The Rise of Black Box Trading in Treasuries

Bloomberg reports:

Six computer screens crowd the desk of Sanjay Verma in Morgan Stanley's third-floor trading room near Times Square in Manhattan. Verma, the firm's top government-bond trader, keeps his attention glued to just one of them.

Verma, 37, is monitoring a computer that his team programmed with mathematical models, or algorithms, to conduct rapid-fire bond trades without human intervention. On Wall Street, systems like Verma's are called black boxes because only insiders know the variables that trigger their transactions.

``I never take my eye off it,'' says Verma. ``If we didn't have a black box system we'd be missing the boat.''

Black boxes are transforming the U.S. Treasury market, which has long been dominated by primary dealers -- the big firms such as Morgan Stanley that are required to bid at government debt auctions.

Now, traders with the best mathematical models and the fastest links to electronic exchanges are gaining the edge. They include commodity traders and hedge funds, which have expanded into Treasuries, becoming some of the market's biggest traders. For the dealers, algorithms are both an opportunity to find new profit and, in the hands of others, a threat to the dealers' control of the market.

You'll want to read this one to see how the primary dealers are affected.