pretending we're all fine.

We're not.

[UPDATE 11:49 AM] Think about the Fed's security buying scheme while the NY Times is complaining we haven't given out enough bailout cash to the "good banks" in an article ripe with Randian silliness. You're not being fair to the banks that didn't take TARP money! Why should they be punished? It's noooooot faaaaaaaair!

They're just getting money off of schemes like this instead, you see.