By Pam Martens and Russ Martens: November 3, 2014
The Federal Reserve Board of Governors in Washington, D.C., which functions as the central bank of the United States, has farmed out much of its Quantitative Easing (QE) programs to the Federal Reserve Bank of New York since the financial crisis of 2008. The Federal Reserve Bank of New York has, in turn, contractually farmed out a hefty chunk of the logistics of that work to JPMorgan Chase in the last six years.
Sitting quietly on the Federal Reserve Bank of New York’s web site is a vendor agreement and other documents indicating that JPMorgan Chase holds all of the Mortgage Backed Securities (MBS) that the New York Fed has purchased under its various Quantitative Easing programs. As of last Wednesday, that figure was $1.7 trillion dollars. (The New York Fed has confirmed that JPMorgan is custodian for these assets.)
In addition to holding the MBS, JPMorgan also has a contractual agreement to exercise discretion (its own judgment) in trading the surplus cash that sits in the New York Fed’s cash account. While JPMorgan is restricted to holding collateral backed by U.S. government securities for these cash trades in Repurchase Agreements, its approved list of counter parties include global banks variously charged with rigging the international interest rate benchmark known as Libor, money laundering, aiding and abetting tax evasion, and defrauding clients.
During the period in which JPMorgan has been the trusted custodian of a major part of the assets of the U.S. central bank, it has been repeatedly charged with serial crimes. In January of this year, JPMorgan paid $2.6 billion and made history in being the first Wall Street mega bank to be charged with two felony counts and receive a deferred prosecution agreement. The crime was aiding and abetting the Madoff fraud – the largest Ponzi scheme in the history of modern finance. In September of last year, JPMorgan settled its London Whale scandal for $920 million in penalties. That case involved its use of depositors’ savings to gamble in exotic derivatives in London, lose at least $6.2 billion of those deposits, and initially misstate the amount of losses to its regulators.
There has also been a stream of other charges and settlements by JPMorgan for rigging electric rates, abusing credit card customers, and rigging Libor. According to press reports, another charge and settlement is ahead involving the rigging of foreign currency exchange trading – potentially as soon as this month.
The contract between the New York Fed and JPMorgan (located here under “Vendor Agreements – Agency Mortgage Backed Securities Purchase Program”) is a textbook study in the mushrooming conflicts evolving from the New York Fed being a regulator of Wall Street banks while simultaneously needing their help to conduct open market operations to carry out monetary policy for the nation.
In the case of the QE assets, the contract designates the New York Fed as JPMorgan’s “customer,” adding another incestuous twist to the relationship Wall Street banks have with their regulator. The conflicts which the New York Fed must tolerate, as a customer handing over $1.7 trillion of its assets to JPMorgan, are breathtaking. Here’s a partial list:
“Customer acknowledges that Bank [JPMorgan Chase] or its Affiliates may have a material interest in transactions entered into by Customer with respect to the Accounts or that circumstances are such that Bank may have a potential conflict of duty or interest. For example, Bank or its Affiliates may…
“act in the same transaction as agent for more than one customer…
“earn profits from any of the activities listed herein…
“Customer further acknowledges that Bank or its Affiliates may be in possession of information tending to show that the instructions received may not be in the best interests of Customer but that Bank is not under any duty to disclose any such information.”
According to a fee agreement dated September 19, 2009, JPMorgan will be handsomely paid for its work. It is to earn 10 basis points on all the assets it holds for the New York Fed; will earn transaction fees ranging from $1.25 to a $1.00 per transaction; $5 for each wire transfer; $25.00 for each manual instruction placed by the New York Fed; $1.25 to $1.00 every time a Mortgage Backed Security pays down principal; and various other fees for administration and trading the cash balances.
In addition to the New York Fed’s System Open Market Account (SOMA) oversight of the $1.7 trillion in MBS held at JPMorgan, the New York Fed oversees $2.3 trillion in U.S. Treasury notes and bonds, also purchased under QE programs. Why has it only farmed out the MBS portion to one of the banks it regulates?
MBS are high maintenance products, consisting of pools of mortgages. As mortgage owners sell their homes or refinance, principal is returned. Interest is also being regularly paid on the bonds. On $1.7 trillion of these securities, that’s a ton of record-keeping and cash management work.
To maintain downward pressure on interest rates to stimulate the recovery, the New York Fed, under mandates from the Federal Open Market Committee (FOMC) of the Federal Reserve System, plans to continue to reinvest the principal on the MBS as it pays down into more MBS, as well as to roll over maturing Treasury securities into additional Treasury offerings — for an indefinite period.
According to Q&A on its web site, the New York Fed, itself, has been making the QE purchases of bonds as well as the reinvestments. It may have simply decided that farming out the high maintenance work to custody MBS and reinvest the cash flow short term is more cost effective than attempting to staff up and develop applications to custody the assets in house.
The problem for the New York Fed is that it effectively has no bank in America, or anywhere else for that matter, big enough to hold $1.7 trillion in bonds which doesn’t have a serious rap sheet. And the growing feeling is that the New York Fed is an incompetent and/or compromised regulator that has contributed to creating recidivist banks.
Senators Sherrod Brown and Elizabeth Warren are pushing for Senate hearings on the New York Fed’s role as a regulator. Carmen Segarra, a bank examiner fired by the New York Fed after refusing to change her examination that was critical of Goldman Sachs, recently had her internal tape recordings released through ProPublica and public radio’s “This American Life” exposing the New York Fed as a watchdog with no bark or bite when it comes to powerful Wall Street banks.
It is now perfectly clear that a series of hearings on the New York Fed, by both the Senate Banking and Permanent Subcommittee on Investigations, are in order and long overdue.