Financial Services: From Servant to Lord of the Economy

Here is an interesting chart that shows the ascendancy of the financial sector in the US.

Commercial banking is largely an administrative function, with a few highly paid decision makers, and many lower paid functionaries and clerks that make a decent if unspectacular wage commensurate with a utility function.

Starting with the Reagan privatization revolution, the finance sector began to grow in importance, moving from a utility serving the capital distribution and storage needs of the real economy taking a relatively small percentage of real output, to a dominant force in the national decision making process, controlling the allocation of capital through its powerful influence and lobbying in Washington, placement of its supporters in political positions of power, and the consolidation of the mainstream media into an oligopoly of four or five major corporations.

Now we have a financial sector dominated by a relatively few number of multinational corporations that are certainly not utilities serving the productive economy. In reality the big multinational banks have become hedge funds speculating in a broad range of markets, often in competition if not contrary to the interests of their customers, relying on other people's money for capital to sustain an outsized leverage and a steady stream of rents and speculative winnings, and to cushion any losses in the event of the occasional market downturns.

And if we do not give the banks their demands, if we do not maintain the status quo, then they threaten that they cannot protect the world from financial ruin and a collapse of the money system, which they themselves control. And this is no mere extortion, no corruption of a single party or person, but the foundation of an enduring modern tyranny.

“Single acts of tyranny may be ascribed to the accidental opinion of a day; but a series of oppressions, begun at a distinguished period and pursued unalterably through every change of ministers, too plainly prove a deliberate, systematic plan of reducing a people to slavery." Thomas Jefferson

Daily Charts: Trendus Intactus, At Least For Now

Right to the support lines.

Next week will be interesting.

Front Running the Fed In the Treasury Market

I had a friend from the old neighborhood who was Comptroller of a major casino in Las Vegas in 1970-80s, where I also was married in 1981. Only lasting win from there, ever.

According to this dour son of Italy the way he could spot a problem, besides the more aggressive methods of observation and detection, would be to examine the returns on a table basis. In the short run they will vary, but in the longer term each game will provide a statistical return that rarely deviates from the forecast, unless someone is cheating. We would walk through the casino, and he would point to a table game and say "at the end of the month, this table will bring in xx percent."

It was he who introduced me to Bill Friedman's book, Casino Management, which is a useful read if you wish to learn more about that end of the speculative business from the house perspective.

Attached is some information from a reader. I cannot assess its validity, not being in the bond trading business. But it does sound like someone has tapped into the Fed's buying plans to monetize the public debt and is front running those buys, essentially 'stealing' money from the public. Its what they call 'a sure thing.'

To try and figure out who might be doing it, I would look for some big player who is showing extraordinary returns on their trading, with consistent profit that is not statistically 'normal,' too consistently good. The problem with cheaters is that they sometimes get greedy and call attention to themselves.

In Las Vegas the bigger cheats were often taken out into the desert for further inquiry and final disposition. On Wall Street they are somewhat more arrogant and persistent, defying resolution with that ultimate defiance, "We'll just find other ways to cheat again."

Time for a trip to the desert?

Here are a reader's observations from the bond market.

From a reader:

I used to work for a BB on a prop desk until the financial crisis took hold and they fired the less senior guys on the desk. I now trade US Treasuries, for a small prop firm in xxxxx, to scalp basis trades in mostly on the run securities. Occasionally, I will also take position in the repo markets for off the runs if I see something "mispriced." Your recent article piqued my interest because we too have noticed "shenanigans," of sort, in the QE program of USTs.

What we noticed, especially in smaller issues like the 7 Year Cash is that before a Fed buy back would be announced the price would pop significantly as buyers would run through all the offers on two major electronic exchanges (BGC Espeed and ICAP BrokerTec). This occurred more than several times as the 7 Year Cash would be overvalued both by its BNOC by 20-30 ticks and its relative value to similar off the runs. This buyer(s) would lift every offer they could, driving the price substantially above its "value" for sometimes a week at a time. After this buying would occur, the Fed would then announce the purchase of that security sometimes a handle above its approximate value. This "luck" did not just occur in the on the run 7 Year sector, it also occurred in the 30 Year Cash, 3 Year Cash, and more than several off the runs. Again, it was especially prevalent in the less liquid treasury products. Often the "appetite" for these securities would begin approximately 2 weeks to 1 week before the official Fed announcement. The buying was well organized and done in such a way as to completely knock it off kilter from its relationship with like cash Treasuries and the CME Ten Year Contract. If you examine the charts of some of the selected buy backs before the official announcement, you will see a similar occurrence.

While I have not broken this down into a paper to prove it (and I see nothing positive coming out of contacting the ESS-EEE-SEE about this issue), I can assure you that it was occurring on a consistent basis across the entire curve.

A certain issuance would be bid up through the market (substantially above value, as derived by several metrics) only to be later gobbled up by the Fed at the unreasonable price. These player(s) had substantial pockets as we, the small guys (but with a decent capital base), would take the other side of what seemed to be an obvious fade. While this did not occur in every single issuance of the QE program, it occurred often enough to be obvious to any learned observer.

While I am not sure if this can be attributed to purposeful Fed policy or someone at the Fed talking to his pals, I am certain it transpired."

Corruption is inevitable when the government is engaged in manipulating the markets with public monies. That portion of the Fed's activities needs to be scrutinized by the GAO on a continual basis. And the activities of the Exchange Stabilization Fund and the Treasury in market intervention should be subject to review by the legislative branch on behalf of the people.

Of course another option is to keep the Fed and the Treasury out of the public markets altogether excepting short term interest rates and specifically identified emergencies.

About Those MBS Purchases in Option Expiry Week

Several readers were kind enough to write in with more material about this correlation as noted in the ContraryInvestor as I had requested.

If the Fed is buying in the TBA portion of the MBS, it is clear that this is a cross-correlation, since both this market and option expiration have similar dates.

Friend Lee Adler over at the Wall Street Examiner has also been tracking this and notes:

"Jesse (whose work I greatly respect or I wouldn't feature it) is wrong on this count in my view, but correct in that the MBS purchases do have an impact on stocks, as does any liquidity pumping. But that impact is far less than the direct impact of open market operations directly with the Primary Dealers, as was the case in the direct Treasury purchases, and the GSE purchases. When the MBS liquidity is withdrawn it will have an impact, but mostly on the Treasury market. The impact on stocks will be secondary, and not pretty, I might add."

He specializes in this area, and his analysis seems to be 'spot on.' But I have to add to this that Jesse is not the Contrary Investor, although I would be glad to be the author of his databases and excellent analysis on the markets, on the whole, week in and week out. And I often rely on information and perspectives from a variety of connoisseurs of financial data, who add immeasurably to the daily fare here.

Here is what JESSE said.

"The data is intriguing to say the least. As you may recall, option expiration in the US stock indices occurs on the third Friday of every month. We have pointed out in the past that this monthly event is often the occasion of some not so subtle racketeering by the funds and prop trading desks of the banks in separating the option players from their positions, and pushing prices around to maximize the pain.

Why would the Fed wish to provide extra liquidity, to the tune of $60 billion or so, for the banks during that week? There must surely be other ways to support the equity markets. Such as buying the SP futures in the thinly traded overnight session. I am not aware of a strong correlation for stock selloffs or extraordinary weakness in option expiry weeks per se.

It might not be a coincidence, but there could be some unrelated event in the mortgage markets that also occurs on the third Friday or Thursday of each month. We are not aware of it, but that does not mean it does not exist. They might also be making the purchases more randomly, but reporting them on some schedule as the Fed does its H.41 reports, for example. Anyone who might know of such a cross correlation would be kind to let us know of it."

And here is my addendum from today.

Addendum 22 Jan: Several readers have written to suggest that the Fed is buying
in the TBA markets, new issues, and that they have fixed settlement dates that
roughly coincide with stock options expiration. That does not remove the
potential material effect of providing liquidity in options expiry week, but it
certainly does nullify the imputation of deliberation. I think the front running
as noted in the blog today in Treasuries is more obvious and plausible."

I was intrigued but skeptical of the meaning of this correlation, confessed my lack of specific knowledge, AND suggested an unrelated cross-correlation, with a request for input from readers. It was just too obvious and did not seem to have a point. Option expiry is a week of back and forth manipulation and not a substantial ramp. It also goes against my basic model that the Fed minds the bond market, and the Treasury, as head of the Working Group on Markets and the Exchange Stabilization Fund, keeps it eye on stocks via the SP futures. And a defendant will have gone to prison on weaker circumstantial evidence than that which supports the case for central bank manipulation in the precious metals markets.

"Jesse" is often on the edge in his inquiry, and asks a lot of questions, reads lots of material, but always seeks the data, and cuts it with a skeptical eye. That is the method of preparation in Le Cafe.

Related, here is some additional information on how MBS Analysts Watch the Fed's Every Trade.

I think the real question does remain, "What happens when the Fed stops buying?" and of course, "Is someone front running the Fed's purchase in the Treasury markets (and perhaps MBS for that matter)?"

Audit the Fed, and we will know much more.