US treasury market – The mechanics: fear of counterparty failure has frozen the Treasury repo market

Although the catalyst that led to this record amount of fails in treasuries, spiking at $2 trillion, was the collapse of Lehman Brothers, it is the settlement system and lack of regulatory oversight that has led to this risk of market failure.

The treasury market has always been highly liquid. Dealers are able to sell treasuries without owning them, borrowing them in overnight through the repo markets in order to meet the T+1 delivery. The supply of treasuries into the repo market has, in calmer markets, been so bountiful that selling treasuries without owning them was not considered by most traders to be a concern.