Why Isn’t Maiden Lane ‘Prop’?
May 27, 2012 3 Comments
We note Citigroup won the latest ‘Maiden Lane III’ auction. For those unaware, this is an auction of $1.6 billion face value of securities (stuff that used to be in CDOs, as it happens) that the Federal Reserve (our central bank), like, bought a while ago. Note also, every time this happens it noticeably affects/moves the markets. It’s almost as if the Fed is acting like a ‘whale’ when they dump these things…
Let’s back up. A while ago, during the The Financial Crisis™, the Federal Reserve bought a ton of bonds (the ‘Maiden Lane’ portfolios). Let’s leave aside why. This means they didn’t have them previously, but then they handed over ‘their own money’™, and got them. They’ve been holding onto them. Our central bank. For years. Billions of dollars’ worth of bonds and whatever the hell.
Recently, from time to time, they’ve been auctioning some of them off. Part of their stated rationale is, usually, ‘improving market conditions’. This means that they bought them for one price, then, possibly not being idiots or wanting to lose money, waited for the price to go up before selling them, so they could make money or at least not lose money on them. (Yes the Fed may have other motives i.e. ‘not wanting to spook the markets’ etc. but I don’t know why we’d assume they don’t prefer not to lose money as well.)
Now Citi and other banks have been buying them up in these auctions. This is a process in which the Fed asks some banks, ‘how much will you give us for this stuff?’. Each bank came up with a bid. ’72′. Or whatever. The Fed said to the highest bidder: ‘yours!’ For example, in this latest auction, Citi didn’t have the securities. Then when they won the auction, they handed over ‘their own money’, and then got the securities. And now they have the securities!
Now before you protest, yes it’s possible, even likely, they turned around and traded some of those securities to interested clients right away, clients who had said ‘we’ll bid through you guys’. What is unlikely to have happened is that their entire bid for the full $1.6 billion came entirely from clients to which they sold right away. Some of it, they presumably just took down, and now own, and are trying to offload over time.
So, to review, and sorry to be pedantic, but:
- The Fed asked ‘who wants these bonds?’
- Citigroup said ‘we do! we’ll pay X!’
- The Fed sold them to Citigroup
- Citigroup got them (or whatever portion wasn’t crossed immediately anyway).
We also presume that Citigroup, not being idiots and preferring to make rather than lose money, calibrated their bid X to what they thought they’d be able to realistically sell these bonds for some time later. In other words, they wanted to (drumroll) buy low and sell high, not vice versa. Now they surely would be pleased if whatever Maiden Lane bonds they still have, go up in price. Why? Because that would make them money, silly!
My question: Is a bank just bidding on and buying a bloc of billions of dollars worth of impaired securities, hoping to sell them later for a higher price, a ‘prop trade’? If not why not? If so why is the Fed, in soliciting bids on ex-CDO portfolios from a small number of dealers, knowingly enabling ‘prop trades’ by banks, when we’ve all now agreed that that should be outlawed because Paul Volcker doesn’t like it?
Because perhaps I’m stupid – it never pays to exclude the possibility that I’m stupid – but I myself have no idea why these aren’t ‘prop trades’. More precisely, I can’t imagine an objective definition of ‘prop trade’ to which the Maiden Lane auctions (and indeed, the Fed’s initial purchase of all these things as well! Why are we letting the Fed ‘prop trade’ – aren’t taxpayers on the hook for Fed activity?) wouldn’t apply – unless of course, contra my hunch, each such auction has been entirely and immediately crossed to clients. But clearly, you can note that, outside of perhaps Matt Levine@Dealbreaker, there hasn’t been a lot of handwringing in the past weeks and months musing about whether the Maiden Lane transactions might be ‘prop trades’ thus run afoul of the Volcker Rule.
Why, it’s almost as if ‘prop trade’ has no consistent definition.