Sunday, March 18, 2007

Pushing On a String - The New York Fed

Sunday edit: After re-pouring through the Fed data, I am adjusting my figures from $76 bln to $55 bln in injections during the past week by using treasury, agency and mortgage backed 'accepted' figures. The $76 bln came from using the agency 'submitted' method that some are using out there, but I'm not comfortable with that and actually think it is wrong. The $55 bln figure, to me, makes a whole lot more sense and is still astoundingly high for one week.

Did you catch the ad in the Broker Dealer Times run by the NY Fed offering low interest short term loans? The ad touted a wide variety of possible purposes....

  • Pay off some old bills!
  • Extra Cash For Unexpected Market Dislocations!
  • Take that Special Vacation!
  • Send Billions directly to Your Trading Desk to Prop Up the Markets!
OK, bad humor aside, the New York Federal Reserve has been busy doing those short term market operations which I first blogged about in early February. This week alone over $55 BILLION flowed to primary dealers. What exactly for we don't exactly know, but the conventional guess is the capital is being deployed to prop up the stock market. The NY Fed data, or perhaps smoking gun is in the pattern of the operations this past week. The largest reqests for injections came after the stock market tanked on Tuesday.

Given the fairly anemic trading volume on what some had mistakenly mis-characterized as an important "reversal day" (I just didn't see it that way) on Wednesday, it would seem as if the preferred method of the managing the market is within the realm of manipulating futures (see: Andy Swan's excellent 101 primer here. It sure isn't going directly into stocks and pushing volume up; after all the NY Fed Window money is supposed to be paid back and institutions playing around with the stuff don't want to be left holding stocks that could conceivably fall further. The tell tale sign that futures were kicking the buy programs in was the sudden, from out of nowhere 1100+ NYSE ticks that invaded the market on Wednesday and to a lesser extent on Thursday. Dave Fry at ETF Digest has also noticed this recently, so I'm not the only one to have found this to be of interest (though he seems to using the Agency 'submitted' figures).

What did that $55 bln buy for this week IF NY Fed Window money is indeed paying to prop up the market? A 1.4% Dow decline for the past five trading sessions. While the primary dealers may get to play around with a lot of cash, it safe to say that shrewd funds were meeting the onslaught of futures related buying with selling which kept a lid on the market.

$55 bln here, $55 bln there and pretty soon you're talking serious money.

Edit: as an after thought to writing this post last night, I might add that I am reserving judgment as to success or failure since it's still early in the process. As I noted in the comments section, The Federal Reserve has evolved from hands off (eg. not doing anything about the 1929 to 1932 stock market collapse) to a Central Bank that has learned to take aggressive action, to the extent that it can, by providing money, or liquidity. My point of concern here is that even for our times $55 bln in one week is a lot of coin -an annual rate of nearly $3 TRILLION. $55 bln a week makes the war in Iraq look like a petty cash expense. While I realize the Fed won't need to inject $55 bln every week into the system, I can't help but to wonder how much moolah it will take if the Fed has to address a market emergency that goes beyond the stock market and into the realm of something scary like the 10x to 15x leveraged OTC derivatives market. Really the question that comes to mind - What is it that Bernanke and Paulson are afraid of to not allow the market to fall naturally? There's also the inflationary issue. While these open market operations involve money that is lent out for periods of 1 day to a few weeks, there is basic 'Money 101' velocity of money where each loaned dollar that is used ends up in someone else's pocket and so on. So even if the original loan is paid back each loaned dollar perhaps is spent on a futures transaction, then re-loaned by the seller of the futures contract, spindled, washed, rinsed, etc. Effectively, billions are being created out of thin air by the NY Fed operations which end up being added into the money supply over time. It's no wonder they eliminated reporting M3. This sudden currency creation, in my simple mind, would seem to be dollar negative and bad from an inflationary standpoint for everyone over time. Oh, and with a 2008 presidential election cycle ahead, there also the question of what happens to Republican chances of capturing the White House again if the stock market goes into a bear market and the economy tanks into a recession. Perhaps that adds an extra dimension of urgency to keep the markets propped up? Now I'm getting too conspiracy theorist.

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