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When the back office moved to the front burner: settlement fails in the treasury market after 9/11

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Author Info

  • Michael J. Fleming
  • Kenneth D. Garbade

Abstract

Settlement fails, which occur when securities are not delivered and paid for on the date scheduled by the buyer and seller, can expose market participants to the risk of loss due to counterparty insolvency. This article examines the institutional and economic setting of the fails problem that affected the Treasury market following September 11 and describes how the Federal Reserve and the U.S. Treasury responded. The authors explain that fails rose initially because of the physical destruction of trade records and communication facilities. Fails remained high because a relatively low federal funds rate and investor reluctance to lend securities kept the cost of borrowing securities to avert or remedy a fail comparable to the cost of continuing to fail. The fails problem was ultimately resolved when the Treasury increased the outstanding supply of the on-the-run ten-year note through an unprecedented "snap" reopening. The article also suggests other ways to alleviate chronic fails, such as the introduction of a securities lending facility run by the Treasury and the institution of a penalty fee for fails.

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Bibliographic Info

Article provided by Federal Reserve Bank of New York in its journal Economic Policy Review.

Volume (Year): (2002)
Issue (Month): Nov ()
Pages: 35-57

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Handle: RePEc:fip:fednep:y:2002:i:nov:p:35-57:n:v.8no.2

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Related research

Keywords: Treasury bills ; Government securities ; War - Economic aspects;

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Citations

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Cited by:
  1. Stratmann, Thomas & Welborn, John W., 2013. "The options market maker exception to SEC Regulation SHO," Journal of Financial Markets, Elsevier, vol. 16(2), pages 195-226.
  2. Silber, William L., 2005. "What happened to liquidity when world war I shut the NYSE?," Journal of Financial Economics, Elsevier, vol. 78(3), pages 685-701, December.
  3. Boni, Leslie & Leach, Chris, 2004. "Expandable limit order markets," Journal of Financial Markets, Elsevier, vol. 7(2), pages 145-185, February.
  4. Michael J. Fleming & Kenneth D. Garbade & Frank Keane, 2005. "Anomalous Bidding In Short-Term Treasury Bill Auctions," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 28(2), pages 165-176.
  5. José Ramón Martínez-Resano, 2005. "Size and heterogeneity matter. A microstructure-based analysis of regulation of secondary markets for governments bonds," Banco de Espa�a Occasional Papers 0501, Banco de Espa�a.
  6. Kenneth D. Garbade & Matthew Rutherford, 2007. "Buybacks in Treasury cash and debt management," Staff Reports 304, Federal Reserve Bank of New York.
  7. Boni, Leslie, 2006. "Strategic delivery failures in U.S. equity markets," Journal of Financial Markets, Elsevier, vol. 9(1), pages 1-26, February.
  8. Torben G. Andersen & Luca Benzoni, 2007. "Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification test for Affine Term Structure Models," NBER Working Papers 12962, National Bureau of Economic Research, Inc.
  9. Edgardo Barandiarán, 2003. "El Prestamista de Última Instancia en la Nueva Industria Bancaria," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 40(120), pages 337-358.
  10. Devriese, Johan & Mitchell, Janet, 2006. "Liquidity risk in securities settlement," Journal of Banking & Finance, Elsevier, vol. 30(6), pages 1807-1834, June.
  11. Thorsten Koeppl & Cyril Monnet & Ted Temzelides, 2009. "Optimal Clearing Arrangements for Financial Trades," Working Papers 1222, Queen's University, Department of Economics.
  12. Christopher J. Neely, 2004. "The Federal Reserve responds to crises: September 11th was not the first," Review, Federal Reserve Bank of St. Louis, issue Mar, pages 27-42.
  13. Iori, Giulia, 2004. "An analysis of systemic risk in alternative securities settlement architectures," Working Paper Series 0404, European Central Bank.
  14. Michael J. Fleming & Kenneth D. Garbade, 2004. "Repurchase agreements with negative interest rates," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 10(Apr).
  15. Kenneth D. Garbade & John E. Kambhu, 2005. "Why is the U.S. Treasury contemplating becoming a lender of last resort for Treasury securities?," Staff Reports 223, Federal Reserve Bank of New York.
  16. Kenneth D. Garbade, 2004. "Origins of the Federal Reserve book-entry system," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 33-50.
  17. Michael J. Fleming & Kenneth D. Garbade, 2005. "Explaining settlement fails," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 11(Sep).
  18. Benjamin Lester, 2006. "A Model of Interbank Settlement," 2006 Meeting Papers 282, Society for Economic Dynamics.

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