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Deutsche Bank, Credit Suisse Lead Fed’s MBS Trades

The headquarters of Deutsche Bank AG stand in Frankfurt. Photographer: Ralph Orlowski/Bloomberg
The headquarters of Deutsche Bank AG stand in Frankfurt. Photographer: Ralph Orlowski/Bloomberg

Dec. 1 (Bloomberg) -- Deutsche Bank AG and Credit Suisse Group AG led bond dealers that entered contracts to buy and sell government-backed mortgage securities to the Federal Reserve as the central bank acquired $1.25 trillion of the debt beginning in January 2009.

The purchases, aimed partly at bolstering the housing market by lowering financing costs, represented the largest portion of an unprecedented $1.72 trillion in debt-buying by Chairman Ben S. Bernanke’s Fed during its first round of quantitative easing. The central bank announced a second round, dubbed QE2, last month.

The Fed released the names of counterparties, purchase prices and other information about its mortgage-bond program today to meet disclosure requirements in July’s Dodd-Frank financial-oversight law. Lawmakers including Bernard Sanders, a Vermont Independent and self-declared socialist, and Jim DeMint, a South Carolina Republican advocate for Tea Party candidates, called for greater openness.

“We see this not as the end of a process but really a significant step forward in opening the veil of secrecy that exists in one of the most powerful agencies in government,” Sanders, who authored the legislation’s provisions on Fed transparency, told reporters Nov. 17.

Bear Bailout

In a July interview about the central bank’s 2008 bailout of Bear Stearns Cos., in which the Fed gained stakes in riskier real-estate debt that lacks government backing, Sanders said that “the American people have a right to know what the Fed is doing with trillions of their taxpayer dollars.” The central bank never took credit risk with its purchase of so-called agency mortgage securities, a Fed official said yesterday.

Purchases of mortgage-backed securities, or MBS, “supported mortgage and housing markets, lowered longer-term interest rates, and fostered economic growth,” the Fed said in a statement today.

The central bank announced its plan to buy the securities in November 2008, when deleveraging by debt funds and financial companies curbed demand for even the safest securities. Bonds explicitly guaranteed by the U.S. through federal agency Ginnie Mae traded at yields more than 1 percentage point higher than the average premium over benchmark rates during the previous five years.

Largest Counterparties

Lehman Brothers Holdings Inc.’s collapse two months earlier had roiled housing and credit markets, leading the Fed to expand the limits and types of its emergency aid for companies and markets, which peaked at $3.3 trillion. Home prices around 20 large U.S. metropolitan areas, which had fallen almost 26 percent from a 2006 peak through November 2008, extended declines to nearly 32 percent before bottoming the following May, according to S&P/Case-Shiller index data.

The Fed’s next largest counterparties in its mortgage-bond program were Morgan Stanley and Bank of America Corp.’s Merrill Lynch unit, the Fed data show. All the brokers were among the so-called 18 primary dealers that trade directly with the central bank.

Renee Calabro, a spokeswoman for Frankfurt-based Deutsche Bank, Mark Lake, a Morgan Stanley spokesman in New York, and Robert Stickler, a spokesman for Charlotte, North Carolina-based Bank of America, declined to comment on the mortgage-bond program.

Gobbled Up

“Although Credit Suisse did not participate in most of the Federal Reserve’s emergency programs, our roles in the Term Securities Loan Facility and the MBS Buyback program reflected our duty as a primary dealer and our desire to help maintain liquid markets during one of the most volatile periods in the global markets in decades,” the Zurich-based bank said in a statement sent by Steven Vames, a spokesman, who declined to comment further.

The Fed’s purchases, which began in January 2009 and gobbled up almost a quarter of the more than $5 trillion market, had little effect on overall trading volumes. Trading averaged about $300 billion daily as the central bank was buying, compared with about $275 billion over the previous five years and almost $310 billion since, Fed data show. The week before the Fed’s announcement, volume averaged $252.3 billion, as markets for other mortgage debt were essentially shut.

The program, which was initially announced as a $500 billion plan on Nov. 25, 2008, grew by $750 billion as the Fed sought to inject more money into the economy. While the initiative officially ended in March, the Fed didn’t stop entering contracts to buy and sell debt until June.

Market Shortages

During that period, in response to shortages in the market, the central bank continued to offset some of its outstanding contracts to purchase home-loan securities with agreements to sell the debt. At the same time the Fed entered into new contracts to take other types of securities or buy the same bonds later when more might be available.

The Fed’s trading totaled $2.45 trillion, including $1.85 billion of purchase contracts and $600 billion of sales contracts, according to the data. Deutsche Bank handled $410.8 billion of the trades; Credit Suisse was responsible for $383 billion; Morgan Stanley transacted $280 billion and Merrill Lynch traded $244.6 billion.

Unlike with its purchases of Treasuries and so-called agency debentures, the central bank didn’t announce publicly when it would buy specific home-loan bonds, and it didn’t open auctions to any primary dealer offering the best price.

Electronic Platforms

Instead, when the Fed sought the securities, guaranteed by government-backed entities led by Washington-based Fannie Mae, the central bank would announce its intentions via private asset managers on electronic platforms, according to people who participated in the program. They declined to be identified because they weren’t allowed to talk publicly.

In these announcements, the central bank would specify the amount and type of bonds it was seeking, and would typically put only four dealers in competition with each round of buying, the maximum allowed by the trading platform, the people said. The central bank rotated among different groups of four, though not in a way meant to be regular or provide completely equal opportunities to all dealers as it sought to deal with the most active firms in the market, they said.

Jeffrey V. Smith, a spokesman for the New York Fed, declined to comment on the procedures.

“It sounds like they made an effort” to avoid overpaying dealers “but unless they disclose the prices and someone can then match those to prices on similar issues over that period of time, it’s going to be hard to tell,” said former Atlanta Fed research director Robert Eisenbeis, now chief monetary economist at Cumberland Advisors Inc. in Sarasota, Florida.

Dealers Profit

Even with daily price information, gauging whether the Fed overpaid would require knowing the exact time of day of transactions, which the central bank didn’t release, as well as market prices at those times.

No matter what, sellers to the Fed could profit: Typically, brokers offer to buy agency mortgage securities for 1/64th or 1/32nd of a cent on the dollar less than they offer to sell them, according to data compiled by Bloomberg. On $1.25 trillion of debt, those bid-ask spreads translate to $195 million to $390 million, respectively. While dealers risk losses if values fall as they carry bonds in inventory, dealers can also profit on the interest paid on the securities they hold.

The Fed’s mortgage buying initially relied on units of four private money managers: Pacific Investment Management Co., Goldman Sachs Group Inc., BlackRock Inc. and Wellington Management Co. In August 2009, the Fed said it was dropping Pimco and Goldman and downgrading BlackRock to an administrative role.

‘Intended Effect’

Representative Patrick Murphy, a Pennsylvania Democrat, last year unsuccessfully sought reports to Congress on the potential conflicts of interest within those asset managers, whose activities were also further detailed in today’s disclosures, as the Fed said which handled particular trades.

In an October 2009 speech, Bernanke listed the mortgage-bond buying among programs that were “having their intended effect.” Interest rates on 30-year fixed-rate mortgages, “which responded very little to our cuts in the target federal funds rate, have declined about 1.5 percentage points since we first announced MBS purchases in November, helping to support the housing market,” he said.

Average 30-year mortgage rates fell to a then-record low of 4.71 percent in December 2009 before climbing and then retreating again to 4.17 percent early last month.

‘Major Success’

The effects of the mortgage-bond buying weren’t as large as they appeared, John B. Taylor and Johannes C. Stroebel, economics professors at Stanford University in Stanford, California said in a December 2009, paper. The decline in mortgage rates instead could be seen as reflecting lower concern that Fannie Mae and Freddie Mac would default on their obligations and a decrease in interest-rate volatility and other causes of prepayment risk, they wrote.

“The program was a major success and kept home prices from really collapsing,” said Scott Simon, the mortgage-bond head at Newport Beach, California-based Pimco, in March. Simon wasn’t part of the unit hired by the Fed.

Pimco’s Total Return Fund, the world’s biggest bond fund, dropped its mortgage-securities holdings as the Fed bought; the share of its investment in them declined to less than 20 percent by the program’s end, from 86 percent in February 2009, according to its website. Such reductions led to investors bolstering other markets, ranging from high-yield corporate bonds to non-guaranteed mortgage securities, according to analysts including at JPMorgan Chase & Co.

Dealers That Traded Mortgage Securities with Fed
Deutsche Bank Securities Inc.                 $410.8 billion
Credit Suisse Securities (USA) LLC            $383 billion
Morgan Stanley & Co. Inc.                     $280 billion
Merrill Lynch, Pierce, Fenner & Smith Inc.    $244.6 billion
Citigroup Global Markets Inc.                 $236.7 billion
Goldman, Sachs & Co.                          $207.5 billion
J.P. Morgan Securities LLC                    $194.8 billion
Barclays Capital Inc.                         $153.4 billion
UBS Securities LLC                            $105.3 billion
BNP Paribas Securities Corp.                  $90.4 billion
RBS Securities Inc.                           $82 billion
Nomura Securities International, Inc.         $43.8 billion
Cantor Fitzgerald & Co.                       $9.2 billion
RBC Capital Markets, LLC:                     $7.3 billion
Mizuho Securities USA Inc.                    $1.2 billion
Jefferies & Company, Inc.                     $350 million

To contact the reporter on this story: Jody Shenn in New York at

To contact the editor responsible for this story: Alan Goldstein at

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