Sunday, October 05, 2008

Dark Politicians of Liquidity

Investment analysts sometimes refer to dark pools of liquidity - private trades of liquid securities between financial institutions that avoid the open market. We're going to be seeing a lot more of these in the near future thanks to the bailout, with the crucial difference that a major counterparty will now be the U.S. Government.

Treasury will start implementing the bailout plan this week, with or without a well-defined structure for managing and auditing transactions. Uncle Sam has contracted with BGI and State Street to start the purchases, but are they using the reverse auction process that Bernanke and Paulson outlined in their testimony? I wouldn't bet on it. Those two firms have gigantic internal crossing networks and access to other private networks, and these dark pools of liquidity can hide a lot of transactions from the prying eyes of government auditors. Congress' toothless oversight board won't think about prying into those firms' proprietary crossing networks, and they may need a Congressional subpoena to do so if the thought to peek in actually occurs to them.

Hank and Ben are probably just betting that they can keep Congress in the dark while they keep the banking system afloat by flooding institutions with purchase orders for junk MBSs above fair market value. They're going to have to throw money away to prevent all these banks from failing. They'll also have to buy a lot of non-mortgage debt, so you can count on that $700B bill to double in FY09. They may even try to buy MBSs directly from pension plans, which is where those internal crossing networks will really come in handy. BGI and State Street both manage assets for huge pension plan clients.

Will they succeed? Maybe if every European country legislates bailouts of their own banks. All of this capital that could have gone to productive investment in the public commons - infrastructure, mass transit, green energy, and the like - is now going to cure a hangover.