Who Are the Fed's Primary Dealers?

Money Morning Liquidity Tracking Specialist Lee Adler showed us how the U.S. Federal Reserve's "sweetheart deal" with some of the world's biggest banks could introduce some extreme volatility as their relationships change.

The Fed needs these relationships - mechanisms, if you will - to help it run more efficiently.

That's the theory, at any rate...

The truth is, the Fed probably couldn't get much done without its "accomplices," the primary dealers. This is the secret to the Fed's outsized influence on the markets.

Let me show you how it works...

Here Are the Fed's Primary Dealers

The Fed’s Primary Dealers*

·         Bank of Nova Scotia
·         BMO Capital Markets
·         BNP Paribas Securities
·         Barclays Capital
·         Cantor Fitzgerald
·         Citigroup Global Markets.
·         Credit Suisse Securities
·         Daiwa Capital Markets America.
·         Deutsche Bank Securities
·         Goldman, Sachs
·         HSBC Securities
·         Jefferies
·         J.P. Morgan Securities
·         Merrill Lynch, Pierce, Fenner & Smith
·         Mizuho Securities USA
·         Morgan Stanley & Co.
·         Nomura Securities International
·         RBC Capital Markets
·         RBS Securities
·         Societe Generale,
·         TD Securities
·         UBS Securities
·         Wells Fargo Securities

*U.S.-registered affiliates/subsidiaries unless otherwise noted.

Primary dealers can be thought of as the Fed's trading counterparties, but they have to be. They're tasked by the Fed to assist in implementing monetary policy. They are either banks or broker-dealers of securities who have accounts at the Fed and use them to trade directly with the Fed, purchasing U.S. Treasury bonds or securities.

Currently, there are 23 primary dealers based all around the world, including the United States, Canada, the United Kingdom, France, Switzerland, Germany, and Japan.  You can see the complete list on the right.

In addition, primary dealers are expected to make markets for the Fed on behalf of its official account holders as deemed necessary.

In order to "make" a market, investment banks employ people - the market makers - to provide liquidity in tradeable instruments. They're obligated to buy and/or sell accordingly.

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The Fed's primary dealers work in much the same way, but bigger. They bid in all Treasury auctions at "reasonably competitive prices."

In addition, they're expected to provide data on their trading activities and their cash and financing positions in treasuries and other securities every week.

Now, here's the thing: While the Fed expects primary dealers to report accurately, it does not audit the data they provide.

There are, however, certain checks and balances that go into play here.

Presently, federal supervision and regulation of major Wall Street financial institutions (plenty of which have national bank affiliates and are primary dealers) is divided between the Federal Reserve System - specifically, the Board of Governors and the Office of the Comptroller of the Currency.

Now, although the supervisory and inspection responsibilities of the Fed are a "delegated function" separate from the Board of Governors, the really big calls regarding sanctions and policy are mostly made by the Board.

That supervisory responsibility (along with the Fed's dependence on the Open Market Desk that implements monetary policy on behalf of the Federal Open Market Committee) is a source of influence and "regulatory capture." The Fed's dependence on this tiny group of primary dealers provides strong incentives for the banking and Federal Reserve systems to support those institutions during, say, a financial crisis such as the one we experienced in 2008.

The key takeaway: The Fed would not have the amount of influence and power it has in the stock market today without its "accomplices," the primary dealers.

At the same time, that certain predictability is what makes it possible for a system like Lee Adler's Sure Money to make money whenever the Fed moves. That's how investors can stay on the right side of those moves.

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