Monetizing the Debt: My Response to Zero Hedge

August 10th, 2009 12:14 am | by John Jansen |

The Zero Hedge blog composed a very fine piece on the composition of the   Open Market Desk purchases of Treasury coupon securities and the time frame relative to the recent auction that the purchase was made.

I discovered this pattern early in the process on March 27 and then again on April 2 and posted about it each time.

So I agree with ZH regarding the fact that the Federal Reserve has purchased large blocks of recently auctioned issues.

I vigorously disagree with that blog’s implication,intimation or assertion that there is collusion between the primary dealers and the Federal Reserve in which the Federal Reserve backs stops the dealers and guarantees the primary dealers that purchases of auction bonds will not produce a loss.

The conspiracy theory which that blog so desperately wishes to promulgate breaks down with a common sense analysis of the elements which would be necessary for such a scam to be successful.

I believe that there are currently 17 primary dealers. How does the Open Market Desk communicate to the dealers that they can not lose money on a trade? Do they call Jamie Dimon at JPM or Ken Lewis at B of A?

How does the CEO of those companies communicate to the trading desk that it will be participating in a fraudulent enterprise?

And then one must believe that this call from the Federal Reserve happened not once or twice but seventeen times and that seventeen rich and powerful men would acquiesce to participate in such a lawbreaking enterprise. It strains common sense and the credulity of reasonable persons to believe that not one solitary CEO would have reported such activity to Barney Frank or Chuck Schumer or Eric Holder.

The scheme make even less sense at the actual point of execution. In my experience, when primary dealers offer bonds to the Federal Reserve one person is the point person on the transaction. At the larger primary dealers there can be many traders offering bonds to the Federal Reserve. Benchmark Treasury issues are used by mortgage desks, swap desks, agency desks and corporate bond desks to hedge positions.

Suppose the head trader at a large dealer is coordinating the offerings to the Federal Reserve. How does that head trader handle the offerings of his colleagues who desire to sell bonds to the Federal Reserve? Does he tell them that they must sit this one out because all of the primary dealer community is involved in an illegal enterprise?

And what about mid level employees at the Federal Reserve who process the transaction? Are they told to stay home that day because the hierarchy is conducting an illegal operation?

Every securities firm also has a bevy of operations personnel who process tickets and ensure that securities are delivered and money is transferred between counterparties properly. They are not market persons per se but there are some savvy people in that crowd who are cognizant of the machinations in the market. Successful completion of the scam would require that everyone one of those pros should be either hoodwinked or complicit.

What is my point here? My point is that a legion of people at every level at numerous organizations would need to be complicit in order for the Zero Hedge scenario to play out successfully.

In my nearly three decades on Wall Street I met too many very honest people who would be repulsed by the suggestion and such a plan would be dead on arrival.

It is a great story for a blog to tell but it is virtually impossible that anyone in the real world would posit such a scheme and it is even less likely that it could succeed.

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  1. 33 Responses to “Monetizing the Debt: My Response to Zero Hedge”

  2. By reddweb on Aug 10, 2009 | Reply

    the $400B that ben promised he would monetize, was communicated to the PDs(& everybody else). Wasn’t there a implicit nod or signal by ben choosing to do so by specifically buying back from PDs? He gave the taste of the drug – and its addictive.

    Are you saying Ben/FED is NOT trying to interfere in the “free market” nature of these sales. The past couple of years shows otherwise.

  3. By CB on Aug 10, 2009 | Reply

    Agreed with you John. I think you and Tyler (with TD using a much more provocative/incriminating tone) are describing largely the same thing.

    bottom line I see this is: a key function of primary dealer (PD) is to make sure Treasury can successfully auction its securities, with each PD obliged to bid its market share.

    meanwhile the Fed just wants to keep rates low via QE. And as you rightly pointed out, the Fed has an incentive to lower benchmark on-the-run securities as that is what most people tend to track.

  4. By longtime lurker on Aug 10, 2009 | Reply

    “How does the CEO of those companies communicate to the trading desk that it will be participating in a fraudulent enterprise?”

    Three Words


  5. By franko on Aug 10, 2009 | Reply

    mr jansen – my hat is off to you – very thorough and i concur

    keep up your good work


  6. By vanorton on Aug 10, 2009 | Reply

    just finished “smartest guys in the room”, its amazing how many people knew what was going on, the traders didnt just execute orders from above they embraced it and took it to another level (at least thats what the book says)

    regarding if the fed breaks the law, i dont really know, all i know is that they have changed the rules several times this last two years and if people can not see that they must be pretty naive.

    i had hoped for a better response from you on the zero hedge post, this “to many people involved” is something that even i could have written.

    i guess only time will tell if “something is rotten in the states”

  7. By Byzantine Ruins on Aug 10, 2009 | Reply

    I vigorously disagree with that blog’s implication,intimation or assertion that there is collusion between the primary dealers and the Federal Reserve in which the Federal Reserve backs stops the dealers and guarantees the primary dealers that purchases of auction bonds will not produce a loss.

    “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”
    –Upton Sinclair

    Reporter: And the senator, while insisting he was not intoxicated, could not explain his nudity.
    –WKRP in Cincinatti

  8. By S on Aug 10, 2009 | Reply


    When you look at the composition of the remianing PDs it seems that the Fed would not being dealing with 17. The list includes foreign banks. They just added RBC and Jefferies I believe. Indeed there are really only 3 dealers that would likely be party to such a deal: MS, GS, C and BAC.

    Would you be willing to draw a nexus between the saving of the TBTF banks and the Gov’t debt funing window?

    This list follows:
    BNP Paribas Securities Corp.
    Bank 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.
    J. P. Morgan Securities Inc.
    Jefferies & Company Inc.
    Mizuho Securities USA Inc.
    Morgan Stanley & Co. Incorporated
    Nomura Securities International Inc.
    RBC Capital Markets
    RBS Securities Inc.
    UBS Securities LLC.

  9. By M on Aug 10, 2009 | Reply


    I think you let yourself to far be pushed into a defensive position by the screaming style of mr Tyler Durden, rather than approaching the facts with a cool and understanding that you normally possess.

    You don`t have to prove that the FED does not agree with the PDs, because you have no way of proving it. All you need to do is use your experience to blow the facts as presented by Zerohedge to pieces. You have the sources and the knowledge to do that. Not that you have to, if I were you I would just ignore the whole thing and continue with what you are doing. Unfortunately you got sucked in by the conspiracy crowd, and no matter how you argue, they will not let you because …. well, that is how they work.

    Anyways, a few facts from TDs story that are easy to rebut:
    Supposed fact 1: The data proves that the FED inspired the PDs to make the 7 year auction a succes.
    Real fact 1: the PDs took way less of the 7 year auction compared to the failed auctions the two days before. Clearly other parties had an interest and therefore the data does not prove that fact, but it actually blows that fact away.

    Supposed fact 2: the PDs were happy to buy at the auction because the FED guaranteed somehow that they would take it off of them.
    Real fact 2: The FED did guarantee it would intervene in the market, as it had publicly announced to do so. However, it did not guarantee the price. The PDs would have made a substantial loss if there was nothing more but the agreement with the FED to take it off them. Therefore no way it worked that way. (I won`t even touch the argument that FED somehow would make them whole because 1. there is no proof for that 2. It would take actions beyond the FED power to do that). It just would not make sense.

    Furthermore there must be a whole slush of historic data to prove (or not) how the FED actually works and has worked over the years to buy treasuries. I will leave that aside as I do not have the exact details and data.

    All the best with your excellent blog, that I continue to read daily in my reader and hardly ever gets boring, and most of all with your family of course. I hope you can continue to enjoy the excellent work you are doing.

  10. By cars on Aug 10, 2009 | Reply

    It’s very hard to debunk a conspiracy theory. Why? Because conspiracy theories are examples of pure dogma.

    The following is worthwhile reading as we are all facing conspiracist thinking in our daily lives.

    I see that a couple of comments in this thread already exhibit the following trait of conspiracy theorists, that of confirmation bias. Here’s how it’s described:

    “Conspiracists disregard arguments that refute their thesis, usually by relying on the Genetic Fallacy–the source is in on the conspiracy, and therefore cannot be trusted. There is no truth, only opinion, and only the right opinion is acceptable. The Grand Cabal “got to them”, or their interests are somehow served by the conspiracy. Their motives are therefore impure, and nothing they say can be considered worthy to discredit the conspiracy theory. Since conspiracists consider all arguments to be arguments from authority, the choice is not between correct methodologies, but correct authority.”

    This is just one trait, there are others described in the article that help explain how conspiracists think and their defense mechanisms.

    Now lets get back to the bond market action. That’s the reason this is the first blog I read every morning.

  11. By maynardGkeynes on Aug 10, 2009 | Reply

    There are two well-known types of collusion in antitrust law. Jansen has effectively demolished the case for the first type, explicit collusion, in which there is actual communication, memos, explicit coordination. However, what is more likely here is “tacit” collusion, in which various signals are laid out there by the cartel leader (by the FED in this case) as to the cartel leaders likely course of action (providing no-loss protection to dealers). Then, it is in the interest of dealers, recognizing mutual self-interest, to go along with the FED managed cartel, without any need for explicit (and possibly illegal) agreements between themselves or the FED, simply by following the suggested course of conduct (purchasing at auction at inflated prices). I suspect that this is what is actually behind Zero Hedge’s not implausible scenario, and Jansen has not addressed this, nor shown that it is unlikely. I await his response.

  12. By blah on Aug 10, 2009 | Reply

    My point is that a legion of people at every level at numerous organizations would need to be complicit in order for the Zero Hedge scenario to play out successfully.
    o yea, and this never happens right? wink-wink-wink

  13. By Dr.Dan on Aug 10, 2009 | Reply

    maynardGkeynes is making a great point.

    What if this is all schemed to be the normal mundane work at PD firms ?

  14. By Carlos on Aug 10, 2009 | Reply

    John you have no credibility when you say:
    “It strains common sense and the credulity of reasonable persons to believe that not one solitary CEO would have reported such activity to Barney Frank or Chuck Schumer or Eric Holder.”

    Do I need to point out to you the threats that emanated from the FED and the Treasury when BoA tried to pull out of the Merrill deal (allegedly)? There is plenty of circumstantial evidence of collusion among the FED, The Treasury and Wall Street.

  15. By David Merkel on Aug 10, 2009 | Reply

    John, Caroline Baum and I agree with you on the low likelihood of conspiracies working. She’s written some very trenchant prose on the matter, though not recently.

  16. By Bman on Aug 10, 2009 | Reply

    Yes, when a system is on the brink of collapse, there is collusion – domestic and international – was, and is.

  17. By Carlos on Aug 10, 2009 | Reply

    Funny though that “saving” a system at the “brink of collapse” ends up enriching the very same people that actively created the collapse to begin with. Collusion was and is being used not to save the system but to save the players – a distinction that few in this “business” don’t seem to see or care to see. This is the same blindness that dominates ALL banana republics out there and it never ends well.

  18. By Chicken on Aug 10, 2009 | Reply

    I know a gentleman who graduated from the school of wall street, and he assures me that there is a great deal of collusion between those organizations. In fact, until recently, the SEC would telephone ahead to announce their intents.

    Yes, there’s a flurry of collusion and Ken Lewis (BAC) has long been a thorn in the side of wall street.

  19. By Bryan on Aug 10, 2009 | Reply

    I know that the New York Fed’s relationship with the PDs goes closer than arms length. Fifteen years when a reporter for Institutional Investor’s newsletter division wrote that there was advance signalling of the Fed bank’s intent to dealers, that reporter was fired after intervention by the Fed reps. I was that reporter.

  20. By John Jansen on Aug 10, 2009 | Reply


    Ms Baum is great and trenchant is the right word to describe her prose.

    As an aside she coauthored a piece ( in the National Review I think) which was and is the definitive piece on the cattle trading exploits of our Secretary of State

  21. By Bman on Aug 10, 2009 | Reply

    Carlos – do have a 410K/IRA? Money in a bank account? How were you feeling on Sep. 18th?

  22. By Tyler K on Aug 10, 2009 | Reply

    You mean, John, you question Hillary’s actual knowledge and acumen with pork belly futures? Scandalous….

  23. By John Jansen on Aug 10, 2009 | Reply

    If you can find the Caroline Baum story it is fascinating. I believe that the very first trade by a woman who was losing her trading innocence was a short sale.

  24. By jck on Aug 10, 2009 | Reply

    here it is:

  25. By Tyler K on Aug 10, 2009 | Reply

    Yeah, I remember reading it … if memory services correctly, I revisited it (or large portions of it) when the Martha scandal hit the newsstands

  26. By Allen C on Aug 10, 2009 | Reply

    Come on people.

    The Fed doesn’t need to engage in direct collusion. One needs to review oligopoly practices. They communicate to each other via their actions.

    The Fed stated their UST buying budget. The PDs see the Fed’s behavior. The PDs know the Fed is going to support the market.

    What ZH and others seem to be disturbed by is BB stating he’s not monetizing when it is obvious that he is.

    Creating excess money to this extent even with the intention of reversing is still monetizing. If the Fed can actually/eventually sell the paper and retire the fiat money, it is reverse monetizing. I suspect there are no cases of this.

  27. By Carlos on Aug 10, 2009 | Reply

    Mr Bman yes I do have all of them 401K/bank accounts and brokerage accounts. All I can tell you is that once the system is RIGGED and corrupted it may benefit you here and there but EVENTUALLY it leads to the ruin of most. I can tell by your cavalier attitude toward the law that you have never had the “privilege” of living in a banana republic but don’t despair you soon will and then look at your 401K if you will.

  28. By Bman on Aug 10, 2009 | Reply

    Carlos – you are completely missing the point. What do you propose they should have done as the financial system was being electronically drained to the point of near collapse? I’m all ears.

  29. By GreenAB on Aug 10, 2009 | Reply

    so maybe there was some kind of backroom communication or maybe it wasn´t.
    none of us can know for sure.

    situation is:

    a)for the foreseeable future treasury, the fed and PDS are all in one boat.
    working together would be the best for the system.

    b)but in face of a giant supply and a “recovering” economy PDs natural appetite for treasuries should decrease significantly.

    ->with no more room to cut – how does the fed incentify PDs to continue supporting auctions?

  30. By TechGuy on Aug 10, 2009 | Reply

    1. Gov’t Tax revenues are down by 30% and Federal Deficits have nearly quadrupled.

    2. US Trade Deficits have fallen because of less US Consumer imports. This leaves significantly less FCB cash to buy US Treasuries.

    3. Many gov’ts are spending money at home instead of buying US Treasuries to fund their own economic stimulus packages.

    4. Bernanke has been practically caught Red-handed, forcing Bank of America to buy Merrill. For the time being Paulson has stepped in to take the blame.

    5. Since January, the Value of the dollar has been falling. This likely means demand for US currency and US debt is falling.

    Its seems improbable that the Fed isn’t using every measure available to ensure that Treasury yields do not rise. I can’t see how the US gov’t can attract $5 Billion in new loans every single day, at such ridiculously low interest rates. Considering the amount of new debt and the fact that the global economy is in a recession US treasury yields should be at least double.

    I don’t see why a Primary Dealer (PD) carry trade is improbable. The PDs can borrow from the Fed at next to nothing and used the borrowed money to buy longer term US treasury debt and pocket the diffrence in yield. the PD’s did this when Greenspan lowered the overnight rate to 1%, and announced that the Fed would keep raises low for a “considerable period”. There is little risk that the Fed will jack up rates because too many banks and financials are technically insolvant.

  31. By RichL on Aug 10, 2009 | Reply

    I get all sorts of Republican outrage emails which entirely distort reality. I’m seeing much the same mindset in the comments here.

    The Wall Street Journal has become the same way in that the news section is valid but it’s editorial section merely reflects the views of the owner rather than any semblance of reality.

    I’d suggest keeping up the market comments and reading more good books and listening to music. People with attitude cannot be reasoned with.

  32. By Joe V on Aug 11, 2009 | Reply

    RickL I completely agree. The New York Times is a fair alternative to the fringe editorials with the WSJ.

  33. By steak on Aug 11, 2009 | Reply

    Primary dealers need the Fed to remain profitable. The Fed needs primary dealers because a functioning Treasury market is essential to Fed operations.

    We are far far removed from the era where the main expression of corruption was nefarious deals in smoke filled rooms and suitcases of cash changing hands. Nowadays the most egrigous fleecings of the public occur with all sides claiming their actions are saving the world. Kudos to Treasury the Fed and Primary Dealers to creating a perfectly legal but morally corrupt framework whereby its in all their interests to have the most recent issues snapped up as they have been.

    A final point on this, wouldn’t it be in the taxpayer’s interest (regardless of what makes sense from a liquidity standpoint for the dealers) for the Fed to buy older Treasuries with higher yields?

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