Ah, the US keeps inching its way into the behaviors of post-bubble Japan. The latest pending regulatory move it to reduce failures to deliver securities in the Treasury repo market, a vital source of short-term financing for banks and broker dealers. But the remedy under consideration would lead to negative rates on some repos. a rare occurrence in the US but relatively common in deflationary Japan.
From Bloomberg:
Treasuries are in such high demand that investors are lending cash for next to nothing to obtain the securities as collateral through so-called repos, which dealers use to finance their holdings. The problem is many parties involved in repos aren’t delivering the bonds because there is no penalty for not doing so, causing “fails” to exceed $5 trillion…Now, an industry group is trying to fix the mess, which New York Fed Executive Vice President William Dudley said could cause the U.S. borrowing rates to rise if not rectified. The Treasury Market Practices Group wants to impose a “penalty” on failed trades, a move that may result in borrowers who put their Treasuries up as collateral for loans effectively receiving 2 percent interest.
“This is an extraordinary thing to perceive for a market of the size and significance of the U.S. repo market,” said Lena Komileva, an economist in London at Tullett Prebon Plc, the world’s second-largest interdealer broker…
“The more chronic fails disrupt the Treasury market, the more it reduces its liquidity and efficiency,” Dudley said in a Nov. 12 interview. “Over time, this could have some negative consequences for the ability of the U.S. Treasury to raise money at the lowest cost possible. Reduced liquidity also affects other markets as the Treasury market is used to hedge positions in other security classes.”…
Yves here. Something tells me this is not the real reason, but I do not know this market well enough to divine what the real reason might be. Reader input invited.
Back to Bloomberg:
In a repurchase agreement, one party provides cash to another in exchange for a security, and vice versa. …Since the bankruptcy of Lehman Brothers Holdings Inc. in mid-September traders, investors and dealers have been willing to lend cash to obtain Treasuries at almost zero interest…
Repo trades go uncompleted when it’s difficult to obtain the securities or the cost to get them becomes too expensive. Fails aren’t usually considered a breach of contract and the parties involved typically keep re-scheduling delivery…
“A negative rate repo is somewhat counterintuitive as basically, a lender is not only lending money, but paying a borrower to take that money,” said Robert Toomey, managing director of the Securities Industry and Financial Markets Association, a New York-based trade group. “The borrower has something, in this case a particular security, that the lender really wants. It’s essentially paying a premium to get a particular security.”
Negative repo rates have happened before. The Bank of Japan’s decision to adopt a zero interest-rate during the “Lost Decade” of the 1990s because of deflation and a protracted banking crisis triggered the phenomenon for Japanese government debt. Rates less than zero surfaced in the U.S. in 2003, when the Fed’s target fell to 1 percent and traders sought to cover bets against 10-year Treasuries after their yields jumped more than a percentage point in about a month….
“For certain sectors of the Treasury curve, such as the short-end, the implementation of negative repo rates would provide a significant kick to the market,” said Ira Jersey, an interest-rate strategist at Credit Suisse in New York. “Yields have room to fall further, with the front end outperforming the long end.”.
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John Jansen from Across the Curve, who traded Treasuries for a long time, has a possible explanation:
Several market participants with whom I speak suggest that the problem resides with several large central banks and who have chosen not to lend securities in the repo market. If those entities could be cajoled into lending again it would take quite a bit of pressure off the market.
This is plausible, and it passes the smell test: “is this action beneficial for U.S. financial institutions?” Our foreign creditors gotta just love us.