Treasury Hoarding Leads to Dramatic Increase in Repo Fails

Today’s Bloomberg provides yet another example of how the credit crisis is producing behavior well outside historical norms. We had noted, courtesy Alea, that fails in the repo market had reached “massive” levels.

The explanation? A lot of Treasuries are now held by investors who aren’t willing to lend them (this is often due to simple lack of experience, plus retail buyers having failed to authorize the account to lend securities). I wonder if this has the potential to complicate the operation of the Fed’s new facilities designed to unfreeze the mortgage market. The Fed may be running into constraints beyond the size of its balance sheet (note technically it can make its balance sheet larger, but those operations would be “unsterilized” or inflationary).

The scarcity of Treasuries for repos means that buying for repoing will also lead Treasury prices to rise and yields to plummet, which is one reason why three month bills traded at an 50 year low of 0.56% yesterday and a stunning 0.39% today, a rate last seen in 1954.

Since bill prices are used as the input into other pricing models (most notably the Black-Scholes option pricing model), the distortions in the Treasure market have the potential to feed into other markets (we’ve already seen problems with new issue bond pricing due to sharp increases in spreads and blow-ups of correlation models in the credit default swaps market).

From Bloomberg:

Surging demand for U.S. Treasuries is causing failures to deliver or receive government debt in the $6.3 trillion a day market for borrowing and lending to climb to the highest level in almost four years.

Failures, an indication of scarcity, surged to $1.795 trillion in the week ended March 5, the highest since May 2004, and up from $374 billion the prior week. They have averaged $493.4 billion a week this year, compared with $359.6 billion over the last five years and $168.8 billion back through July 1990, according to Federal Reserve Bank of New York data.

Investors seeking the safety of government debt amid the loss of confidence in credit markets pushed rates on three-month bills today to 0.387 percent, the lowest level since 1954….

“It shows you the kind of anxieties that are going on and the keen demand for Treasuries,” said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York. “The rise in fails tells us about the inability of dealers to obtain Treasury collateral.”

In a repurchase agreement, or repo, a customer provides cash to a dealer in exchange for a bill, note or bond. The exchange is reversed the next day, with the customer receiving interest on the overnight loan. A Treasury security is termed on “special” when it is in such demand that owners can borrow cash against it at interest rates lower than the general collateral rate.

The Treasury Department cautioned dealers in January to guard against failing to settle in the Treasury repo market as interest rates fall. It cited periods of such failures to receive or deliver securities, known as `fails’ in the repo market, earlier in the decade when rates dropped.

The difference between the rate for borrowing and lending non-specific Treasury securities, or the general collateral rate, has averaged 63 basis points below the central bank’s target rate for overnight loans this year. The spread has averaged about 8 basis points the past 10 years.

Overnight general collateral repo rates have traded lower than the Fed’s target rate for overnight lending every day this year. The rate on general collateral repo closed today at 0.9 percent, according to data from GovPX Inc., a unit of ICAP Plc, the world’s largest inter-dealer broker, compared with 1.25 percent yesterday. Today’s rate is 1325 basis points below the Fed’s target rate for overnight lending of 2.25 percent.

Investors’ unwillingness to hold privately issued mortgage- backed bonds amid record home foreclosures sent premiums on even Fannie Mae and Freddie Mac guaranteed assets to the highest in 22 years earlier this month. The two government-chartered companies are the biggest sources of U.S. housing finance.

The current rise in Treasury fails is similar to increases that occurred in August 2003, said George Goncalves, chief Treasury and agency strategist at Morgan Stanley in New York.

“At that time, short positions in U.S. Treasuries were building but interest rates were declining, and that led to a pick up in fails as a result,” Goncalves said. “It seems like we have a repeat in the making. This also explains why the repo markets are in flux.”

Treasury fails rose to a record $3.244 trillion in the week ended Aug. 20, 2003, the highest to date through July 1990, or as far back as the New York Fed tracks the data on its Web site. For the month of August 2003, the weekly average was $2.751 trillion.

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  1. Yves Smith

    Anon of 6:15 PM,

    The Bloomberg front page (“most viewed stories”) linked to the Feb 4 piece. I’ve corrected the link to the March 20 story.

    Anon of 6:33 PM,

    This is so out of bounds of normalcy that I’m not certain. The article suggests that a lot of Treasuries are now in the hands of players who aren’t used to repoing them (and it also may be inefficient, say if you have a customer of a high-net-worth investment service, like Citigroup’s Citigold or a private banking customer. It may not be practical for dealers to try to hoover them up from people who own fewer than a few million).

  2. Anonymous

    The rate on the three-month bill, viewed by investors as a haven in times of trouble, dropped 32 basis points, or 0.32 percentage point, to 0.56 percent at 5:30 p.m. in New York, according to bond broker Cantor Fitzgerald LP. It’s the lowest level since May 1958.

    2. The stock market going up, which increase the P/E of the indexes, which reduces the index yield, which implies that some people are willing to buy overvalued stocks, while the rest of investors take shelter for Katrina.

  3. Yves Smith

    Anon of 7:00 PM,

    Sometime Blogger is weird in how it loads changes, it looks OK to me now.

  4. Anonymous

    “Treasuries’ Scarcity Triggers Repo Market Failures (Update1)”
    [ March 20 (Bloomberg) — Surging demand for U.S. Treasuries is causing failures to deliver or receive government debt in the $6.3 trillion a day market for borrowing and lending to climb to the highest level in almost four years.

    Failures, an indication of scarcity, surged to $1.795 trillion in the week ended March 5, the highest since May 2004, and up from $374 billion the prior week. They have averaged $493.4 billion a week this year, compared with $359.6 billion over the last five years and $168.8 billion back through July 1990, according to Federal Reserve Bank of New York data. ]

  5. Anonymous

    The time has come
    for creative fiscal policy measures that address imbalances that are beyond
    Fed influence. Inaction could counteract the progress that the Fed actions
    have achieved and result in a significant and prolonged period of economic
    woe,” agree experts Ward McCarthy and Nancy Vanden Houten of Stone &
    McCarthy Research Associates (SMRA).

  6. Anonymous

    ” The Fed may be running into constraints beyond the size of its balance sheet (note technically it can make its balance sheet larger, but those operations would be “unsterilized” or inflationary).”

    This idea that there is a limit to the FEDs balance sheet operations is absurd. Of course the FED can issue sterilization bills to offset collaterals they finance. There is no limit to the FED’s balance sheet and it doesn’t have to be inflationary if the FED sterilizes.

  7. Yves Smith

    The Fed has another $300 to $400 billion it can play with before it runs into liability constraints. To go beyond and not engaged in unsterilized operations, it would have to issue bills or bonds. The Fed has never done that, and (not having studied its governing rules in toto) I am not sure how it could go about doing that (ie, what authority it could invoke, what approvals would be required).

    More important, the sort of operation you suggest has been undertaken ONLY by third world central banks in a financial crisis. I doubt the Fed wants to wave a red flag saying we are in the same straits as Thailand or Indonesia circa 1997 (although I have made that comparison before). That very action has high odds of triggering a dollar rout.

  8. Anonymous

    I am interested in opinions on the following in regard to the discussion here related to Treasury three month bills trading at a 50 year low of 0.56%. Does anyone see any issues that might be of interest in terms of how that rate might impact profit?

    From USB:

    At December 31, 2007, investment securities, both available-for-sale and held-to-maturity, totaled $43.1 billion, compared with $40.1 billion at December 31, 2006. The $3.0 billion (7.5 percent) increase reflected securities purchases of $9.7 billion partially offset by securities sales, maturities and prepayments. Included in purchases during 2007, were approximately $3.0 billion of securities from certain money market funds managed by an affiliate of the Company. These securities primarily represent beneficial interests in structured investment vehicles or similar structures and are classified as asset-backed securities within the consolidated financial statements.

  9. Anonymous


    If you want to characterize China as a third world banana case go ahead. But thats precisely what the PBOC has been doing. Issuing sterilization bonds is a pretty basic central bank operation.

    We are in the midst of the most severe debt deflation the US has encountered since the great depression. The FED is thinking outside the box and I suggest you should also.

    Due respect and all.

  10. Yves Smith

    I do consider China to be a third world country. They are now in a terribly conflicted position on number of fronts due to ill thought out policies (example: banks can only pay interest rates of less than 1% to retail customers. With inflation around 7%, everyone has piled into the stock market. At first, the powers that be wanted stock prices to fall because they were clearly a bubble, but now that the fall is accelerating, they are trying to put on the brakes, since savings are being destroyed and they risk social backlash).

    I was at a recent set of presentations at the Asia Society (and mind you, these were all by people who work in China in prominent advisory positions for Western firms and are effectively long China via the positions they hold, meaning you’d expect them to be loath to say bad things). One drily remarked that if he wanted to guarantee hyperinflation, he’d use policies like the ones the Chinese have implemented. I would not look to them as a model of sound financial practice.

    As I have said before, first, this problem is bigger than the Fed. This will not resolve until housing prices fall to a level that can be supported by prevailing incomes.

    Trying to prop up asset prices, particularly on this scale will simply not work. Japan is the only modern case where that happened to a degree, and all they did was delay the reckoning and they still got denflation (I have a recent set of notes from a high level buddy in Japan who conducted some interviews of top officials. Their view is, contrary to the conventional wisdom in the West, that more aggressive easing in the early 1990s would not have made much of a difference in outcomes. The banking system was bankrupt, and the real obstacle to reflating was that it took time to persuade the public to support measures to recapitalize them. Remember, the Japanese do not share their dirty laundry, so I doubt any analyst here knows the full extent of the hole in the Japanese banking industry’s balance sheet circa 1992, although Alicia Ogawa and David Asher have taken some stabs at it).

    And Japan had (and still has) very high savings rates, so they could handle their crisis internally. We don’t have that luxury.

    Once investors have some confidence that prices have bottomed, capital which is on the sidelines (including the vast sums overseas) will re-enter the market.

    Second, the Fed’s actions are backfiring (we’ve written at length about this). Even the editorial page of the Financial Times has called on the Fed to do less.

    The answer is not to save markets that cannot be saved, but to alleviate the damage to individuals via fiscal measures. This is the place to get creative, not in the “how do we prop up housing and related debt at unsupportable levels.”

    Third, we have argued for regulatory reform to encourage greater confidence in instruments and institutions, but not much effort has been expended in that direction.

    There are some problems that do not have good solutions, only bad and less bad. I argued earlier that the example of past housing busts (in countries that suffered 20+% declines) was that they had very bad recessions that were comparatively short (2 years-ish). We need to get over trying to save the housing market and the related debt. Others have been down this path and survived, albeit with a good deal of pain.

  11. Yves Smith

    To clarify: two years is not short for a recession, but it is far shorter than what Japan suffered fighting the tape.

  12. Francois

    If, as Yves said:
    “As I have said before, first, this problem is bigger than the Fed. This will not resolve until housing prices fall to a level that can be supported by prevailing incomes.”

    Real incomes are still declining as of now. This means that prices have a long way to fall before situation normalize.

    And we consider this data point from Fitch:

    “Roll rates for 2008 vintage subprime first liens are significantly higher than in previous vintages; those roll rates are provided in the graph to the right. Roll rates capture the number of loans moving from current to delinquent each month — and the graph shows that 2007 vintage loans are rolling into default at a greater than 4 percent rate. Per month. Every month. Consistently. And that only includes originations through the third quarter of last year, to boot.” [Emphasis mine]

    Then I cannot see how in the world we could have a recession that goes on for only 2 years.

    Perhaps we’ll be lucky if we get out of this in 2011. And let’s not forget that short of smart intervention by the federal government, like realizing, AT LAST,that our infrastructure needs at least a trillion in investment for repair and that btw, this could help putting tons of idle hands to work, then society as a whole will suffer.

  13. Yves Smith


    Agreed this could be of longer duration (especialy if badly managed), but remember that wreckage in the housing market does not go in lockstep with GDP growth. The 1990-1991 recession was also accompanied by housing recession that started before the GDP fall kicked in. Housing prices took 15 quarters to bottom. Although I am not sure what the official duration of the recession was, the subjective experience was that it was short and severe (18 months; I’m highly confident the official stats don’t say anything remotely like that). So last time we went through anything like this, the duration of the recession was much shorter than the duration of the decline in housing prices.

    Having said that, the wild card is that consumers are much more overextended than then…..

    The precedents for the 20+% housing decline were other countries who had worse housing markets around that time.

  14. Rich_Lather

    Has anyone considered the mass of baby boomer-soon to retire 401-k/IRA folks who are not economics junkies, trying to save what they have in a secure asset? They’re not rich, individually, but as a mass, they must surely have an effect on the markets.

    How does the power of many children of Depression era parents compare to a rich Saudi prince or a few families in Manhattan?

  15. David Pearson


    What you propose is different from the intent of the PBOC program, which is to manage the level of the Remimbi.

    Sterilization bond issuance would in effect create a “bank” taking in funding to lend against specific types of securities — much like a mortgage REIT. The intent is not to be a “lender of last resort” against systemic illiquidity. Rather, it is to support the prices of a class of instruments held by certain types of insitutions — mainly broker dealers and hedge funds. This is “first resort” lending, not “last resort”.

    The problem with such “first resort” lending is, of course, how you remove it. Withdrawal is bitch, to be blunt. As has been the case repeatedly in recent years, the Fed is too busy reacting to think about the longer term consequences of its actions.

  16. Anonymous

    8:19, Per David, I have to think the debt and currency market reaction would be unpredictable at best to something like that….and it could be really negative, which would make things worse than if the Fed stood aside.

  17. James


    Your point on bankruptcy is the one thing I have been saying to everyone. The US banking system is bankrupt and we still aren’t admitting it. The problem is that we are far less socialist than japan and doing a recapitilization will tear US to pieces.

  18. David Pearson

    Just on other thing on sterilization bonds: many third world countries that I can think of did NOT resort to financing bad debt through the Central Bank. Mexico’s ’95 Forbaproa scheme, for instance, was financed off of the federal budget. Argentina did not, to my knowledge, instruct its Central Bank to buy up defaulted dollar debt, of which there was plenty to be had. Two cases of extreme financial crises where the Central Banks of those countries showed enough independence no to intervene.

    So, my question to the sterlization bond boosters is this: did those countries screw up? Should their Central Banks have been more “innovative” and “creative”?

    I’ll provide my own answer: they didn’t intervene and buy bad debt because to do so would have jeopardized further the confidence in the currency.

  19. Yves Smith


    Forgot to address your comment. The concentration of capital in the hands of governmental entities is unprecedented and presents a challenge to investing will operate. This comes from the summary of a McKinsey Global Institute study released last fall:

    In terms of dollars in hand, the tripling of world oil prices since 2002 has made petro-investors the largest of the four new power brokers. MGI estimates that oil investors have between $3.4 trillion and $3.8 trillion in foreign financial assets. Close behind are the Asian central banks, with foreign-reserve assets of $3.1 trillion—the results of soaring trade surpluses, significant foreign investment in the region, and exchange-rate policies.

    Note those figures do not include Norway’s SWF.

    By contrast, total retirement assets (defined benefit plans, 401 (k)s and other self directed plans) are about 85% of GDP, or $11.6 trillion. The SWF assets are growing at a faster rate than US retirement assets.

  20. Anonymous

    What is the consequence of the failure to deliver? If there are are $1.795 trillion of a failures a week, and it is hardly mentioned then it seems like it cannot be that big a deal. Does it indicate that Federal Reserve Notes and short term treasuries are essentially equivalent now?

  21. FairEconomist

    Yves, what housing recessions produced short sharp recessions? Do you have links to your discussions? That’s the opposite of what I expect.

  22. Yves Smith


    Thanks for asking. I love it when I get to recycle old posts. This comes towards the end of one in August last year:

    The housing recession of the early 1990s was far worse overseas…..

    “In the late 1980s and early 1990s, the United Kingdom, Finland, Norway, and Sweden experienced peak to trough falls in prices of greater than 25 per cent. Sharper falls have been observed in some South and East Asian economies over the 1990s, particularly in Hong Kong and Japan.”

    ….yet despite Gross invoking the specter of the Depression, these economies suffered only short, nasty recessions. UK GDP fell 2.5% in 1991 and 0.5% in 1992.. According to NATO, Finland had a steeper fall because its contraction was caused by economic overheating, depressed foreign markets, and the dismantling of the barter system between Finland and the former Soviet Union under which Soviet oil and gas had been exchanged for Finnish manufactured goods. Thus its fall in housing prices was more a consequence than a cause of its recession. Sweden similarly suffered from disruption of its trade relationship with the former USSR. Hong Kong has enjoyed high growth and volatile real estate prices, but the only year it had negative GDP growth was 1998, the year after its reunification with the mainland, when it suffered a major capital flight.

    So while these economies all have different structures than the US, their experience nevertheless suggests that even severe housing recessions do not inflict long-term damage. I’d very much like to hear the views of those who have studied the international record more deeply, but this quick survey suggests the price of a housing recession is a sharp but short-lived real economy contraction.

    The post continued with a discussion of the bust in Japan, if you are curious. Any comments appreciated.

  23. a

    “bill prices are used as the input into other pricing models (most notably the Black-Scholes option pricing model)”

    Don’t think so, but this is a very good and interesting theoretical question! I think you’re assuming that this is the “riskless” interest rate, which is what the option model supposedly calls for. But in fact the model is based on arbitrage of delta hedging, and in delta hedging the relevant interest rate is the one available to the bank. That is, if I sell a call on a stock, I need to buy stock and finance; I don’t finance this at the riskless rate (as much as I would like to!), but at the rate my bank borrows.

    I guess this is most easily seen with future prices. If I were to use the riskless rate when selling an index future say and buying and holding the underlyings, I would be selling the future too low and be locking in a loss, because my actual rate of financial the buys would be much higher.

    So if there is any bank actually using the riskless rate in their prices, please post their name.

  24. Yves Smith


    Thanks. This is one reason I have studiously avoided doing anything that involves Black Scholes. The model has several assumptions that trouble me (they are not observed in the real world) and per your comment, as a result, the inputs used aren’t the ones the model calls for.

    Which in my mind means it works as long as everyone respects the conventions, but those conventions seem awfully subject to breakage.

  25. FairEconomist

    Yves, thanks for the info. There’s entirely too much rhetoric and too little data in all theses discussions. In spite of the vast amount of discussion I’ve seen on the housing bubble, this is the first reference I’ve seen to the foreign 90’s crashes, which I agree seem plausible as analogues. Besides the scale and housing foci, another point of similarity is that the late-80’s boom was partly driven by low interest rates dropped to save the world economy from a stock market crash.

    I’m a little late to the bubble, but I’ve read an awful lot on this and it’s pretty shocking these examples aren’t leading the discussion. Everybody discusses Japan, and I agree with you that that was a far more extreme situation, with a larger RE bubble coinciding with a monster stock bubble. I say it’s extreme foolishness to confront this crisis blind, without benefit of prior experience, yet that seems the current process.

    The one issue I’m concerned with is whether the financial system has more exposure in the US than in the 90’s examples. I know the UK in particular has led us in mortgage “innovation” and maybe they had lots of 5% or no down mortgages in the 1990’s. Or maybe not. Another thing to research. I think they would have been more exposed in terms of DTI since housing costs have long been higher there.

    I do have to disagreee with your evaluation of the UK recession as “short”. 2 years of negative GDP growth is a long recession, IIRC worse than anything the US has seen since 1945 except 1981-3. That’s actually a honker of a recession. But, it’s not a depression, and not a threat to the existence of the economic system.

  26. FairEconomist

    Replying to myself, it looks like the UK at least may not be a good analogue. According to the Independent, the UK housing crash peaked with negative equity of 1.5 million, delinquent payments of 350,000 and foreclosures of 75,000. Given the UK housing stock of 13 million owner-occupied residences, the 12% negative equity is within the range of current estimates for the US but the delinquency rate (2.7%) is lower than the current US rate of 4.7% and the foreclosure rate (0.6%) is low even for ordinary times in the US. Current US annual foreclosure rates are already to 3.3% or more than 6 times as bad, and we almost certainly haven’t seen the worst yet.

    Assuming the loss per foreclosure is similar, the US financial system will take something like 10 times as many losses as the UK did. More of that will go abroad or to investors but it’s still a much bigger hit on the banks. So if the UK hit produced a severe recession, we may very well be looking at something worthy of the term “depression” – although I still think it will be nothing like Japan in the 90s.

  27. Yves Smith


    Thanks for the update. I suspect the differences result from:

    1. More than half of the recent-vintage subprimes being “cash-out refis” meaning the mortgage was sucking more equity out of the house. Cash-out refis are often the last resort of people who are overextended.

    2. Much higher equity extraction among all borrowers due to home equity loans (if memory serves me right, they were a new product 20 years ago, and I would suspect not common in the UK then either)

    3. Few loan mods today. The servicers lack the incentives and the skills to do them. In the old days, it was a given that banks went to some lengths to keep the owner in place.

    Even though that may mean a worse recession than the precedents, I don’t see trying to prop up the markets as remotely viable. Unlike Japan, we lack the savings to execute an internal resolution, and I can’t imagine our foreign creditors will supply enough capital, particularly as our slowdown hits their economies. It would be politically a non-starter.

  28. vlade

    going back to the repo failures, it’s interesting to see how the over-subscription of UK bills went up in the last few weeks. The auction on the 7th was oversubscribed about twice (for 1M bill), on 13 it was oversubscribed 4.2 times, but on 20th it was oversubscribed over 7.1 times! 3M went from slightly over 5 to slightly over 8.

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