A primary dealer is a bank or securities broker-dealer that may trade directly with the Federal Reserve System of the United States (“the Fed”).
Such firms are required to make bids or offers when the Fed conducts open market operations, provide information to the Fed’s open market trading desk, and to participate actively in U.S. Treasury securities auctions.
They consult with both the U.S. Treasury and the Fed about funding the budget deficit and implementing monetary policy. Many former employees of primary dealers work at the Treasury, because of their expertise in the government debt markets, though the Fed avoids a similar revolving door policy. 
Between them, these dealers purchase the vast majority of the U.S. Treasury securities (T-bills, T-notes, and T-bonds) sold at auction, and resell them to the public. Their activities extend well beyond the Treasury market, for example, according to the Wall Street Journal Europe (2/9/06 p. 20), all of the top ten dealers in the foreign exchange market are also primary dealers, and between them account for almost 73% of forex trading volume. Arguably, this group’s members are the most influential and powerful non-governmental institutions in world financial markets. Group membership changes slowly.
The primary dealers form a worldwide network that distributes new U.S. government debt. For example, Daiwa Securities and Mizuho Securities distribute the debt to Japanese buyers. BNP Paribas, Barclays, Deutsche Bank, and RBS Greenwich Capital (a division of the Royal Bank of Scotland) distribute the debt to European buyers. Goldman Sachs, and Citigroup account for many American buyers. Nevertheless, most of these firms compete internationally and in all major financial centers.
In response to the subprime mortgage crisis and to the collapse of Bear Stearns, on March 19, 2008, the Federal Reserve set up the Primary Dealers Credit Facility (PDCF), whereby primary dealers can borrow at the Fed’s discount window using several forms of collateral including mortgage backed loans.
Paul Krugman on the nexus of Wall Street, Federal Reserve and the Treasury and the damage to our democracy…
~~~~ “Earlier this week, the inspector general for the Troubled Asset Relief Program, a k a, the bank bailout fund, released his report on the 2008 rescue of the American International Group, the insurer. The gist of the report is that government officials made no serious attempt to extract concessions from bankers, even though these bankers received huge benefits from the rescue. And more than money was lost. By making what was in effect a multibillion-dollar gift to Wall Street, policy makers undermined their own credibility — and put the broader economy at risk.
For the A.I.G. rescue was part of a pattern: Throughout the financial crisis key officials — most notably Timothy Geithner, who was president of the New York Fed in 2008 and is now Treasury secretary — have shied away from doing anything that might rattle Wall Street. And the bitter paradox is that this play-it-safe approach has ended up undermining prospects for economic recovery. For the job of fixing the broken economy is far from done — yet finishing the job has become nearly impossible now that the public has lost faith in the government’s efforts, viewing them as little more than handouts to the people who got us into this mess.
About the A.I.G. affair: During the bubble years, many financial companies created the illusion of financial soundness by buying credit-default swaps from A.I.G. — basically, insurance policies in which A.I.G. promised to make up the difference if borrowers defaulted on their debts. It was an illusion because the insurer didn’t have remotely enough money to make good on its promises if things went bad. And sure enough, things went bad.
So why protect bankers from the consequences of their errors? Well, by the time A.I.G.’s hollowness became apparent, the world financial system was on the edge of collapse and officials judged — probably correctly — that letting A.I.G. go bankrupt would push the financial system over that edge. So A.I.G. was effectively nationalized; its promises became taxpayer liabilities.
But was there any way to limit those liabilities? After all, banks would have suffered huge losses if A.I.G. had been allowed to fail. So it seemed only fair for them to bear part of the cost of the bailout, which they could have done by accepting a “haircut” on the amounts A.I.G. owed them. Indeed, the government asked them to do just that. But they said no — and that was the end of the story. Taxpayers not only ended up honoring foolish promises made by other people, they ended up doing so at 100 cents on the dollar.
Could things have been different? Some commentators argue that government officials had no way to force the banks to accept a haircut — either they let A.I.G. go bankrupt, which they weren’t ready to do, or they had to honor its contracts as written.
But this seems like a naïve view of how Wall Street works. Major financial firms are a small club, with a shared interest in sustaining the system; ever since the days of J.P. Morgan, it has been common in times of crisis to call on the big players to forgo short-term profits for the industry’s common good. Back in 1998, it was a consortium of private bankers — not the government — that put up the funds to rescue the hedge fund Long Term Capital Management.
Furthermore, big financial firms have a long-term relationship, both with the government and with each other, and can pay a price if they act selfishly in times of crisis. Bear Stearns, the investment bank, earned itself a lot of ill will by refusing to participate in that 1998 rescue, and it’s widely believed that this ill will played a major factor in the demise of Bear Stearns itself, 10 years later.
So officials could have called on bankers to offer a better deal, for their own sake, and simultaneously threatened to name and shame those who balked. It was their choice not to do that, just as it was their choice not to push for more control over bailed-out banks in early 2009.
And, as I said, these seemingly safe choices have now placed the economy in grave danger.
For the economy is still in deep trouble and needs much more government help. Unemployment is in double-digits; we desperately need more government spending on job creation. Banks are still weak, and credit is still tight; we desperately need more government aid to the financial sector. But try to talk to an ordinary voter about this, and the response you’re likely to get is: “No way. All they’ll do is hand out more money to Wall Street.”
So here’s the real tragedy of the botched bailout: Government officials, perhaps influenced by spending too much time with bankers, forgot that if you want to govern effectively you have retain the trust of the people. And by treating the financial industry — which got us into this mess in the first place — with kid gloves, they have squandered that trust.”~~~~
# # #
And the New York Times reports on the vote on the Paul/Grayson amendment to audit the Fed…
~~~~”In a display of populist anger toward the Federal Reserve, a House panel voted on Thursday to let Congress carry out sweeping new oversights of the central bank’s policy decisions and operations.
The House Financial Services Committee approved a measure proposed by Representative Ron Paul of Texas that would allow Congress to order audits of all the Fed’s lending programs as well as of its basic decisions to set monetary policy by raising or lowering interest rates.
If the measure becomes law, it would expose the Federal Reserve to far more political pressure than it has faced for decades. Fed officials have adamantly opposed the measure, saying it would undermine the central bank’s political independence and gravely threaten its credibility as a bulwark against inflation.
The vote on Thursday occurred despite the opposition of Representative Barney Frank, Democrat of Massachusetts, who had wanted to shield the Fed’s decisions on monetary policy from political pressures.
Mr. Paul, a libertarian Republican who has called for abolishing the Fed entirely, has introduced a version of his bill in every session of Congress since the early 1980s and never made any progress. But the Fed’s trillion-dollar efforts to bail out major banks and rescue the financial system provoked a popular firestorm that ignited both right-wing Republicans and left-wing Democrats.
Mr. Paul’s amendment would instruct the Government Accountability Office, the investigative arm of Congress, to carry out audits of all the Fed’s operations. Those include an array of emergency lending programs, bailouts of giant financial institutions, dealings with foreign central banks and the central bank’s efforts to drive down interest rates by intervening in bond markets….”~~~~
# # #
The comment that I posted on Professor Krugman’s op ed above…
“Thank you for an excellent column Professor Krugman.
The Paul/Grayson effort to audit the Federal Reserve is central to reforming our financial system.
The relationship of the world’s largest banks to our central bank is a stranglehold on our economy. These primary dealers are now back to making substantial profits as our economy collapses under the impossible load of debt.
I was sitting in the House Financial Services Committee hearing yesterday next to the lobbyists from SIFMA, the Wall Street banks trade group, as the roll call vote was made on the Paul/Grayson amendment… they couldn’t believe that the people’s representatives were voting to create transparency on the operations of the Federal Reserve. They have operated in the dark for so long. And profited as such great expense of the people.
The overarching policy question for our nation is whether President Obama will have the courage to tame the bond markets as he creates policy for our economy. Or whether like the last Democratic president the “bond vigilantes” proscribe the direction fiscal and monetary policy will take.
Although some have advocated abolishing the Federal Reserve I think an intermediate solution would be to eliminate the primary dealers as the only entities with whom the System Open Market Account (SOMA)of the New York Federal Reserve conducts operations.
By placing these banks in a closed symbiotic relationship with the Federal Reserve in the conduct of monetary policy we have created an untenable situation when these banks become unstable. This is what happened last fall in the collapse of Lehman Brothers. Banks stopped lending to each other and froze the system.
The New York Fed must open it’s counterparty arrangements to directly include mutual funds, hedge funds, insurance companies, pension funds, state and local governments, private companies and foreign central banks.
The Federal Reserve has relied on the balance sheets of the primary dealers to mediate credit into the financial system. The balance sheets of these banks are not capable of absorbing more Treasury debt. The management of the yield curve through repo and other Fed lending has become so complex that it’s unclear that this tool will still function after the Fed discontinues buying MBS.
By enshrining primary dealer banks as the heart of our financial system we grant them tremendous power and profit.
This dominance must end.”
# # #
Can our nation reform itself?
Can we throw off the yoke of Wall Street? And it’s dominance over our financial system and federal government?
Yes… yes we can reform… but everyone must push back at the attempt for control and influence by the major banks… starting with the President of the United States… he must weigh the value of keeping his Treasury Secretary and his knowledge of Wall Street and global monetary operations..
It’s Wall Street or Main Street… democracy or ….