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US treasury market – The solution: more incentives to lend, steeper financial penalties for failing to deliver

The Federal Reserve should now be running out of patience with industry participants that have allowed fails to deliver to continue for as long as they have. Promises from market participants to reduce fails have not only been broken – fails have in fact increased in number.

Jonas says: “From a macroecononic perspective, the Fed has to be annoyed. The repo market is not here to help dealers make money. It’s how the Fed implements monetary policy.” Perhaps, the Treasury will finally crack the whip. It might have to.

The Treasury was forced to reopen some notes in the first week of October, a response which is credited with reducing fails to the reported $1.3 trillion. Such drastic action was also taken following 9/11 when cumulative fails to deliver in treasuries hit $1.3 trillion from just $1.7 billion the week before. The Treasury responded with a snap auction that brought daily average fails back down to $63 billion by November that year. At that time, Treasury under-secretary Peter Fisher warned that such responses would not happen again and that the market should resolve the issue itself, although he admitted “never is a long time”.

Investigations into broker behaviour in certain notes is at least under way. On November 7, the Treasury called for reports from entities with $2 billion or more in two specific notes. These were to be submitted by November 14.

Both Sifma, and the Fed-sponsored Treasury Market Practices Group have been rallying to offer a solution to the fails to deliver without formal regulation.

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