Stand and delever

Every credit market we turn to seems to be fracturing. Even the most fundamental.

Take a look at these numbers from jck at Alea:

Repos Fails
U.S. Treasury Securities
to receive:$2.5 trillion
to deliver: $2.3 trillion

There is a huge demand for US Treasuries among banks. But the main mechanism for providing those liquid treasuries - repo agreements whereby banks swap Treasuries for cash - is failing.

What the above numbers mean is that $2.5 trillion dollars of Treasury securities failed to arrive in the accounts of institutions when they were supposed to, and $2.3 trilllion of Treasury securities failed to leave the accounts of institutions when they were supposed to.

The numbers differ because only primary dealers report the figures. If a primary dealer is supposed to lend to another primary dealer, then both sides of the failed exchange show up - one reports a failure to deliver, the other a failure to recieve. But in a repo where a primary dealer lends to a non-primary dealer client, for example, only a failure to deliver would be reported.

The latest numbers then, point to the fact that Treasuries aren’t being returned to primary dealers. Putting it all into perspective, here’s a graph of historical repo failure rates from Michael Cloherty at Bank of America:

The ‘01 and ‘03 spikes wrought havoc in their own right. This week’s spike is catastrophic.

The bottom line is that financial institutions are hoarding cash or cash-like liquid securities. They’re anticipating a huge liquidity squeeze.

Today’s Lehman CDS auction is almost certainly the major driver of that.

Banks are thus not returning treasuries on time to the primary dealers. In return, that has the primary dealers cutting back on lending out the treasuries in the first place, exacerbating the problem.

That explains why the Fed’s money market operations aren’t being fully utilised. Primary dealers aren’t taking the Treasuries because they’re not lending them out.

The basic market for the world’s most liquid securities is falling into a terrifying liquidity trap.

With more huge CDS auctions looming, this won’t abate after Lehman’s auction today.