Primary Dealer Holdings: Interesting Stuff

First, the list of primary dealers (those authorized to trade directly with the Federal Reserve):

BNP Paribas Securities Corp.		Goldman, Sachs & Co.
Banc of America Securities LLC*		Greenwich Capital Markets, Inc.
Barclays Capital Inc.		HSBC Securities (USA) Inc.
Cantor Fitzgerald & Co.		J. P. Morgan Securities Inc.
Citigroup Global Markets Inc.		Merrill Lynch Government Securities Inc.*
Credit Suisse Securities (USA) LLC		Mizuho Securities USA Inc.
Daiwa Securities America Inc.		Morgan Stanley & Co. Incorporated
Deutsche Bank Securities Inc.		UBS Securities LLC.
Dresdner Kleinwort Securities LLC
*It is anticipated that the two primary dealers will merge sometime in the first quarter of 2009. The below graph highlights the dramatic change in risk profile for these dealers.  They have abandoned corporate debt, making it difficult for businesses to refinance and keep workers employed.  Their appetite for insured product has stabilized.  The most interesting component is the Treasury position.  Often, a dealer will hedge overall interest rate risk of a bond they are long by shorting a Treasury issue.  This protects the dealer against overall increases in interest rates.  Of course, the dealer is still subject to the credit risk component of the bond they are long. Basically, dealers are now flat Treasuries, implying that they are betting that the overall direction of rates will be lower.  Perhaps they became tired of losing on these short positions as Treasuries rallied because of the poor economic scenario.  Either way, they are quite vulnerable to rates moving higher.  Unintended consequences indeed.