MF Global casts doubt on NY Fed primary dealer plan

Yet banks and securities dealers have clamoured for the status, not because being a primary dealer is a lucrative business but because it is as a sign that the firm is in the big leagues.

"Talk about egg on the face of the Fed," said Joshua Rosner, managing director of Graham Fisher & Co, an independent research consultancy. "A primary broker is supposed to be of unquestionable strength."

But it's possible New York Fed officials are taking MF Global's failure in stride:

"If nobody ever drops off the list for financial reasons, maybe you're being too stringent," said one former New York Fed official who did not wish to be named.

The bankruptcy does raise questions, however, about how the Fed picks the primary dealers -- especially since MF Global was one of four firms added to the ranks after new, more stringent requirements were put in effect in 2010.

A spokesman for the New York Fed declined to comment.

STATUS UNKNOWN

The New York Fed heavily scrutinizes applicants for primary dealer status and holds primary dealers, which help distribute U.S. debt and carry out monetary policy, to capital requirements other securities firms do not necessarily have to meet.

In the wake of MF Global's failure, other applicants for primary dealer status are wondering what the New York Fed will do differently in the future.

"My guess is there probably will be a pause in the application and approval process while they figure out what went wrong and what they're going to do, if anything," said Douglas Landy, a former New York Fed lawyer who is now a partner at Allen & Overy.

That may slow the already clogged pipeline of primary dealer hopefuls. TD Securities, for instance, has been waiting since early 2009 for its application to go through. Pierpont Securities and CRT Capital Group have been waiting more than a year.

Despite new application guidelines the New York Fed released in 2010, there is still some mystery to the process. MF Global won approval in February despite its reputation for taking big risks.

"I think they stood out a little bit before," said Otis Casey, director of credit research at Markit. "I don't know to what extent their leverage was inside or outside any guidance from the Fed, but they were highly leveraged compared to peers."

But MF Global was led by a prominent public figure, Jon Corzine, the former New Jersey senator and governor as well as former CEO of Goldman Sachs, which may have boosted its reputation.

"The principal of MF Global was once the head of government bond trading at Goldman Sachs in a different era and the firm may have been cut some slack given who he is," Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York, said in a note to clients.

FILLING OUT THE RANKS

The New York Fed is left with 21 primary dealers with which to carry out its operations, including the Fed's latest effort to stimulate the the economy, dubbed "Operation Twist."

The $400 billion program involves selling shorter-dated Treasury securities from the Fed's balance sheet and using the proceeds to buy longer-dated notes and bonds. The New York Fed executes the program, and the primary dealers are its only counterparties.

Ernest Patrikis, another former New York Fed lawyer, now a partner at White & Case, said he would advise the primary dealer applicants still waiting for approval from the New York Fed to renew their efforts.

"Call the Fed and say you're ready," Patrikis said.

(Additional reporting by Kristina Cooke Chris Reese and Pedro Nicolaci da Costa; Editing by Dan Grebler)