The Debts Of The Spenders: Naked Treasury Shorts And Failures To Deliver

There is an incredible amount of naked shorting of Treasuries.

You have to look at failures to deliver since they are the root of the problem. Until the Treasury implements a real "penalty" for treasury holders (aka primary dealers) that refuse to surrender their bonds in a timely manner then there will be no fix.

Paulson won't investigate the problem b/c he knows that the banks have been playing an arbitrage game against the slight fees and penalties they incur. In fact he and Bernanke are ENCOURAGING it as part of their quantitative easing policy.

To see why we must examine repos. A repo is essentially an unsecured "loan" or promise backed by nothing more than the primary dealer's "full faith and credit" to deliver the asset in a timely manner. (Sounds suspiciously like Uncle Sam? Where else did you think the big boys learned such irresponsible behavior from?)

To understand why the repo market is malfunctioning we have to examine the "I know it when I see it" test made famous by Justice Potter Stewart of the Supreme Court when he tried to explain "hard-core" pornography, or what is obscene, by saying, "I shall not today attempt further to define the kinds of material I understand to be embraced . . . [b]ut I know it when I see it . . . Jacobellis v. Ohio, 378 U.S. 184, 197 (1964).

In other words something funny is going on in Wall Street. But then again something funny is ALWAYS going on in Wall Street. The question we have to ask ourselves is "Exactly how does Wall St benefit from delayed deliveries of Treasuries?"

The repo market is suffering from a liquidity crunch w/all kinds of maturities - not just bills. In fact I am going so far as to say that many of the primary dealers would become de facto insolvent if they were to honor their obligations RIGHT NOW.

Even the new treasury auction schedules won't help for 3 and 7 year notes. It's the REPO market that matters and repo buyers want the paper that they are familiar and comfortable with - not something that has unknown liquidity.

The result is that most treasury funds have simply stopped accepting new clients. W/interest rates so low the fund managers are squeezed for fees and can't legally justify dipping into the investors' principal to pay themselves.