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Treasury Market Practices Group Addresses Failure To Deliver
The flight to safety on account of the ongoing credit crisis has precipitated a sub-crisis in the repo market. Failure to deliver Treasuries on repos have increased dramatically. It is speculated that the low interest rates, and thus low penalties, create a disincentive for counter parties to deliver Treasuries in a repo transaction.
Treasury Market Practices Group Addresses Problems
The scarcity of US Treasuries for repo transactions also manifested itself in a sharp increase in the number of Treasury settlement fails. Whereas fails to deliver Treasuries had averaged around $90 billion per week during the two years preceding the crisis, they rose to above $1 trillion during the Bear Stearns episode and then soared to record highs of almost $2.7 trillion following the Lehman default. The extraordinarily low GC repo rates during this period exacerbated the problem by reducing the cost of failing.
Normally, the failing party would borrow the necessary security through a reverse repo to avoid failing. But when repo rates are close to zero, the interest rate earned overnight is below the cost to borrow the required securities, so there is no incentive to avoid failing (Fleming and Garbade (2005)). As settlement fails increased, investors who had previously lent out their Treasuries pulled back from the repo markets, as the low GC rates available were not enough to compensate for the risk that the securities might not come back. These dynamics have been recognised by the Treasury Market Practices Group, a body of market participants convened by the Federal Reserve Bank of
New York, which in November proposed several measures aimed at reducing the number and persistence of fails.
Source: Bank of International Settlements Quarterly Report
Relevant Links: Treasury Market Practices Group
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