Financial thoughts

The Treasury Department is reviewing the trading of two- and five-year notes after a scarcity in U.S. government securities triggered by the credit crunch led to a record level of failed transactions.

The probe comes two days after Karthik Ramanathan, the acting assistant secretary for financial markets, told bond dealers to fix chronic settlement problems or submit to tougher regulation. The Treasury has conducted at least nine such reviews, known as “large position reports,'' to monitor trading and guard against market manipulation since 1997.

The overnight repurchase, or repo, agreement rates for two- and five-year notes have traded at about 0.05 percent since the start of October, among the lowest of all Treasuries. When demand for a security rises, traders lend cash at a wider spread below the federal funds rate to obtain the needed securities, charging even zero interest at times. Failures to deliver or receive all Treasuries in the repo market climbed to a record $5.31 trillion in the week ended Oct. 22.

“The Treasury is very concerned and wants the market to be fluid and liquid,'' said E. Craig Coats Jr., co-head of fixed income at Keefe, Bruyette & Woods Inc. in New York. “They are looking at these position reports from the standpoint that if you have one person that is just hoarding a security and disrupting the market, then the Treasury is going to have a conversation with them to find out why and encourage them not to.''

`Elevated Level'

The Treasury asked for information on the 2 percent note maturing Sept. 30, 2010, and the 3.125 percent note maturing Sept. 30, 2013. Bond dealers or investors with “reportable positions in either of these notes equal to or exceeding the $2 billion threshold must submit a separate report for the security to the Federal Reserve Bank of New York'' before noon on Nov 1000 cash advance. 14, the Treasury said in a statement released in Washington.

“The request for information this morning pertains to the elevated level of fails to deliver in these particular securities for a prolonged period of time,'' Treasury spokeswoman Brookly McLaughlin said. “This request is another way, beyond speaking with market participants, to ensure that Treasury understands current market conditions.''

The large position reporting program was established in 1996 in the aftermath of the Salomon Brothers bond market scandal. The confidential reports requested today are for positions held on Nov. 6 at the close of business. McLaughlin declined to comment on the results of previous position reports.

Trading Fails

Failed trades, or “fails,'' have been a problem since 2003, when supply shortages first collided with the technical effects of low interest-rate levels.

“The Treasury is definitely interested in putting an end to these trading failures,'' said Bulent Baygun, head of interest-rate strategy in New York at BNP Paribas Securities Corp., a unit of France's largest bank. “There isn't a whole lot that they can do besides reopening issues and they expressed this week a big aversion to'' doing that.

Securities that can be borrowed at interest rates close to the Fed's target rate are called general collateral, while those in the highest demand are called “special'' by traders because rates on loans secured by these securities are lower.

The overnight general collateral repo rate was 0.25 percent today, which match where the overnight fed funds rate traded. The central bank's official target rate for overnight loans is 1 percent.

Source