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Wednesday, November 26, 2008

 

more on repo fails


following up on last month -- via paul kedrosky -- this euromoney article discusses the accelerating rate of failures to deliver on treasury repo agreements even in the face of government jawboning to quell the issue.

THE US TREASURY market, the foundation of government bond and corporate bond markets worldwide, is suffering a crisis of confidence at the worst possible moment. ...

There is an even more pressing concern for many participants in this increasingly swollen market: the settlement system has broken down. Following the collapse of Lehman Brothers in September, fails to deliver among the 17 primary dealers in the US treasury market have rocketed to more than $2 trillion over a period of weeks and still lie above $1.3 trillion. Broker/dealers have stopped delivering bonds. Holders of US treasuries are now scared to lend into the repo market in case their bonds are not returned, and potential buyers sit on the sidelines fearful of handing over their money to a counterparty that at best might not deliver a bond on time, and at worst might go under.

... As a result of fails to deliver, the most transparently priced instrument available now has investors scratching their heads. The natural balance of supply and demand has been altered and the true price of treasuries has become obscured. The effects are being seen across other bond markets. “The TIPS (Treasury Inflation Protected Securities) market is also clearly broken,” says Pond. “An obvious trade right now would be to go long TIPS where real yields are high and short the nominal bond in a breakeven inflation trade but hedge funds are fearful that if they go through the repo market the borrow could fail. So we have a situation now in the 10-year TIPS where the market is pricing in zero or negative average inflation for the next 10 years. Inflation has not been that low since the 1930s.” Economists also claim that fails have spread across to other bond markets such as municipals, agencies, mortgage-backed and corporate bonds.

Why the Federal Reserve is not urgently considering regulation is bewildering. As yet, the US Treasury has merely asked for market participants to sort out the situation themselves. That might help reduce fails but it will not eliminate them, and in panic periods they will simply creep back up. The global economy has significantly contracted since the collapse of Lehman Brothers, which spurred the fails to deliver. More market-shocking events are certain to lie ahead. The solution is simple – delivery needs to be enforced, and liquidity returned. If not, confidence in the US treasury markets will be lost. Loans made using treasuries as collateral will be reconsidered, bond markets priced off treasuries will further dry up and, with equity markets so volatile, central banks and investors will not know where to turn.

Fails to deliver in the treasury markets are not a new phenomenon. There is data for fails for treasuries, agencies and mortgage-backed securities as far back as 1990, says Susanne Trimbath, an economist, and former employee of the Depository Trust Co, a subsidiary of Depository Trust and Clearing Corp.

Back then, though, there would be $50 billion of fails in a whole year, she says. That figure has grown enormously. Failures in US treasuries were 8.6% of all treasuries outstanding in the first five months of this year, compared with 1.2% in the first five months of 2007. That has ballooned further over the past three months, hitting more than $2 trillion for almost the entire month of October – more than 20% of the daily treasuries trading volume.

What the treasuries market faces now, at this critical moment, is the consequence of long neglect of some murky aspects of short-term tactical trading in government bonds. ... For years, efforts by the US Treasury itself to formally resolve the growing fails issue have been brushed aside by market participants as unnecessary.


if naked stock shorting is supposed to be an issue, one would think that naked treasury shorting would receive the brunt of government anger. but the treasury itself is such a thoroughly captured institution under the rule of the predators of the bush administration that it seems impossible to imagine a regulatory crackdown when investment banks are likely the preponderant beneficiaries of repo fails. this regulatory issue too, it seems, will roll over to the obama adminstration in wait of an adult hand of discipline.

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