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EuroMoney reports
that US treasury market is reaching the
breaking point.
(emphasis mine) [my
comment]
US
treasury market reaches breaking point
Helen Avery
Tuesday, November 25, 2008
As attention focuses on the treasury market's ability to cope with the
US's growing funding needs, Euromoney reveals the structural issue that could
cause the world's market of last resort to grind to a halt in its hour of
greatest need.
The
problem: the settlement system for the US government bond market has broken
down
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. Investors in treasuries are the lenders enabling the US government
bail-out of the country’s broken financial institutions. That leaves
them financing purchases of equity of volatile and highly questionable worth
and backing a ragbag of distressed assets. For now, treasury yields are at
record lows across the term structure as investors with cash to invest
conclude that they can trust no one else with their money. But investors must
wonder at what point the expanded supply of government debt and its use will
make the borrower inherently less creditworthy.
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.
With global stock markets plummeting, investors are still turning to
treasuries as a safe haven. But investors might become nervous if something
is not done soon to sort out the market’s problems. “As yet
investors are still coming in, but in the longer term the worry is the lack
of functionality in the treasury market. That could impact investor
perception on a longer-term basis,” says Mike Pond, US treasury and
inflation-linked strategist at Barclays Capital in New York. If investors
turn their back on treasuries, the US government will find it increasingly
difficult and expensive to raise money and roll over its maturing debts.
Upward pressure on interest rates will occur at a time when the government
needs to be loosening monetary policy in order to jump-start a domestic
economy that is heading towards a depression.
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 [A lack of any morals? Total corruption?
Stupidity? Hard to say what is motivating the fed today]. As
yet, the US Treasury has merely asked for market participants to sort out the
situation themselves [The wonders of self-regulation]. 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. [Since they have lost access to the
credit markets, brokerages are funding themselves through selling imaginary
assets, including treasuries.]
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.
EuroMoney reports
that fear of counterparty failure has frozen
the treasury repo market.
US
treasury market – The mechanics: fear of counterparty failure has
frozen the Treasury repo market
Tuesday, November 25, 2008
Although the catalyst that led to this record amount of fails in
treasuries, spiking at $2 trillion, was the collapse of Lehman Brothers, it
is the settlement system and lack of regulatory oversight that has led to
this risk of market failure.
The treasury market has always been highly liquid. Dealers are able to
sell treasuries without owning them, borrowing them in overnight through the
repo markets in order to meet the T+1 delivery. The supply of treasuries into
the repo market has, in calmer markets, been so bountiful that selling
treasuries without owning them was not considered by most traders to be a
concern. After Lehman collapsed, however, several things happened to dry up
supply to the repo market, explains Rob Toomey, formerly with the BMA which
is now part of Sifma (The Securities Industry and Financial Markets Association).
“There was a tremendous flight to quality so a lot more investors were
buying treasuries,” he says. “At the same time, holders of
treasuries that would ordinarily lend the securities overnight in the repo
markets stopped lending as they became fearful of counterparty risk.”
Investors in treasuries are largely risk-averse by nature. Central banks,
for example, and pension funds are large holders of treasuries.
‘They’re not going to risk lending out treasuries in this
environment,” says Stan Jonas, director of Axiom Capital
Management, a New York investment and banking firm. “If you lend stock
in a bear market you get collateral in exchange and then if your counterparty
goes belly-up you’ll keep that and the stock will have dropped so you
can buy it back cheaper than when you loaned it. Not so in the treasury
market. A lender receives just the interest rate on the bond for the
overnight period but if the borrower goes under, the bond is not returned and
the lender has lost everything.”
Investors are essentially facing the proposition of being paid the Fed
Funds rate overnight while waiting for delivery. That is the same as
receiving US government yield for broker/dealer risk says Trimbath.
That’s not a great trade with risk premia on financial credits rising
to record highs. “Those investors are being paid the
“risk-free” rate of interest – what lenders charge the US
government,” she says. “As far as I’m aware Warren
Buffett is getting paid 10% for taking on Goldman Sachs risk. So how is this
being allowed to happen?”
With interest rates so low, and in some cases negative, there is even less
incentive to lend out treasuries as the amount to be gained from lending out
overnight is too small to compensate for the counterparty risk. The Fed Funds
overnight rate was 0.37% on November 17, with the repo rate lower still and
on occasions in negative territory.
The dramatic and rapid seize-up in overnight treasury supply resulted in a
sharp uptick in the number of fails to deliver.
“The repo market was a great invention,” [Repo
market helped turn the US financial system into a giant Ponzi scheme] says
Jonas. “It was thought to be the safest form of lending and
borrowing but that assumed you could complete the trade. Since we now know
that is not the case, confidence has deteriorated.” He points out
that swaps are viewed as less risky than treasuries today.
Further discouraging the supply of treasuries into the repo market is the
very fact that failure to deliver has not been punished. Huther and his
colleagues were never able to enforce a severe enough repercussion for
failure. At present, failing to deliver incurs only a continued overnight
interest rate. When that interest rate is close to zero, and the penalty for
failing is zero there is little incentive to deliver a bond.
This failure to deliver also has the effect of creating phantom securities
– a higher number in the system than actually exist. “In a sense,
the repo market is like a Ponzi scheme,” says Jonas. “If no
delivery is forced then that bond can be lent over and over again. One
security can underlie a hundred trades. So the amount of securities traded is
far more than exists. That is the way the world works today. If it
doesn’t break, that’s great. But when one link in that system
breaks, those trades have to be unwound...”
Sifma’s Toomey admits that “maybe there are more bonds sold
than are available [Maybe??? No honesty or credibility here]”
although he claims that it is not a good metric for assessing fails to
deliver.
Trimbath, however, is less sanguine about the impact that phantom bonds
have on the financial system. She compares the situation to musical chairs. “Who
is going to get the chair when the music stops? It’s not the individual
investor. I’ve seen positions just deleted from people’s
statements without investors even knowing as the security they supposedly
owned turns out to not exist. When push comes to shove, and the buy-ins
start, who will not receive their delivery? The individual investors or the
institutional clients who are more profitable for the broker/dealers?”
[Key
point: Investors think they own treasuries, but what they really own is an
IOU from their broker. When the dollar and Wall Street collapse, these
investors will find themselves general creditors to bankrupt financial
institutions. This will probably come as a pretty big shock to those
investors…]
EuroMoney reports
about higher costs for the US government at the
very moment it is poised to borrow more.
US
treasury market – The consequences: higher costs for the US government
at the very moment it is poised to borrow more
Tuesday, November 25, 2008
More bonds being traded than exist defies the natural laws of supply and
demand. While greater demand for treasuries should be allowing the US
government to lower borrowing costs, the inflated supply through duplicated
bonds could lead to higher borrowing costs.
“These undelivered treasuries represent unfulfilled demand –
demand by investors willing to lend money to the US government,” says
Trimbath. “That money has been intercepted by the selling
broker-dealers. By selling bonds that they cannot or will not deliver to the
buyer, the dealers have been allowed to artificially inflate supply, thereby
forcing prices down. These artificially low prices are forcing the US
government to pay a higher rate of interest than it should in order to
finance the national debt. It shouldn’t take a PhD-trained economist to
tell you that prices are set where supply equals demand. If a dealer can sell
an infinite supply of bonds then the price is, technically speaking, baloney.
And the resulting field of play cannot be called a market.
“If regulators and the central clearing corporation will only
enforce delivery of treasury bonds for trade settlement at something
approaching the promised, stated, contracted and agreed upon T+1, there will
be an immediate surge in the price of treasury securities. As the prices of
bonds rise, the yield falls. This yield then translates into the interest
rate that the US government will have to pay in order to borrow the money it
needs to fund the budget deficit [and to refinance the existing national
debt].”
Huther also pointed to the higher borrowing costs for the Treasury as a
result of fails in November 2005 when proposing a securities lending
facility. The reduced secondary market liquidity resulting from fails might
lead to erosion of the liquidity premium the Treasury receives for securities
at auction he pointed out. Compliance would also increase costs for all
participants, and ultimately fails could lead to “the potential erosion
of benchmark status,” warned Huther.
At present, investor appetite has not been discouraged [Because
most investors don’t have a clue that they are being sold imaginary
treasuries]. The auctions and issuance in two-year and five-year
notes in October were well received by investors. The government’s $34
billion sale of two-year notes on October 28 drew a yield of 1.60%, the
lowest since March 2004. The US also auctioned $24 billion of five-year notes
on October 30 at a yield of 2.825%, less than the rate drawn in the previous
month’s sale.
However, concerns about the system and its functioning did have an impact on
the government’s $10 billion reopening of 30-year bonds in November.
One trader says that investors were nervous how the process would turn out,
resulting in the reopening being 20 basis points cheaper by the end of the
day to yield 4.35%. That has since dropped to 3.64% as confidence and
therefore demand has returned.
EuroMoney reports
that dealers have resisted improvements in
their greed for profits.
US
treasury market and fails to deliver – The history: dealers have
resisted improvements in their greed for profits
Tuesday, November 25, 2008
For years, efforts by the US Treasury itself to formally resolve the
growing fails issue have been brushed aside by market participants as
unnecessary.
Jeff Huther, the former director of the Office of Debt Management at the Treasury
had battled for several years for a solution, getting as far as a White Paper
produced in April 2006 suggesting stricter enforcement of delivery and
penalties.
No need, responded the Bond Market Association. “The
Association has worked with its members [bond traders and dealers] to address
chronic fail issues with respect to risk, pricing and liquidity,” it
asserted. “Indeed, the Association has focused its efforts on
developing pre-emptive practices that would make it unlikely that a
significant fails event would occur.”
That was in spite of warnings by Treasury Committee members themselves at
the end of 2005 that the chronic fails had begun to affect the
mortgage-backed and corporate bond markets. Trimbath believes that given that
a blind eye was turned to fails in the treasuries markets, that in turn
encouraged fails to deliver in the mortgage bond markets and to a lesser
extent the corporate bond market. “In 2004 the failure to deliver rate
for government agency MBS was 40%,” she says.
Significant fails in 2003 caused chaos for treasury market participants,
but still no penalty was introduced. In June 2003, the Fed Funds target
rate had been reduced to 1%. As the specials rate (a repo rate only for a
specific security) approached zero there was little incentive to borrow the
notes to cover short positions and failures. For five weeks, fails to deliver
in the treasury market were more than $1 trillion [meaning
$1 trillion “imaginary treasury” or “treasury IOUs”
were floating around the US financial system…]. The
consequences, admitted the BMA at the time, were “most particularly,
regulatory capital requirements imposed lost opportunity costs on dealers as
capital requirements increased. Firm personnel spent significant time in
back-office and industry-wide attempts to resolve fails. In addition,
customer relations became strained as fails to receive and deliver in
customer transactions increased.”
But despite the inconveniences of the fails, fears that stringent
prevention of fails to deliver would reduce profits deterred the market from
supporting Huther and his colleagues’ attempts at solution. “It
was politically difficult to convince the market to put a stop to fails to
deliver in treasuries,” claims one former Treasury employee.
“There were some forceful voices insisting that if the Treasury got
involved, they would take the incentives out of the specials market
altogether. Those making their living as specialist dealers, as well as those
making a living shorting securities outright, were worried about potential
supply changes which would eliminate trading opportunities for them.”
In 2002, Michael Fleming and Kenneth Garbade, now at the Federal Reserve
Bank of New York, reported that some market participants might indeed fail
“strategically”. They claimed that by failing to deliver bonds on
the initial sell order of a repurchase agreement, a broker-dealer can nearly
triple its net revenue in two weeks over what it would have earned in the
straight execution of the repurchase agreement, banking on interest rates
rising.
By simply enforcing delivery or deterring failed delivery by penalties and
forced buy-ins, this market manipulation could have been stopped.
The inaction has led to the build-up of $2 trillion in undelivered bonds. Moreover,
the number of fails is almost certainly higher than is being reported, claim
insiders, possibly substantially so. The $2 trillion in fails fell to
$1.3 trillion at the week ending 5 November, according to the New York Fed
but Trimbath points out this is only data volunteered by about 17 primary
dealers. The fail rate by those dealers in US treasuries hit 30% one week in
October. By 11 November it was still at 22%. “And what about the two to
three hundred bond dealers who settle through the DTCC? The DTCC does not
reveal publicly the fails to deliver there. Imagine the magnitude of the true
amount of fails to deliver,” she says.
The former Treasury employee also explains that the Fixed Income Clearing
Corp (part of the DTCC) started netting fails in 2005/06, whereby FICC uses
bonds due to a participant to offset bonds due from the same participant in
the same security. “The actual amount of true fails appears to be less,
therefore. You can’t compare the figures now with historical
fails.”
EuroMoney reports
about the solution of the US treasury market
breakdown: more incentives to lend, steeper financial penalties for failing
to deliver.
US
treasury market – The solution: more incentives to lend, steeper
financial penalties for failing to deliver
Tuesday, November 25, 2008
The Federal Reserve should now be running out of patience with industry
participants that have allowed fails to deliver to continue for as long as
they have [industry participants are running a ponzi scheme. If
the Federal Reserve takes away the ability to sell imaginary assets, the US
financial system and the dollar will collapse (this will happen anyway)].
Promises from market participants to reduce fails have not only been broken
– fails have in fact increased in number. [self-regulation
is an idiotic concept]
Jonas says: “From a macroecononic perspective, the Fed has to be
annoyed [doubtful. The fed created and encouraged this
problem through deregulation. If anything, the fed has to be scared out of
its mind about what will happen when the ponzi scheme it enabled (the US
financial system) collapses]. The repo market
is not here to help dealers make money. It’s how the Fed implements
monetary policy.” Perhaps, the Treasury will finally crack the whip. It
might have to.
The Treasury was forced to reopen some notes in the first week of October, a
response which is credited with reducing fails to the reported $1.3 trillion.
Such drastic action was also taken following 9/11 when cumulative fails to
deliver in treasuries hit $1.3 trillion from just $1.7 billion the week
before. The Treasury responded with a snap auction that brought daily average
fails back down to $63 billion by November that year. At that time, Treasury
under-secretary Peter Fisher warned that such responses would not happen
again and that the market should resolve the issue itself, although he
admitted “never is a long time”.
Investigations into broker behaviour in certain notes is at least under
way [Agreed]. On
November 7, the Treasury called for reports from entities with $2 billion or
more in two specific notes. These were to be submitted by November 14.
Both Sifma, and the Fed-sponsored Treasury Market Practices Group have been
rallying to offer a solution to the fails to deliver without formal
regulation.
The TMPG is comprised of market participants. Tom Wipf, chairman of the TMPG
and global head of institutional securities group financing at Morgan
Stanley, says the group was set up a few years back and is designed to deal
with treasury market issues before they get to the point of additional
regulation.
In November, the group recommended several changes. The first is a
financial penalty on fails [A penalty for selling imaginary
treasuries? Why in the world do that? (VERY heavy sarcasm)]. While
buy-ins are supposed to be enforced by the NYSE and Finra, up to now
penalties have been undefined [No penalties for
selling non-existent treasuries… I can’t even comment on this, it
is so wrong]. The new
recommended penalty is between 300bp and zero depending on the Fed Funds
target. “History has shown us that fails only occur in excess when
the Fed Funds target rate is near zero [ie: when there
is virtually no consequence to fail to deliver]. At
3% and beyond, fails are less frequent,” says Wipf. He
adds that the DTCC will be responsible for charging the dealers [The
DTCC is OWNED by the dealers. Dealers would just be paying penalties to
themselves]. The penalty should encourage lending
even in the low interest rate environment. At Sifma’s November 4
meeting, members pointed out there was little economic incentive to lend
securities when general collateral rates stood at 20bp and the penalty for
failing was zero basis points.
Sifma’s Toomey says the association is working with its members to
implement some of the suggestions made by the TMPG. “The fails are
steadily coming down but it can take time to find the bonds. We are looking
at best practices for preventing fails to deliver, but we think it is
important to take care not to limit liquidity by dampening shorting.”
The former Treasury employee says he believes penalties alone will indeed dry
up liquidity. “The chains involved in treasuries can often result in
fails if one party does not deliver,” he says. “If the penalty
rate is too severe then it will simply deter borrowing and lending of
treasuries, as parties will not want to open themselves up to fines for what
could be simply a result of counterparty failure or administrative
error.” [This is BS]
He suggests that alongside the penalty there must be a backstop supply that
the party that owes the fine can go to and pay for. This alternative supply
will encourage more lending initially and eventually will not be required
unless in extreme circumstances. TMPG is suggesting a backstop facility be
created in the future.
Jonas is less convinced, however, that the proposals will be sufficient. “The
300bp penalty does change the risk profile now so that some parties may be
tempted back in. The entire structure needs to be altered to be risk-free
before people will truly start to have confidence in the treasury market
again. There needs to be a government-guaranteed clearing mechanism like an
on-exchange, with cash settlements like we are with CDS. But then, it
won’t pay to be a dealer in that situation – their money is made
in providing liquidity and they will no longer be needed. But we are at the
point where change is needed, and I imagine in six months to one year the
settlement process will look very different.”
Trimbath is less optimistic that something will be done to prevent fails
to deliver from continuing. “This issue has gone unanswered for years.
What is going on is simple stealing. We don’t need new laws against
that, we already have them. If the Fed won’t step in, then the
Department of Justice has to. The problem is, however, that if delivery is
forced, then the real price of treasuries will be much higher to the point
where counterparties will go bust when they have to buy in. That’s when
the music stops.”
If nothing is done to correct prices, Trimbath says, investors will turn
their backs on debt markets as their confidence in benchmarks and pricing
deteriorates. Instead they might have to look to equity markets in their
pursuit of better returns [Same thing is going on in
equities and commodity markets]. Prices of
equities will rise and public companies will be able to return to equity
markets for financing. “But that assumes that broker/dealers also have
to deliver securities in the equity markets,” says Trimbath. Throughout
2008 it appears that has not been the case.
My reaction: The
settlement system for the US government bond market broke down last September.
1) Following the collapse of Lehman Brothers, fails to deliver in the US
treasury market rocketed to more than $2 trillion.
2) The number of fails is almost certainly higher than is being reported. For
one, the DTCC, used by two to three hundred bond dealers for settlements,
does not reveal publicly the fails to deliver there.
3) Also, the Fixed Income Clearing Corp (part of the DTCC) started netting
fails in 2005/06, whereby FICC uses bonds due to a participant to offset
bonds due from the same participant in the same security, making the actual
amount of true fails appears to be less. (The DTCC is doing the same netting
of fails in equity markets)
4) As with stocks,
dealers are able to sell treasuries without owning them.
5) After selling non-existent treasuries to their clients, dealers are
supposed to buy or borrow those securities. This is called “settling a
trade”, and it is what dealers are failing to do.
6) The supply of treasuries available to borrow through the repo market has,
in the past, been so bountiful that selling treasuries without owning them
was not considered risky by most traders.
7) The lending of treasuries in the repo market has largely stopped
occurring. The two main reasons are:
A) Investors in treasuries are largely risk-averse by nature and are not
going to risk lending them out in this environment.
B) With interest rates so low, there is no incentive to lend out treasuries.
8) Failure to deliver treasuries is not punished. At present, failing to
deliver incurs only a continued overnight interest rate, and so, with
interest rate near zero, there is no incentive to deliver a bond.
9) Fails have spread across to other bond markets such as municipals,
agencies, mortgage-backed and corporate bonds.
10) The US Treasury has merely asked for market participants to sort out the
situation themselves (because self-regulation has worked so well so far
(sarcasm)).
11) The natural balance of supply and demand has been altered and the true
price of treasuries has become obscured, as is the case in equity and
commodity markets.
12) If they realize they are being sold assets that do not exist, investors
might become nervous.
Conclusion: If this
isn’t enough to scare the hell out of you, nothing will. Below are the
absolutely key passages from articles above, repeated for emphasis.
Further
discouraging the supply of treasuries into the repo market is the very fact
that failure to deliver has not been punished. Huther and his colleagues were
never able to enforce a severe enough repercussion for failure. At present, failing
to deliver incurs only a continued overnight interest rate. When that
interest rate is close to zero, and the penalty for failing is zero there is
little incentive to deliver a bond.
This failure to deliver also has the effect of creating phantom securities
– a higher number in the system than actually exist. “In a sense,
the repo market is like a Ponzi scheme,” says Jonas. “If no
delivery is forced then that bond can be lent over and over again. One
security can underlie a hundred trades. So the amount of securities traded is
far more than exists. That is the way the world works today. If it
doesn’t break, that’s great. But when one link in that system
breaks, those trades have to be unwound...”
Trimbath,
however, is less sanguine about the impact that phantom bonds have on the
financial system. She compares the situation to musical chairs. “Who is
going to get the chair when the music stops? It’s not the individual
investor. I’ve seen positions just deleted from people’s
statements without investors even knowing as the security they supposedly
owned turns out to not exist. When push comes to shove, and the buy-ins
start, who will not receive their delivery? The individual investors or the
institutional clients who are more profitable for the broker/dealers?”
“These
undelivered treasuries represent unfulfilled demand – demand by
investors willing to lend money to the US government,” says Trimbath. “That
money has been intercepted by the selling broker-dealers. By selling bonds
that they cannot or will not deliver to the buyer, the dealers have been
allowed to artificially inflate supply, thereby forcing prices down. These artificially
low prices are forcing the US government to pay a higher rate of interest
than it should in order to finance the national debt. It shouldn’t take
a PhD-trained economist to tell you that prices are set where supply equals
demand. If a dealer can sell an infinite supply of bonds then the price is,
technically speaking, baloney. And the resulting field of play cannot be
called a market.
The
inaction has led to the build-up of $2 trillion in undelivered bonds. Moreover,
the number of fails is almost certainly higher than is being reported, claim
insiders, possibly substantially so. The $2
trillion in fails fell to $1.3 trillion at the week ending 5 November,
according to the New York Fed but Trimbath points out this is only data
volunteered by about 17 primary dealers. The fail rate by those dealers in US
treasuries hit 30% one week in October. By 11 November it was still at 22%. “And
what about the two to three hundred bond dealers who settle through the DTCC?
The DTCC does not reveal publicly the fails to deliver there. Imagine the
magnitude of the true amount of fails to deliver,” she says.
The former Treasury employee also explains that the Fixed Income Clearing
Corp (part of the DTCC) started netting fails in 2005/06, whereby FICC uses
bonds due to a participant to offset bonds due from the same participant in
the same security. “The actual amount of true fails appears to be less,
therefore. You can’t compare the figures now with historical
fails.”
Trimbath
is less optimistic that something will be done to prevent fails to deliver
from continuing. “This issue has gone unanswered for years. What is
going on is simple stealing. We don’t need new laws against that, we
already have them. If the Fed won’t step in, then the Department of
Justice has to. The problem is, however, that if delivery is forced, then the
real price of treasuries will be much higher to the point where
counterparties will go bust when they have to buy in. That’s when
the music stops.”
Broker/dealers can't sell their bonds to their brokerage customers, so they
are selling them imaginary treasuries instead. This is a sweet deal for the
broker/dealers, as they are effectively borrowing at a "risk free"
rate. The deal is a little less sweet for the brokerage customers, who are
unknowingly picking up a lot more counterparty risk then they bargained for.
Eric de Carbonnel
Market Skeptics
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