Thursday, September 17, 2015

A Few Comments on the Interagency Report on the U.S. Treasury Market on October 15, 2014

On July 13, 2015, five agencies – the U.S Treasury, the Federal Reserve Board, the Federal Reserve Bank of New York, the SEC, and the CFTC – issued a report prepared by their staffs   entitled The U.S. Treasury Market on October 15, 2014. It attempts to analyze the sharp increase in the price of the 10-year note and the quick reversal of this increase between 9:33 a.m. and 9:45 a.m. on October 15. The report reaches no conclusion as to why this happened.

Antonio Weiss, Counselor to Treasury Secretary Jack Lew, was apparently heavily involved in preparing this report. He gave a speech about the report at a Brookings event on August 3 – “Are there structural issues in the U.S. bond market?” Antonio Weiss, you may recall, is the former Lazard investment banker whose confirmation as Treasury Under Secretary for Domestic Finance was blocked by Senator Elizabeth Warren.

The report clearly entailed a lot of work and usefully highlights changes in the Treasury market and the development of technology, most particularly the growth of electronic platforms and automated trading. The report, though, is unsatisfying, and not just because the authors were unable to develop a clear explanation about what happened on October 15.

First, there is no clear explanation as to why anyone but market participants should care about this unusual event. In this connection, Jerome (“Jay”) Powell, currently a Federal Reserve Governor and a former Treasury Domestic Finance Under Secretary in the George H.W. Bush Administration (I worked for him when he was a Treasury official), remarked at the Brookings event:

“So I think it's important to take a step back and put it in context. So technology is evolving from risk appetite and risk management is evolving, the supply and demand of liquidity is evolving, and regulation is evolving, and they're all evolving at the same time. Markets are adapting to that at the same time. So you have to look at these events and ask whether they matter or not, which is kind of a sense of your question. Does it matter that the 12 minutes -- things that we couldn't really explain? So if it only happens once, maybe it doesn't matter so much, but the real question is, is there a pattern? And I just don't think we know, I think it's frustrating but we don't really know. I think rates will be increasing over time, presumably volatility as we get over the zero lower bound, volatility will return to normal levels just as an arithmetic matter we'll be able to do that. And I think we'll be learning. I think that's what we have to do is learn as this process goes on.” (Transcript, p. 62.)
Second, there is no discussion of developments that day in other financial markets, including the U.S. stock market and stock and fixed-income markets abroad, which may or may not have had something to do with what happened in the Treasury market on the morning of October 15.

Third, the report intriguingly discusses a “heightened level of self-trading” – “defined as transaction in which the same entity takes both sides of the trade so that no change in beneficial ownership results” (p. 32 of report). The report though does not analyze whether this had any effect on market prices and studiously avoids any judgment of whether any of this activity might have been illegal or an attempt at market manipulation. Given that the one group for which what happened on October 15 really mattered, the active traders that made or lost money that morning, this is a hole in the report. The enforcement staffs of the agencies which participated in this report presumably did not participate in its preparation, and it is understandable that in interviewing market participants the researchers did not want to be making what might appear as an enforcement investigation. Nevertheless, more attention to who made and lost money in this event might have shed light on what happened.

Finally, it is interesting to note that in response to a question Antonio Weiss emphasized the need for “better access to data” and Jay Powell said he “was very surprised at how difficult it was to the data.” It is worth noting that in this respect that in the 1992 Joint Report on the Government Securities Market, the Treasury and the Federal Reserve opposed imposing audit trail requirements on the government securities market. In the 1993 amendments to the Government Securities Act of 1986, the SEC did receive the authority to request transaction reports form government securities brokers and dealers in order “to reconstruct trading in the course of a particular inquiry or investigation being conducted by the Commission for enforcement or surveillance purposes.” The Treasury also received large position reporting authority in when-issued and recently issued Treasury securities. (Government Securities Act Amendments of 1993, Sec. 103 and 104.) There seems to be a hint that the Treasury and the Fed may be thinking of supporting legislation granting enhanced authority to impose record-keeping rules and information reporting on significant market participants and lowering the hurdles of sharing this information among interested government agencies. It is unlikely that this will happen, if at all, before the next President and the next Congress are in power.   

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