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FTR #823 Caution, Banksters at Work, Part 2 (Still More Collateralized “Death” Obligations)

Dave Emory’s entire life­time of work is avail­able on a flash dri­ve that can be obtained here. [1] The new dri­ve is a 32-giga­byte dri­ve that is cur­rent as of the pro­grams and arti­cles post­ed by 10/02/2014. The new dri­ve (avail­able for a tax-deductible con­tri­bu­tion of $65.00 or more) con­tains FTR #812 [2].  (The pre­vi­ous flash dri­ve was cur­rent through the end of May of 2012 and con­tained FTR #748 [3].)

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Lis­ten: MP3

Side 1 [7]   Side 2 [8]

[9]Intro­duc­tion: In FTR #‘s 772 [10] and 792 [11], we looked at a rash of sus­pi­cious deaths in the bank­ing indus­try, coin­cid­ing with a num­ber of inves­ti­ga­tions into mis­deeds by the insti­tu­tions at which many of the deceased had been employed.

This pro­gram updates that line of inquiry, sup­ple­ment­ing the pre­vi­ous broad­casts with dis­cus­sion of some new, sus­pi­cious “sui­cides,” as well as prob­lems loom­ing on the hori­zon of the glob­al finan­cial lan­scape.

Begin­ning with a Finan­cial Times sto­ry about a social psy­chol­o­gy exper­i­ment indi­cat­ing that the bank­ing pro­fes­sion inclines those who work in it toward dis­hon­esty, the broad­cast notes the deaths of Deutsche Bank’s Calogero Gam­bi­no [12] and Citi­cor­p’s Shawn Miller [13], both sup­posed “sui­cides.”

Both Cit­i­group and Deutsche Bank are among the finan­cial insti­tu­tions under inves­ti­ga­tion for var­i­ous mis­deeds. Deutsche Bank is a tar­get [14] of the New York Fed’s crit­i­cal eye at the moment.

Adding to anx­i­eties about the future of the finan­cial indus­try is the dab­bling by maj0r invest­ment banks in com­modi­ties. A Sen­ate inves­ti­ga­tion found that those insti­tu­tions’ expo­sure to fluc­tu­a­tions in the com­modites’ mar­kets placed them–and by exten­sion US–at risk.

Much of the pro­gram sets forth a sto­ry about a scary fluc­tu­a­tion in the mar­ket for U.S. Trea­sury bills, a finan­cial safe haven of choice in these per­ilous eco­nom­ic times. From the stand­point of sta­tis­ti­cal prob­a­bil­i­ty, the chances of such an event hap­pen­ing is rough­ly once in every 1.6 bil­lion years!

Pro­gram High­lights Include: Calogero Gam­bi­no’s pre­vi­ous work for the SEC; review of the death of Deutsche Bank’s William Broeksmit; com­par­i­son of the roles of Broeksmit and Gam­bi­no at Deutsche Bank; col­la­tion of the endeav­ors of some of the deceased bankers and activ­i­ties being inves­ti­gat­ed by var­i­ous reg­u­la­to­ry bod­ies; Cit­i­group’s Shawn Miller’s 911 calls pri­or to his “sui­cide;” Shawn Miller’s ani­mat­ed argu­ments with an uniden­ti­fied man pri­or to his “sui­cide;” rumi­na­tion about the pre­cip­i­tous decline in the price of oil and its pos­si­ble impact on invest­ment banks that have engaged in com­modi­ties spec­u­la­tion; dele­te­ri­ous effects of the invest­ment banks’ com­modi­ties invest­ing,

1. Worth con­sid­er­ing is the pos­si­bil­i­ty that the prob­lem is, in the most lit­er­al sense of the term, “sys­temic.”

“Bank­ing Makes You Less Hon­est, Research Finds” by Clive Cook­son; Finan­cial Times; 11/20/2014; p. 3.

Swiss researchers have come up with what they say is com­pelling sci­en­tif­ic evi­dence that bankers lie for finan­cial gain.

The team at the Uni­ver­si­ty of Zurich used game play­ing exper­i­ments to show “that the pre­vail­ing cul­ture in the bank­ing indus­try weak­ens and under­mines the hon­esty norm, imply­ing that mea­sures to reestab­lish an hon­est cul­ture are very impor­tant.”

The study, pub­lished in the jour­nal Nature, probes the psy­chol­o­gy behind what the researchers call ‘a dra­mat­ic loss of rep­u­ta­tion and a cri­sis of trust in the finan­cial sec­tor” as a result of rogue trad­ing, rigged inter­est rates such as Libor and tax eva­sion scan­dals. . . . . .

If every­one was com­plete­ly hon­est, the pro­por­tion of win­ning toss­es across each group would be 50 per cent. The con­trol group came close to this with 51.6 per­cent.

The treat­ment group, who had been primed by the pre­lim­i­nary ques­tions to think about bank­ing, report­ed 58.2 per cent win­ning tosses–a sta­tis­ti­cal­ly sig­nif­i­cant tilt towards dis­hon­esty; the pro­por­tion who cheat­ed was esti­mat­ed at 26 per cent. . . .

2a. Deutsche Bank is in hot water, accord­ing to the New York Fed.

“NY Fed Found Seri­ous Prob­lems at Deutsche Bank” by Katherin Jones and Arno Schuet­ze [Reuters.com]; Yahoo News; 7/23/2014. [14]

The Fed­er­al Reserve Bank of New York has found seri­ous prob­lems in Deutsche Bank AG’s U.S. oper­a­tions, includ­ing shod­dy finan­cial report­ing, weak tech­nol­o­gy and inad­e­quate audit­ing and over­sight, peo­ple close to the mat­ter told Reuters.

In a let­ter to the Ger­man lender’s exec­u­tives last Decem­ber, a senior offi­cial with the New York Fed described finan­cial reports pro­duced by some of the bank’s U.S. divi­sions as “low qual­i­ty, inac­cu­rate and unre­li­able”, said one of the sources, who is famil­iar with the let­ter.

The New York Fed, as the U.S. cen­tral bank’s eyes and ears on Wall Street, direct­ly super­vis­es the biggest U.S. and for­eign banks, part­ly through embed­ded reg­u­la­tors who go to work each day inside the firms.

“The size and breadth of errors strong­ly sug­gest that the fir­m’s entire U.S. reg­u­la­to­ry report­ing struc­ture requires wide-rang­ing reme­di­al action,” said the let­ter, first report­ed by the Wall Street Jour­nal. (http://on.wsj.com/1r3VIn3 [15])

The New York Fed declined to com­ment, cit­ing the con­fi­den­tial­i­ty of super­vi­so­ry activ­i­ties. The Euro­pean Cen­tral Bank and Ger­man finan­cial watch­dog Bafin declined to com­ment.

Deutsche said it was invest­ing 1 bil­lion euros ($1.4 bil­lion) to upgrade its inter­nal sys­tems, includ­ing the qual­i­ty of its report­ing, with about 1,300 peo­ple work­ing on the improve­ments. “We have been work­ing dili­gent­ly to fur­ther strength­en our sys­tems and con­trols,” a spokes­woman said.

The let­ter is nonethe­less a blow to Deutsche Bank co-Chief Exec­u­tives Juer­gen Fitschen and Anshu Jain, who have been seek­ing to trans­form the lender’s cor­po­rate cul­ture amid scan­dals, inves­ti­ga­tions and fines fol­low­ing the finan­cial cri­sis of 2008–2009.

While the New York State Depart­ment of Finan­cial Ser­vices is look­ing at Deutsche in rela­tion to issues includ­ing pos­si­ble forex manip­u­la­tion and Iran sanc­tions vio­la­tions, the New York Fed’s con­cerns are sep­a­rate and arose from rou­tine exam­i­na­tions by its staff, a source famil­iar with the mat­ter said. . . .

2b. Did Deutsche Bank’s difficulties–set forth above–have any­thing to do with the sui­cide of Calogero Gam­bi­no?

“Anoth­er Deutsche Banker and For­mer SEC Enforce­ment Attor­ney Com­mits Sui­cide” by Tyler Dur­den; zerohedge.com; 10/26/2014. [12]

Back on Jan­u­ary 26, a 58-year-old for­mer senior exec­u­tive at Ger­man invest­ment bank behe­moth Deutsche Bank, William Broeksmit, was found dead after hang­ing him­self at his Lon­don home, and with that, set off an unprece­dent­ed series of banker sui­cides through­out the year which includ­ed for­mer Fed offi­cials and numer­ous JPMor­gan traders.

Fol­low­ing a brief late sum­mer spell in which there was lit­tle if any news of bankers tak­ing their lives, as report­ed pre­vi­ous­ly [16], the banker sui­cides returned with a bang when none oth­er than the hedge fund part­ner of infa­mous for­mer IMF head Dominique Strauss-Khan, Thier­ry Leyne, a French-Israeli entre­pre­neur, was found dead after jump­ing off the 23rd floor of one of the Yoo tow­ers, a pres­ti­gious res­i­den­tial com­plex in Tel Aviv.

Just a few brief hours lat­er the WSJ [17]report­ed [17]that yet anoth­er Deutsche Bank vet­er­an has com­mit­ted sui­cide, and not just any­one but the bank’s asso­ciate gen­er­al coun­sel, 41 year old Calogero “Char­lie” Gam­bi­no, who was found on the morn­ing of Oct. 20, hav­ing also hung him­self by the neck from a stair­way ban­is­ter, which accord­ing to the New York Police Depart­ment was the cause of death. We assume that any rela­tion­ship to the famous Ital­ian fam­i­ly car­ry­ing that last name is pure­ly acci­den­tal. . . .

. . . . As a reminder, the oth­er Deutsche Bank-er who was found dead ear­li­er in the year, William Broeksmit, was involved in the bank’s risk func­tion and advised the fir­m’s senior lead­er­ship; he was “anx­ious about var­i­ous author­i­ties inves­ti­gat­ing areas of the bank where he worked,” accord­ing to writ­ten evi­dence from his psy­chol­o­gist, giv­en Tues­day at an inquest at Lon­don’s Roy­al Courts of Jus­tice. And now that an almost iden­ti­cal sui­cide by hang­ing has tak­en place at Europe’s most sys­tem­i­cal­ly impor­tant bank, and by a per­son who worked in a near­ly iden­ti­cal func­tion — to shield the bank from reg­u­la­tors and pros­e­cu­tors and cov­er up its alleged­ly ille­gal activ­i­ties with set­tle­ments and fines — is sure­ly bound to raise many ques­tions.

The WSJ reports that Mr. Gam­bi­no had been “close­ly involved in nego­ti­at­ing legal issues for Deutsche Bank, includ­ing the pro­longed probe into manip­u­la­tion of the Lon­don inter­bank offered rate, or Libor, and ongo­ing inves­ti­ga­tions into manip­u­la­tion of cur­ren­cies mar­kets, accord­ing to peo­ple famil­iar with his role at the bank.”

He pre­vi­ous­ly was an asso­ciate at a pri­vate law firm and a reg­u­la­to­ry enforce­ment lawyer from 1997 to 1999, accord­ing to his online LinkedIn pro­file and biogra­phies for con­fer­ences where he spoke. But most notably, as his LinkedIn pro­file below shows, like many oth­er Wall Street revolv­ing door reg­u­la­tors, he start­ed his career at the SEC itself where he worked from 1997 to 1999. . . .

. . . . Going back to the pre­vi­ous sui­cide by a DB exec­u­tive, the bank said at the time of the inquest that Mr. Broeksmit “was not under sus­pi­cion of wrong­do­ing in any mat­ter.” At the time of Mr. Broeksmit’s death, Deutsche Bank exec­u­tives sent a memo to bank staff say­ing Mr. Broeksmit “was con­sid­ered by many of his peers to be among the finest minds in the fields of risk and cap­i­tal man­age­ment.” Mr. Broeksmit had left a senior role at Deutsche Bank’s invest­ment bank in Feb­ru­ary 2013, but he remained an advis­er until the end of 2013. His most recent title was the invest­ment bank’s head of cap­i­tal and risk-opti­miza­tion, which includ­ed eval­u­at­ing risks relat­ed to com­pli­cat­ed trans­ac­tions.

A thread con­nect­ing Broeksmit to wrong­do­ing, how­ev­er, was uncov­ered ear­li­er this sum­mer when Wall Street on Parade ref­er­enced his name in rela­tion to the noto­ri­ous at the time strat­e­gy pro­vid­ed by Deutsche Bank and oth­ers to allow hedge funds to avoid pay­ing short-term cap­i­tal gains tax­es known as MAPS (see How RenTec Made More Than $34 Bil­lion In Prof­its Since 1998: “Fic­tion­al Deriv­a­tives [18]”)

From Wall Street on Parade [19]:

Broeksmit’s name first emerged in yesterday’s Sen­ate hear­ing as Sen­a­tor Carl Levin, Chair of the Sub­com­mit­tee, was ques­tion­ing Satish Ramakr­ish­na, the Glob­al Head of Risk and Pric­ing for Glob­al Prime Finance at Deutsche Bank Secu­ri­ties in New York. Ramakr­ish­na was down­play­ing his knowl­edge of con­ver­sa­tions about how the scheme was about chang­ing short term gains into long term gains, deny­ing that he had been privy to any con­ver­sa­tions on the mat­ter.

Levin than asked: “Did you ever have con­ver­sa­tions with a man named Broeksmit?” Ramakr­ish­na con­ced­ed that he had and that the fact that the scheme had a tax ben­e­fit had emerged in that con­ver­sa­tion. Ramakr­ish­na could hard­ly deny this as Levin had just released a Novem­ber 7, 2008 tran­script of a con­ver­sa­tion between Ramakr­ish­na and Broeksmit where the tax ben­e­fit had been acknowl­edged.

Anoth­er exhib­it released by Levin was an August 25, 2009 email from William Broeksmit to Anshu Jain, with a cc to Ramakr­ish­na, where Broeksmit went into copi­ous detail on exact­ly what the scheme, inter­nal­ly called MAPS, made pos­si­ble for the bank and for its client, the Renais­sance Tech­nolo­gies hedge fund. (See Email from William Broeksmit to Anshu Jain, Released by the U.S. Sen­ate Per­ma­nent Sub­com­mit­tee on Inves­ti­ga­tions [20].)

At one point in the two-page email, Broeksmit reveals the mas­sive risk the bank is tak­ing on, writ­ing: “Size of port­fo­lio tends to be between $8 and $12 bil­lion long and same amount of short. Max­i­mum allowed usage is $16 bil­lion x $16 bil­lion, though this has nev­er been approached.”

Broeksmit goes on to say that most of Deutsche’s mon­ey from the scheme “is actu­al­ly made by lend­ing them spe­cials that we have on inven­to­ry and they pay far above the reg­u­lar rates for that.”

It would appear that with just months until the reg­u­la­to­ry crack­down and Con­gres­sion­al kan­ga­roo cir­cus, Broeksmit knew what was about to pass and being deeply impli­cat­ed in such a scheme, pre­ferred to take the pain­less way out.

The ques­tion then is just what major reg­u­la­to­ry rev­e­la­tion is just over the hori­zon for Deutsche Bank if yet anoth­er banker had to take his life to avoid being cross-exam­ined by Con­gress under oath? For a hint we go back to anoth­er report, this time by the FT, which yes­ter­day not­ed [21] that Deutsche Bank will set aside just under €1bn towards the numer­ous legal and reg­u­la­to­ry issues it faces in its third quar­ter results next week, the bank con­firmed on Fri­day.

In a state­ment made after the close of mar­kets, the Frank­furt-based lender said it expect­ed to pub­lish lit­i­ga­tion costs of €894m when it announces its results for the July-Sep­tem­ber peri­od on Octo­ber 29.

The extra cash will add to Deutsche’s already size­able lit­i­ga­tion pot, where the bank has yet to be fined in con­nec­tion with the Lon­don inter­bank rate-rig­ging scan­dal.

It is also fac­ing fines from US author­i­ties over alleged mort­gage-backed secu­ri­ties mis­selling and sanc­tions vio­la­tions, which have already seen rivals hit with heavy fines.

Deutsche has also warned that dam­age from glob­al inves­ti­ga­tions into whether traders attempt­ed to manip­u­late the for­eign-exchange mar­ket could have a mate­r­i­al impact on the bank.

The extra charge announced on Fri­day will bring Deutsche’s total lit­i­ga­tion reserves to €3.1bn. The bank also has an extra €3.2bn in so-called con­tin­gent lia­bil­i­ties for fines that are hard­er to esti­mate.

Clear­ly Deutsche Bank is slow­ly becom­ing Europe’s own JPMor­gan — a crim­i­nal bank whose past is final­ly catch­ing up to it, and where legal fine after legal fine are only now start­ing to slam the bank­ing behe­moth. We will find out just what the nature of the lat­est lit­i­ga­tion charge is next week when Deutsche Bank reports, but one thing is clear: in addi­tion to mort­gage, Libor and FX set­tle­ments, one should also add gold. Recall from around the time [22]when the first DB banker hung him­self: it was then that Elke Koenig, the pres­i­dent of Ger­many’s top finan­cial reg­u­la­tor, Bafin, said that in addi­tion to cur­ren­cy rates, manip­u­la­tion of pre­cious met­als “is worse than the Libor-rig­ging scan­dal.”

It remains to be seen if Calogero’s death was also relat­ed to pre­cious met­als rig­ging although it cer­tain­ly would not be sur­pris­ing. What is sur­pris­ing, is that slow­ly things are start­ing to fall apart at the one bank which as we won’t tire of high­light­ing [23], has a big­ger pyra­mid of notion­al deriv­a­tives on its bal­ance sheet than even JPMor­gan, amount­ing to 20 times more than the GDP of Ger­many itself, and where if any inter­nal inves­ti­ga­tion ever goes to the very top, then Europe itself, and thus the world, would be in jeop­ardy.

3. Add the name of Cit­i­group banker Shawn Miller to the list of col­lat­er­al­ized “death” oblig­a­tions.

“Banker, 42, Slashed His Own Throat in Man­hat­tan Bath­tub Dur­ing Drug-and-Booze-Filled Ben­der: Sources” by Tina Moore, Roc­co Paras­can­dola and Bill Hutchin­son; New York Dai­ly News; 11/19/2014. [13]

 The death of a Cit­i­group banker found with his throat slashed in his posh Man­hat­tan pad was being inves­ti­gat­ed Wednes­day as an appar­ent sui­cide, sources told the Dai­ly News.

Shawn Miller’s body was found Tues­day after­noon in the bath­tub of his Green­wich St. apart­ment in Low­er Man­hat­tan, his throat slashed ear-to-ear.

Cops ini­tial­ly sus­pect­ed foul play, say­ing ear­li­er that no weapon was found in the apart­ment and that Miller, 42, was caught on sur­veil­lance video argu­ing with a male com­pan­ion in the building’s ele­va­tor.

When crime scene inves­ti­ga­tors moved Miller’s body, they dis­cov­ered a knife under him, lead­ing them to believe he slashed his own throat and col­lapsed into the tub on top of the weapon, sources said.

Detec­tives now sus­pect Miller killed him­self after going on a booze- and drug-fueled ben­der since at least Mon­day with a stranger he hooked up with through the clas­si­fied adver­tis­ing web­site Backpage.com, the sources said.

Police found evi­dence of alco­hol and drug use in the apart­ment, includ­ing what appeared to be crys­tal meth, sources said.

The man who Miller was argu­ing with in the ele­va­tor appar­ent­ly left the banker’s apart­ment late Sun­day or ear­ly Mon­day, sources. Miller called down to the lob­by and asked the door­man not to allow the man back into the build­ing, accord­ing to sources.

Detec­tives found no evi­dence the man returned to the build­ing and there was no sign of a break-in or strug­gle in Miller’s apart­ment, sources said.

Shawn Miller’s body was found Tues­day after­noon in the bath­tub of his Green­wich St. apart­ment in Low­er Man­hat­tan.

Records showed that at least two 911 calls were made from Miller’s apart­ment since Mon­day. The caller, believed to be Miller, com­plained about some­one out­side his build­ing stalk­ing him, sources said.

The body was found at 3:11 p.m. Tues­day after Miller’s boyfriend called and plead­ed with the building’s door­man to check on Miller’s wel­fare, sources said.

Cit­i­group con­firmed Miller’s death in a state­ment. Miller was man­ag­ing direc­tor of envi­ron­men­tal and social risk man­age­ment and had worked for the finan­cial ser­vices firm since 2004.

“We are deeply sad­dened by this news and our thoughts are with Shawn’s fam­i­ly at this time,” the Cit­i­group state­ment reads.

Miller’s LinkedIn pro­file described him as “a thought leader and pio­neer in sus­tain­able finance focused on cre­at­ing change and build­ing sus­tain­able busi­ness through col­lab­o­ra­tion, engage­ment and part­ner­ship with oth­ers.”

He was a 1995 grad­u­ate the Maxwell School of Cit­i­zen­ship and Pub­lic Affairs at Syra­cuse Uni­ver­si­ty.

4. Spec­u­la­tion in com­modi­ties by major bank­ing insti­tu­tions places the finan­cial sys­tem at risk.

“US Blasts Banks’ Com­modi­ties Deals” by Gina Chon; Finan­cial Times; 11/20/2014; p. 13. 

 Gold­man Sachs, JP Mor­gan and Mor­gan Stan­ley exposed them­selves to cat­a­stroph­ic finan­cial risks, envi­ron­men­tal dis­as­ters and poten­tial mar­ket manip­u­la­tion by invest­ing in oil, met­als and pow­er plant busi­ness­es, accord­ing to a sen­ate report.

The find­ings of the two-year probe by the Sen­ate inves­ti­ga­tions sub­com­mit­tee said that the banks’ involve­ment in the phys­i­cal com­modi­ties put them in the same vul­ner­a­ble posi­tion as BP, which has been hit with sev­er­al law­suits and bil­lions of dol­lars in fines because of the 2010 Gulf of Mex­i­co oil spill.

“Imag­ine if BP had been a bank,” said sen­a­tor John McCain, the senior Repub­li­can on the sub­com­mit­tee. “The lia­bil­i­ty from the oil spill would have led to its fail­ure, lead­ing to anoth­er tax­pay­er bailout.”

A 2012 Fed­er­al Reserve review found four finan­cial groups, includ­ing the three in the sub­com­mit­tee report, had short­falls of up to $15bn to cov­er “extreme loss sce­nar­ios,” the report said, the Fed is con­sid­er­ing restrict­ing banks’ phys­i­cal com­mod­i­ty activ­i­ties.

The report also says the banks’ own­er­ship or invest­ments in phys­i­cal com­mod­i­ty busi­ness­es gave them inside knowl­edge that allowed them to finan­cial­ly ben­e­fit through mar­ket manip­u­la­tion or unfair trad­ing advan­tages. . . .


“Anato­my of a Mar­ket Melt­down“by Tra­cy Alloway and Michael MacKen­zie; Finan­cial Times; 11/18/2014; p. 7.

The Sharp fall in Trea­sury bond yields on Octo­ber 15 has drawn com­par­isons to the ‘flash crash’ in stocks. Reg­u­la­tors and investors are ask­ing if the world’s finan­cial safe haven needs to be shored up.


Leg­end has it that a young man once asked the financier J Pier­pont Mor­gan what the stock mar­ket was going to do. “It will fluc­tu­ate,” Mr. Pier­pont is said to have replied.

Had the young man asked Mr. Pier­pont about today’s US Trea­sury mar­ket – where the US gov­ern­ment sells tril­lions of dol­lars worth of bonds to a wide range of investors – he may have received a very dif­fer­ent response.

For decades, the US Trea­sury mar­ket has been a bedrock of glob­al finance. While stock mar­kets are prone to sud­den price swings, such episodes in the vast and eas­i­ly-trans­act­ed world of Trea­suries have been far rar­er – giv­ing the mar­ket an excep­tion­al rep­u­ta­tion for order­ly trad­ing.

That rep­u­ta­tion took a big hit last month.

On Octo­ber 15, the yield on the bench­mark 10-year US gov­ern­ment bond, which moves inverse­ly to price, plunged 33 basis points to 1.86 per cent before ris­ing to set­tle at 2.13 per cent. While that may not seem like much, ana­lysts say the move was sev­en stan­dard devi­a­tions away from its intra­day norm – mean­ing it might be expect­ed to occur once every 1.6bn years.

For sev­er­al min­utes, Wall Street stood still as traders watched their screens in dis­be­lief.  Elec­tron­ic pric­ing machines, which now play a big­ger role than ever in the trad­ing of Trea­suries, were halt­ed and orders can­celled by ner­vous deal­ers as prices see-sawed.

The events have sparked a finan­cial “who­dunit” as investors, traders and reg­u­la­tors seek to under­stand what hap­pened – and to deter­mine whether Octo­ber 15 was a unique event or a har­bin­ger of fur­ther per­ilous trad­ing con­di­tions to come.

“We’re all look­ing for a chief rea­son because clients want to under­stand the impe­tus behind mar­ket volatil­i­ty,’ says Reg­gie Brown, head of exchange-trad­ed fund trad­ing at Can­tor Fitzger­ald.

Among US reg­u­la­tors’ con­cerns is whether a tougher reg­u­la­to­ry cli­mate for big banks, cou­pled with the inex­orable rise of elec­tron­ic trad­ing, has fun­da­men­tal­ly altered how the $12.4tn gov­ern­ment bond mar­ket func­tions. The answer has pro­found con­se­quences for the con­duct of Fed­er­al Reserve pol­i­cy and how the US funds its nation­al debt.

For the Fed, the resilience of the Trea­sury mar­ket will be a con­sid­er­a­tion as it begins to raise inter­est rates. Ana­lysts say the risk of a high­ly volatile mar­ket reac­tion sug­gests the cen­tral bank will move in mea­sured steps when it begins to raise bor­row­ing costs, which many expect to begin next year.

One wor­ry is that the US Trea­sury mar­ket might have suf­fered a pro­nounced loss of sup­port for prices – or “liq­uid­i­ty” in finan­cial par­lance – due to changes that have swept over Wall Street includ­ing the rise of com­put­er-dri­ven trad­ing.  Some draw par­al­lels with the “flash crash” that hit stock mar­kets in May 2010, which even­tu­al­ly spurred efforts to reform the wider equi­ty mar­ket.

James Angel, asso­ciate pro­fes­sor at George­town Uni­ver­si­ty, says the US Trea­sury mar­ket should be reg­u­lat­ed in a dif­fer­ent way now that it has embraced elec­tron­ic trad­ing.

“When peo­ple use com­put­ers to pro­vide prices across mar­kets it [liq­uid­i­ty] can be with­drawn in a heart­beat,” he says.  “How much mar­ket liq­uid­i­ty real­ly exists under this type of mar­ket struc­ture and what changes should be made are the ques­tions for reg­u­la­tors.”

Unlike oth­er bond mar­kets, US Trea­suries are viewed as being open for busi­ness for the entire glob­al trad­ing day.  They also enjoy safe-haven sta­tus dur­ing times of ten­sion.  The immense size of the mar­ket means investors can eas­i­ly express oppos­ing views about the direc­tion of inter­est rates by buy­ing or sell­ing the gov­ern­ment debt.

Any indi­ca­tion that the mar­ket can sud­den­ly shut down with lit­tle warn­ing rais­es trou­bling ques­tions about how the nature of trad­ing has changed in recent years.  Elec­tron­ic sys­tems are more vis­i­ble to the whole mar­ket, so trades tend to be small­er than those that take place in pri­vate tele­phone con­ver­sa­tions between deal­ers and investors.

A recent gath­er­ing of US Trea­sury offi­cials and key rep­re­sen­ta­tives of deal­ers and investors, known as the Trea­sury Bor­row­ing Advi­so­ry com­mit­tee, held in a Wash­ing­ton hotel, revealed “a wide vari­ety of views regard­ing the poten­tial dri­vers of the intra­day volatil­i­ty” on Octo­ber 15.  Mem­bers of the TBAC include JPMor­gan Chase, RBS, Mor­gan Stan­ley, Black­Rock, Pim­co, Citadel, Bre­van Howard and oth­er major play­ers in the Trea­sury mar­ket.

A num­ber of US reg­u­la­to­ry agen­cies are look­ing at last month’s Trea­sury mar­ket may­hem. An offi­cial at the Fed­er­al Reserve Bank of New York told the Finan­cial Times: “In the course of our nor­mal mar­ket mon­i­tor­ing we reg­u­lar­ly explore and assess mar­ket devel­op­ments.”

Tim­o­thy Mas­sad, chair­man of the US Com­mod­i­ty Futures Trad­ing Com­mis­sion, which reg­u­lates inter­est rate futures trad­ing at the Chica­go Mer­can­tile Exchange, said that the agency’s ini­tial view was that the mar­ket had func­tioned rea­son­ably well giv­en the high num­ber of trades.

“Let me just add, that’s based on our pre­lim­i­nary look.  New evi­dence might come to our atten­tion that sug­gests oth­er­wise.”

When dawn broke on a grey Octo­ber 15 in New York, traders and investors had plen­ty of rea­sons to be ner­vous.  Con­cerns over the spread of Ebo­la and weak­en­ing eco­nom­ic activ­i­ty in Europe and Chi­na were weigh­ing heav­i­ly – help­ing to push bond yields low­er as investors sought the refuge of US trea­suries.

The scup­per­ing of AbbVie’s L32bn [pounds] deal to acquire Shire left many big hedge funds nurs­ing heavy equi­ty loss­es and may have con­tributed to the rapid repo­si­tion­ing that would even­tu­al­ly engulf mar­kets.

When US retail sales for Sep­tem­ber flashed across news screens at 8:30am and con­firmed the first month­ly decline since Jan­u­ary, con­cern mount­ed among investors that the US econ­o­my could well be soft­en­ing.  For investors who had posi­tioned them­selves for a strength­en­ing econ­o­my that would pro­pel the Fed to raise inter­est rates before 2017, it was a painful rever­sal of sen­ti­ment.  Many had placed record bets on inter­est rates mov­ing high­er via futures con­tracts lis­ten on the CME.

With many hedge funds and mon­ey man­agers already suf­fer­ing a poor year, their off­side wagers on inter­est rates and oth­er fail­ing trades now required emer­gency action.  What sub­se­quent­ly unfold­ed, accord­ing to traders, was a series of mas­sive posi­tions being liq­ui­dat­ed and dumped onto the mar­ket.

One hedge fund man­ag­er recalls being bewil­dered by sub­se­quent events:  “What on earth was charg­ing through the mar­ket to want vol­ume at such a price and why, in response to that cat­a­lyst, did the elec­tron­ic mar­ket­place just take any and all liq­uid­i­ty away?”

By 8:45am, liq­uid­i­ty began notice­ably dete­ri­o­rat­ing, and the process accel­er­at­ed after 9:30am, accord­ing to data from Nanex, a mar­ket research firm.  By 9:33am, the yield on the 10-year Trea­sury had sliced through the crit­i­cal 2 per cent lev­el, caus­ing many who had bet on ris­ing yields final­ly to capit­u­late and close out their neg­a­tive bets by buy­ing back US gov­ern­ment debt and var­i­ous inter­est rate futures con­tracts.

In Sep­tem­ber, hedge funds had estab­lished a record net “short” posi­tion in inter­est rate futures accord­ing to CFTC week­ly data.  Between the end of Sep­tem­ber and the week end­ing Octo­ber 21, this big bet shrunk from 1.27m con­tracts to just 217,000 reflect­ing more than $1tn of notion­al expo­sure being cut.

“The ele­phant tried to squeeze through the key­hole,” says John Brady, man­ag­ing direc­tor at RJ O’Brien, a futures bro­ker in Chica­go.

Eric Hun­sad­er, Nanex chief exec­u­tive, says the scale of the shift in US Trea­sury prices may have prompt­ed the “mar­ket-mak­ers” who usu­al­ly sup­port trad­ing of the debt to retreat: “The speed of the move was abnor­mal and trad­ing sys­tems lack his­tor­i­cal data for such episodes that can pro­vide them with some guid­ance.”

When the day drew to a close near­ly $1tn worth of cash Trea­suries had changed hands, illus­trat­ing the inten­si­ty of the rush for the exit.  Such huge vol­umes also show liq­uid­i­ty was avail­able, but was pos­si­bly dif­fi­cult to obtain at prices deemed rea­son­able by investors on the day and amid rapid­ly fluc­tu­at­ing mar­kets.

The head of trad­ing at a major deal­er-bank says: “Once volatil­i­ty shows up, you don’t want to make a mis­take in a fast mar­ket and so you always see deal­ers pull back from pro­vid­ing prices.’

Com­pound­ing such pres­sures are changes that have trans­formed Wall Street since the finan­cial cri­sis, with the big banks who once dom­i­nat­ed Trea­sury trad­ing now under tougher bal­ance sheet con­straints thanks to reg­u­la­tion and new­found aver­sion to risk.

This trend has encour­aged greater elec­tron­ic trad­ing and a migra­tion of expe­ri­enced traders fro deal­ers to hedge funds and asset man­agers, leav­ing a younger gen­er­a­tion of traders man­ning Trea­sury desks at big banks.  Many of these have nev­er expe­ri­enced the gung-ho pre-cri­sis days when banks were more will­ing to make bets on the mar­ket.

“The appetite to take on a posi­tion is low­er than it was pre-new reg­u­la­tion,’ says Greg Gure­vich, man­ag­ing part­ner at Mar­itime Cap­i­tal Part­ners, adding that com­pen­sa­tion struc­tures “do not reward the trad­er to take risk that may ulti­mate­ly cost the trad­er his or her job”.

The two main elec­tron­ic trad­ing venues for US Trea­suries are run by Nasdaq’s eSpeed and Icap’s Bro­kerTec. In recent years these plat­forms have opened up to a range of bro­ker-deal­ers and high-fre­quen­cy traders.  These firms do not under­write US Trea­sury debt sales and are often viewed as oppor­tunis­tic – pro­vid­ing prices when they spot a quick prof­it and then retreat­ing when trad­ing turns tricky.

Cus­tomer orders are now trans­act­ed and almost instan­ta­neous­ly hedged, or off­set, by com­put­er sys­tems – a type of automa­tion that works well when trad­ing is order­ly but rapid­ly breaks down when the sit­u­a­tion changes.  At such moments, turn­ing off the machines becomes a neces­si­ty.   This con­tributed to the down­draft in liq­uid­i­ty on Octo­ber 15.

“Deal­er-banks don’t real­ly posi­tion in bonds,’ said one head trad­er at a large US bank.  “They basi­cal­ly act as a pass-through to places like Bro­kerTec and eSpeed or match off their client flow.  The mar­ket-mak­ers in this new mar­ket are not oblig­at­ed to be there when everyone’s sell­ing.”

The wor­ry is that even the high­ly depend­able US Trea­sury mar­ket may suf­fer from sud­den droughts in liq­uid­i­ty because big banks have been barred from “pro­pri­etary” trad­ing.  The “prop traders” could take the oth­er side of huge cus­tomer demand to buy or sell bonds.

“If the Street – for bal­ance sheet, risk appetite and reg­u­la­to­ry rea­sons – can’t pro­vide a speed bump between buy­ers and sell­ers such as hedge funds and asset man­agers, then the Trea­sury mar­ket will expe­ri­ence a lot more jumps in trad­ing,” says one trad­er.

As the mar­ket becomes increas­ing­ly dri­ven by elec­tron­ic trad­ing, more rules may be required to help deal with sud­den vio­lent swings, sim­i­lar to the adop­tion of cir­cuit break­ers in stock mar­kets.

Prof Angel says: “The Trea­sury mar­ket is a free­wheel­ing world where trad­ing is not for­mal­ized like that of an exchange and where the use of cir­cuit break­ers can help steady activ­i­ty.”  These kind of curbs mat­ter for mar­kets that increas­ing­ly trade elec­tron­i­cal­ly and also influ­ence oth­er finan­cial areas, such as deriv­a­tives and futures.

A broad­er con­se­quence of last month’s tur­moil may be that Fed rate ris­es will be more like­ly to take the form of a series of slow steps, rather than big moves that run the risk of spark­ing tur­moil in the bond mar­kets, accord­ing to ana­lysts.

For the US Trea­sury, which is respon­si­ble for mak­ing sure bud­get deficits and matur­ing debt are refi­nanced smooth­ly, fur­ther episodes of tur­moil could well impair the market’s abil­i­ty to under­write gov­ern­ment debt effi­cient­ly, says Michael Clo­her­ty, ana­lyst at RBC Cap­i­tal Mar­kets.

Mr. Clo­her­ty says the US Trea­sury mar­ket has altered struc­tural­ly and lacks the depth to absorb eas­i­ly sur­pris­es in Fed pol­i­cy and changes in mar­ket sen­ti­ment.  This trend has gath­ered pace as the cen­tral bank has become a major own­er of Trea­sury debt through its emer­gency bond-buy­ing pro­gramme, fur­ther lim­it­ing liq­uid­i­ty.

He adds that any sign that the Trea­sury market’s liq­uid­i­ty has declined would cast a shad­ow over investor con­fi­dence – and may ulti­mate­ly raise the cost of sell­ing gov­ern­ment debt.

Says Mr. Clo­her­ty: “Investors know they can trade large amounts of Trea­suries and any ero­sion of con­fi­dence in the market’s liq­uid­i­ty has long-term con­se­quences.”