Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Treasury Trading Draws More Scrutiny

Continuing with the theme of previous TCM post NY Federal Reserve Calls for Meeting on Treasury Short Squeezes, The Wall Street Journal provides more details on possible Treasury supply manipulations in the October 30th 2006 article entitled Treasury Trading Draws Scrutiny. This article reports that The Securities and Exchange Commission ("SEC") is investigating whether UBS AG was involved in the improper manipulation of Treasury-securities prices and that a Credit Suisse Group bond repo trader, Mr. Thomas Brown, left that firm on September 29th over trading activity in the Treasury two-year note. A broad regulatory inquiry into trading in the Treasury market has quietly been unfolding for the last several weeks.

As the article reports, "Regulators have occasionally cracked down on Treasury-market misdeeds. In the early 1990s, Salomon Brothers was caught skirting rules at Treasury-bond auctions, and its top executives -- some of Wall Street's most prominent figures -- were forced to step down. A Goldman Sachs Group Inc. economist was jailed for relaying an insider tip about Treasury bonds in October 2001 that allowed Goldman to earn millions of dollars in trading profits. It isn't clear whether the current probe will lead to such serious fallout. 'UBS is cooperating in the government's investigation,' a spokesman for the firm said."

The article speculates that the UBS activity under review concerns the February 2006 trading in the Treasury five-year note due in 2011. During the period under review, the repo rate for loans collateralized by that particular security plunged to as low as 0.25%, much lower than the prevailing rate at the time that was more than 4%. By hoarding such securities and lending them to other investors who are short the securities, trading firms and investors could collect this differential as long as the Treasury securities remain in short supply.

There are numerous reasons about why a particular Treasury security might 'go on special' in the repo markets. Sometimes, there is very active customer buying in the current liquid Treasury security as the market rallies. At other times, some foreign investors (like governmental authorities and central banks) buy and hold large amounts of Treasury securities, thereby sharply reducing the supply of securities available for lending purposes.

However, many observers speculate that large firms (on both the buy-side and sell-side) and their traders engage in trading strategies that influence Treasury prices to their short-term advantage. As Michael Basham, who oversaw the Treasury's debt-management activities during the Salomon affair, says, "The games haven't changed in 15 years." Toomre Capital Markets LLC hopes that today's young traders will heed the lessons of the past and continue to scrutinize their activities so that there are not more short-squeezes and headlines like those in the Paul Mozer and Salomon Brothers affair.