Their Pocket or Our Pocket

By: Thomas Tan | Tue, Aug 4, 2009
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There is a very interesting article "Wall Street profits from trades with Fed", published at Financial Times' website last night. It confirms my long time suspicion on the reality and truth about "profit" announced by a few major Wall St. banks these days. As we all know, most of their profit is now coming from the so-called "trading" area. This FT article demystifies at least partially what they are, and where they are coming from. They are actually coming from the Fed, since now Fed is their largest customer (not the public). So it is the trading profit generated within this shadow banking system, or playing games among themselves.

Due to regulation of required transparency, Fed has to announce beforehand their intention to buy certain securities. This gives plenty time to these major Wall St. banks to first load up these securities, and pump up their prices so they can sell them to the Fed later at an inflated prices and book profits that way.

If this is not enough, besides the advanced information, Wall St. also has pricing power. Since a few large players like Bear Stearns and Lehman are out of the way, there are less players left in the field Fed could deal with, a situation of diminished competition. With now only few Wall St. banks in this unfair playfield loading up these securities, they demand and control the prices and liquidity suffers. The spread of these securities are getting wider, so these Wall St. banks are not only making money from the inflated prices, but also from the spreads. Talking about no free lunch, at least not at Wall St.!

Bonus has been a really hot topic everywhere these days. The argument from Wall St. is that now they are making great profits, so need to reward their employees. One of the Wall Street Journal articles put this into perspective, and indicated "Six of the nine banks paid out more in bonuses than they received in profit," the Journal reported, and "one in every 270 employees at the banks - [a total of 5,000 employees] -received more than $1 million."

According to the report by New York Attorney General Andrew Cuomo, Goldman Sachs is on course to pay $20 billion in bonuses in 2009 -- an average of $700,000 for each and every employee. Morgan Stanley's bonuses are up 30%, to an average $340,000. At J.P. Morgan, the incentive pool for the first quarter alone has skyrocketed by 175% to $3.3 billion. All these are happening at the worst economic time and crisis caused by the few Wall St. banks.

Not to mentioning that the bonuses were a third larger than California's budget deficit. Since Fed has dumped trillion of taxpayers' money to save a few of these banks, maybe you think as a good gesture, they might return the favor to fill at least a third of the budget deficit black hole in California, which is World's 8th largest economy?

Keep in mind each trade has a winning side and a losing side. If these few Wall St. banks are making all the "profit" these days by trading with Fed, where is the Fed's money coming from? Who is paying these bills? The funniest thing is that Fed is actually happy to let these few banks on gaming the system since they see this approach is a great way to "save" them by funneling Fed's money to bank's profit/loss statement. Finally Fed can claim to us all "see, the banks are now in great shape! What a great job we have done." This is why the whole TARP act is so ill fated from the very beginning. It is basically ripping off the public, or the taxpayers, to save a few rich bankers.

According to the FT article, a former official of the US Treasury and the Fed said the situation had reached the point that "everyone games them. Their transparency hurts them. Everyone picks their pocket."

Maybe it more appropriate for him to say: it is "OUR" pocket.



Thomas Tan

Author: Thomas Tan

Thomas Tan, CFA, MBA

Disclaimer: The contents of this article represent the opinion and analysis of Thomas Tan, who cannot accept responsibility for any trading losses you may incur as a result of your reliance on this opinion and analysis and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.

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