The Broken Treasury Market

by: Felix Salmon November 25, 2008    
Felix Salmon

Felix Salmon

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If you want to worry about naked shorting, don't worry about the stock market, where it's vanishingly rare. Worry instead about the Treasury market, where it's a major problem.

Helen Avery has a huge and important story up about failures-to-deliver in the Treasury market. It's crucial that there be trust in the Treasury market, but right now, with fails reaching the trillions of dollars, the market is looking increasingly broken.

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.

The problem is that there's little incentive for brokers to deliver bonds they've sold but don't own, since the only penalty for failing to deliver is to pay the Fed's overnight interest rate, which is less than 1%. If that broker goes bust before it can deliver the bonds, then the person who thought they were buying Treasury bonds ends up with nothing but a few days' worth of nugatory interest.

The Bond Market Association seems to be the villain of this story, consistently pushing back against attempts to impose steeper penalties on brokers who fail to deliver Treasury bonds they've sold. And of course there's the general deregulatory trend of recent years, which has mitigated against new regulations. But this should be a top priority for Treasury and the Fed, now. This is not something to wait until January.

(HT: Matt Tubin)

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This article has 6 comments:

  •  
    Nov 25 12:42 PM
    Hmmmm, Felix, something smells fishy...
    Reply | Link to Comment
  •  
    Nov 25 02:40 PM
    "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." - Helen Avery article linked above


    Sounds like the precursor to a popping bubble in USDebt and/or the USDollar. When the doo-doo hits the fan, money will turn to the place it always goes when safety is paramount.

    Gold. Get yours now, before the rush starts.
    Reply | Link to Comment
  •  
    Nov 25 03:12 PM
    Feels like supply is too low to satisfy demand. Everybody and his dog is buying treasuries. Financial world is scared to death.
    Reply | Link to Comment
  •  
    Nov 25 03:56 PM
    militated.
    Reply | Link to Comment
  •  
    Nov 25 05:00 PM
    I prefer a stock of weapons, ammunition and other such necessities to expunge the fear of what-happens-if-the-us... crashes scenerio. Didn't the US Govt confiscate gold at one point? I also seem to remember this happened in Russia at the turn of the 20th century as well. Once you have 90 days food, water, medicine and weapons, you can and should go about your business and you'll let some of the unbridled fear go about the 'what ifs'. I have news for you, it's a chaotic universe and you should ALWAYS have these supplies handy for all eventualities.


    On Nov 25 02:40 PM Smarty_Pants wrote:

    > "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." - Helen Avery article
    > linked above
    >
    >
    > Sounds like the precursor to a popping bubble in USDebt and/or the
    > USDollar. When the doo-doo hits the fan, money will turn to the place
    > it always goes when safety is paramount.
    >
    > Gold. Get yours now, before the rush starts.
    Reply | Link to Comment
  •  
    Nov 26 10:32 AM
    "it's a chaotic universe and you should ALWAYS have these supplies handy for all eventualities." - iThinkBig

    True enough, but something of a veering off the topic of the USDebt markets' problems.
    Reply | Link to Comment
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