Traders see slim pickings with new rule

Sounds nice on paper. What about in practice?

“Warehousing securities is part of creating a liquid market,” says Paul DeRosa, a principal at Mt. Lucas Management Co., a hedge fund, and former chief executive officer of Eastbridge Capital Inc., a primary dealer in the 1990s.

That goes for both the primary and secondary market. Any time a dealer buys Treasuries from a customer or pre-sells securities before an auction, hoping to buy them back at a cheaper price, “the firm's balance sheet is involved,” DeRosa says. “There is no way to do that without taking a prop position.”

Let's say a dealer buys US$200 million of two-year notes from a customer and sells a duration-weighted amount of 10-year notes because he expects the yield curve to steepen. Is that a hedge or a prop trade?

Even if one could properly define and separate the two functionalities, it's naive to think banks would stay in the business of making a market in Treasuries without prop trading.

Just think about it: If the government bans banks from prop trading, and market-making isn't profitable, why stay in that business? Primary dealers aren't in the business of providing charity. The reason they want to be part of the club and comply with the requirements — bidding at Treasury auctions, trading with the Federal Reserve in its open market operations and providing liquidity to customers — is that it conveys some kind of financial advantage or edge.

Currently most of the 18 primary dealers are affiliated with banks. Without them, the Treasury market would be less liquid, and the government would pay higher interest rates. Spreads would widen, more non-banks would see opportunities and apply to become primary dealers, and the whole thing might be self-correcting.

Still, Treasury probably doesn't want to take that chance at a time when it's facing net marketable borrowing of US$392 billion in the current quarter and US$268 billion in the April-to- June quarter, always a “light” quarter because of the April 15 tax payment.

In fact, the whole idea sounds as if it were rushed out, not thought out. Anyone gazing into the 2013 crystal ball could have seen the unintended consequences.

Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.

1|2

PrintEmail

Write a Comment

Terms

Enter your comments - 3000 characters max

Type in image code

Submit

 Receive China Post promos
 Respond to this email