Primary Dealer Banks Want Their Treasury Sales Franchise Protected

Direct bidding means bypassing the 'percentage' that the dealer banks take. The banks hate it. It not only dents their vigorish, but it makes it more competitive in pricing the auction, which cuts into profits as well.

Today's Ten Year Auction was a bit weak, with Direct Bidders down as a percentage.

I have heard that more firms that are not PIMCO class in size are seeking to become Direct Bidders because of the price gaming that is going on with the Primary Dealer Banks serving as intermediaries.

By way of information, 'indirect bidders' are often considered a proxy for foreign purchasers from the official sector.

The Treasury auctioned $25 billion 10-year notes on 10 February 2010.

The high yield was 3.692%, which was 3+ basis points lower than the 1pm "When Issued" yield.

The bid to cover ratio, a measure of auction demand, was 2.67 bids submitted for every one accepted by the Treasury. This compared to a 3.0 BTC in the last 10yr auction

Dealers took 53.3% vs. 53.2% last time

Direct Bidders took 12.9% of the issuance. Previously 17.2%

Indirect Bidders were awarded 51.2% of the auction, vs 52.9% last time.

For some interesting background reading on some relatively recent changes in the bidding process and the definition of indirect bidding made by Treasury, read Smoke, mirrors and Treasury sales by Izabella Kaminska.

ForexPros
Angry US bankers seek curbs on direct bidders
By Emily Flitter
2010-02-09 17:18:22 GMT

NEW YORK, Feb 9 (Reuters) - Two minutes after the U.S. Treasury Department closed a multi-billion dollar debt auction last month, one banker was angrily punching in numbers of a hotline he'd found on the Treasury's Web site.

Primary dealers, including his bank, had just been blindsided by a large order from a group of so-called direct bidding firms whose presence is growing.

Financial firms acting as direct bidders are sapping profits for the big banks that have long seen themselves as the main intermediaries in the sale of government debt.

Primary dealers say direct bidders need tighter control given risks they could make auctions more volatile and expensive for the U.S. government at a time when it is borrowing record amounts to fund its programs.

The U.S. Treasury, however, says it supports broader access to auctions on grounds it raises competition and cuts costs.

The banker, who did not want to be named for this story, said he called Treasury to find out more about the firms in this group: He wanted to know how many had bid that day and what the standards were for allowing them to participate.

Primary dealers say a large direct bid in an auction makes it harder for them to properly price their own bids for Treasuries ahead of time. If primary dealers guess direct bidders will turn out in force for an auction, they could choose to pull back from a portion of their bids. They say Treasury auctions could begin to show less stable results. This would likely raise borrowing costs for the U.S. government.

"Because of the direct bid, determining the accurate price in the auction becomes more problematic. If it becomes more problematic fewer people will be willing to put capital at risk for size in the auctions," said Ian Lyngen, senior government bond strategist at CRT Capital Group in Stamford Connecticut.

Some primary dealers are asking the Treasury for limits on the percentage of direct bids that can be placed in a given auction. This, they say, would cut down on the level of uncertainty that has taken hold ahead of auctions recently.

WHY SO ANGRY?

On the day the angry banker made his phone call, direct bidders took down more than 17 percent of a $21 billion auction of 10-year notes, a far higher portion than normal. Direct bidders took 8.9 percent of the December 10-year note auction, and in November their bids made up 4.5 percent of the total. Similarly, January's three-year note auction saw direct bidders take 23 percent, while they accounted for only 2.9 percent of the December three-year auction.

"More and more buy-side accounts are so starved for yield that they're trying to go around the dealers," said Chris Whalen, co-founder of Institutional Risk Analytics. "Why should PIMCO go through a primary dealer?"

But despite the constant communication between these big banks and the government, they can't hope for much change.

"We support broad access to the auction process and we think that this is a good thing from the standpoint that it breeds competition and helps us achieve our goal of financing the government at the lowest cost over time," said Matthew Rutherford, the deputy assistant Treasury secretary for federal finance, speaking to reporters at last week's quarterly refunding announcement.

The direct bidder issue is one on which the primary dealers have little leverage in persuading Treasury. Despite the record size of recent Treasury issuance, investors are still snapping up U.S. government debt, creating healthy demand that has led to smoothly executed auctions.

This means the Treasury Department has little incentive to do more than listen to primary dealers' complaints about direct bidders.

"I think they like having a larger number of people with access to their auctions," said Rick Klingman, managing director of Treasury trading at BNP Paribas in New York. He explained that in the event of a disaster such as the 9/11 attacks, which knocked out New York firms' systems, a broader network of direct bidders could step in and make sure an auction went smoothly.

There are few details on the makeup of the group of direct bidders available to the public. Treasury does not disclose the number of firms authorized to participate as direct bidders, and there's little information available to indicate the potential size of firms that have direct bidding terminals.

Primary dealers aren't afraid to speculate on who the mystery bidders might be. Some posit they are smaller securities firms that are preparing to apply to become primary dealers, while others say those firms aren't well-capitalized enough to make much of a dent in a single auction.

Current List of Primary Dealers with the New York Fed

BNP Paribas Securities Corp.
Banc of America Securities LLC
Barclays Capital Inc.
Cantor Fitzgerald & Co.
Citigroup Global Markets Inc.
Credit Suisse Securities (USA) LLC
Daiwa Securities America Inc.
Deutsche Bank Securities Inc.
Goldman, Sachs & Co.
HSBC Securities (USA) Inc.
Jefferies & Company, Inc.
J. P. Morgan Securities Inc.
Mizuho Securities USA Inc.
Morgan Stanley & Co. Incorporated
Nomura Securities International, Inc.
RBC Capital Markets Corporation
RBS Securities Inc.
UBS Securities LLC.

NAV of Certain Precious Metal Funds and ETFs

Rorschach's Journal: Last Night, a Comedian Died in New York...

This was no accident, no act of God. No unforeseen mishap, no simple miscalculation.

Somebody pushed AIG out a window, to collect the insurance. Then they saw the opportunity to extort billions from the Congress and a Presidency in transition by bringing the financial system to the point of collapse. And they took it. And somebody knows who and how they did it.

Somebody knows.

NY Times
Goldman Helped Push A.I.G. to Precipice
By GRETCHEN MORGENSON and LOUISE STORY
February 6, 2010

...Well before the federal government bailed out A.I.G. in September 2008, Goldman’s demands for billions of dollars from the insurer helped put it in a precarious financial position by bleeding much-needed cash. That ultimately provoked the government to step in.

With taxpayer assistance to A.I.G. currently totaling $180 billion, regulatory and Congressional scrutiny of Goldman’s role in the insurer’s downfall is increasing. The Securities and Exchange Commission is examining the payment demands that a number of firms — most prominently Goldman — made during 2007 and 2008 as the mortgage market imploded.

The S.E.C. wants to know whether any of the demands improperly distressed the mortgage market, according to people briefed on the matter who requested anonymity because the inquiry was intended to be confidential.

In just the year before the A.I.G. bailout, Goldman collected more than $7 billion from A.I.G. And Goldman received billions more after the rescue. Though other banks also benefited, Goldman received more taxpayer money, $12.9 billion, than any other firm.

In addition, according to two people with knowledge of the positions, a portion of the $11 billion in taxpayer money that went to Société Générale, a French bank that traded with A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.

Goldman stood to gain from the housing market’s implosion because in late 2006, the firm had begun to make huge trades that would pay off if the mortgage market soured. The further mortgage securities’ prices fell, the greater were Goldman’s profits...

In its dispute with A.I.G., Goldman invariably argued that the securities in dispute were worth less than A.I.G. estimated — and in many cases, less than the prices at which other dealers valued the securities.

The pricing dispute, and Goldman’s bets that the housing market would decline, has left some questioning whether Goldman had other reasons for lowballing the value of the securities that A.I.G. had insured, said Bill Brown, a law professor at Duke University who is a former employee of both Goldman and A.I.G.

The dispute between the two companies, he said, “was the tip of the iceberg of this whole crisis.”

“It’s not just who was right and who was wrong,” Mr. Brown said. “I also want to know their motivations. There could have been an incentive for Goldman to say, ‘A.I.G., you owe me more money.’ ”

Goldman is proud of its reputation for aggressively protecting itself and its shareholders from losses as it did in the dispute with A.I.G.

In March 2009, David A. Viniar, Goldman’s chief financial officer, discussed his firm’s dispute with A.I.G. in a conference call with reporters. “We believed that the value of these positions was lower than they believed,” he said.

Asked by a reporter whether his bank’s persistent payment demands had contributed to A.I.G.’s woes, Mr. Viniar said that Goldman had done nothing wrong and that the firm was merely seeking to enforce its insurance policy with A.I.G. “I don’t think there is any guilt whatsoever,” he concluded.

Lucas van Praag, a Goldman spokesman, reiterated that position. “We requested the collateral we were entitled to under the terms of our agreements,” he said in a written statement, “and the idea that A.I.G. collapsed because of our marks is ridiculous.”

Still, documents show there were unusual aspects to the deals with Goldman. The bank resisted, for example, letting third parties value the securities as its contracts with A.I.G. required. And Goldman based some payment demands on lower-rated bonds that A.I.G.’s insurance did not even cover.

A November 2008 analysis by BlackRock, a leading asset management firm, noted that Goldman’s valuations of the securities that A.I.G. insured were “consistently lower than third-party prices.”

To be sure, many now agree that A.I.G. was reckless during the mortgage mania. The firm, once the world’s largest insurer, had written far more insurance than it could have possibly paid if a national mortgage debacle occurred — as, in fact, it did.

Perhaps the most intriguing aspect of the relationship between Goldman and A.I.G. was that without the insurer to provide credit insurance, the investment bank could not have generated some of its enormous profits betting against the mortgage market. And when that market went south, A.I.G. became its biggest casualty — and Goldman became one of the biggest beneficiaries.

Longstanding Ties

For decades, A.I.G. and Goldman had a deep and mutually beneficial relationship, and at one point in the 1990s, they even considered merging. At around the same time, in 1998, A.I.G. entered a lucrative new business: insuring the least risky portions of corporate loans or other assets that were bundled into securities.

...Mr. Egol structured a group of deals — known as Abacus — so that Goldman could benefit from a housing collapse. Many of them were actually packages of A.I.G. insurance written against mortgage bonds, indicating that Mr. Egol and Goldman believed that A.I.G. would have to make large payments if the housing market ran aground. About $5.5 billion of Mr. Egol’s deals still sat on A.I.G.’s books when the insurer was bailed out.

“Al probably did not know it, but he was working with the bears of Goldman,” a former Goldman salesman, who requested anonymity so he would not jeopardize his business relationships, said of Mr. Frost. “He was signing A.I.G. up to insure trades made by people with really very negative views” of the housing market.

Mr. Sundaram’s trades represented another large part of Goldman’s business with A.I.G. According to five former Goldman employees, Mr. Sundaram used financing from other banks like Société Générale and Calyon to purchase less risky mortgage securities from competitors like Merrill Lynch and then insure the assets with A.I.G. — helping fatten the mortgage pipeline that would prove so harmful to Wall Street, investors and taxpayers. In October 2008, just after A.I.G. collapsed, Goldman made Mr. Sundaram a partner.

Through Société Générale, Goldman was also able to buy more insurance on mortgage securities from A.I.G., according to a former A.I.G. executive with direct knowledge of the deals. A spokesman for Société Générale declined to comment.

It is unclear how much Goldman bought through the French bank, but A.I.G. documents show that Goldman was involved in pricing half of Société Générale’s $18.6 billion in trades with A.I.G. and that the insurer’s executives believed that Goldman pressed Société Générale to also demand payments.

Goldman’s Tough Terms

In addition to insuring Mr. Sundaram’s and Mr. Egol’s trades with A.I.G., Goldman also negotiated aggressively with A.I.G. — often requiring the insurer to make payments when the value of mortgage bonds fell by just 4 percent. Most other banks dealing with A.I.G. did not receive payments until losses exceeded 8 percent, the insurer’s records show.

Several former Goldman partners said it was not surprising that Goldman sought such tough terms, given the firm’s longstanding focus on risk management.

By July 2007, when Goldman demanded its first payment from A.I.G. — $1.8 billion — the investment bank had already taken trading positions that would pay out if the mortgage market weakened, according to seven former Goldman employees.

Still, Goldman’s initial call surprised A.I.G. officials, according to three A.I.G. employees with direct knowledge of the situation. The insurer put up $450 million on Aug. 10, 2007, to appease Goldman, but A.I.G. remained resistant in the following months and, according to internal messages, was convinced that Goldman was also pushing other trading partners to ask A.I.G. for payments.

On Nov. 1, 2007, for example, an e-mail message from Mr. Cassano, the head of A.I.G. Financial Products, to Elias Habayeb, an A.I.G. accounting executive, said that a payment demand from Société Générale had been “spurred by GS calling them.”

Mr. Habayeb, who testified before Congress last month that the payment demands were a major contributor to A.I.G.’s downfall, declined to be interviewed and referred questions to A.I.G. The insurer also declined to comment for this article. Mr. van Praag, the Goldman spokesman, said Goldman did not push other firms to demand payments from AIG....

Read the entire story here.