We’ll call this the 7-11 edition of the Market Structure Map because it covers July 7-11 and because we’re here for your convenience and open early and late (Note to 7-11 corporate lawyers: lighten up, you people).
First, a word on trading last week: We saw big banks (the Citigroups and Lehmans and JP Morgans for instance) in particular cutting equity positions – probably getting back in line with federal capital-ratio requirements specific to primary-dealer status. These efforts not only fostered selling pressure in equity markets, but also meant fewer managed dollars flowing back into equities.
Which brings us to Primary Dealers. These eighteen banks (if you consider Bear Stearns and JP Morgan a single entity, and if you back out Countrywide, acquired by BofA) have authority to trade directly with the Federal Reserve, and they provide data and services to help the Fed manage money supply, mortgage-backed securities and US treasuries. Ten of the eighteen are international, curiously, and range from BNP Paribas to UBS to some you might find surprising including Daiwa and Mizuho, and fixed-income specialist Greenwich Capital, owned by the Royal Bank of Scotland, which wrote off $12 billion in collateralized debt obligations last quarter, the great bulk of which reflected events at Greenwich. Remember, it was RBS CEO Fred Goodwin who pegged CDO writeoff risks last fall at “over $100 billion” (now much larger than that). These 18 banks trade on average $600 billion per day in US government securities (versus about $190 billion per day in US equities) and over $300 billion per day in mortgage-backed securities, the bulk of which likely are Freddie Mac and Fannie Mae originated. This activity actually shot up by over $100 billion per day in the week ending July 4. Ahead of Freddie Mac and Fannie Mae trouble.
Why does this stuff matter, IROs and CFOs and CEOs? Because federal interests and federally supported mortgage-backed obligations, and therefore federal monetary policy is directly contributing to the decline in your – yes your – equity value. The data are right there plain as day for anyone to see. I pulled them down in Excel to write this edition of The Map. Your government is diverting funds from the markets by using the Primary Dealers to focus on credit obligations instead of equity trading. And if they must commit capital to assist…they can’t commit capital to help investors. And investors have to sell stock. And stocks go down. And investors don’t then have access to capital and services to buy. So stocks go down further.
We submit that this is why Christopher Cox, chairman of the SEC yesterday (July 14) invoked emergency powers to threaten naked shorts targeting Freddie and Fannie…and the Primary Dealers (that one sort of snuck by if you weren’t paying attention).
Naked shorting is the practice of selling shares short that one has not borrowed. It’s not illegal but Regulation SHO requires broker-dealers to have reasonable certainty of availability of shares within the standard three-day settlement period. Ironically, mathematics and humans simultaneously trading sometimes unintentionally conflict with each other and exacerbate naked shorting because program trading systems may predicate automated trading reactions on historical share-availability data – at a time when there are runs on the bank, so to speak, and active human traders are addressing short-term issues. Thus, the systems may buy or sell more shares than are actually available.
So is naked shorting a big problem? No. It’s not. If you can’t get liquidity to meet your settlement obligation, and you’re a trader, the risk shifts to you. But warning traders not to naked short the Fed’s partners shifts attention to traders and away from the real source of the problem right now – and you can figure out what we mean. Facts are facts. Follow the money right to the root of the problem.
Margaret E. Wyrwas - Knight Capital Group, Inc. (Nasdaq: NITE)
Senior Managing Director, Corporate Communications & Investor Relations
Equity Analysis™ subscriber since March 2007
"In global markets driven by automation, changing market structure regulation and dynamic investment objectives, today's investor relations professionals require new data points in order to remain relevant and add value in their company's quest to reduce its cost of capital."
