The recent difficulties settling futures contracts in Chicago have highlighted a growing problem: there are big derivatives markets out there that aren't built to take the strain being put on them.

Last spring it was the credit default swaps; now it's the 10-year bond; and this fall there will probably be another bonus-killer lurking somewhere.

In June, some large holders of the June 10-year Treasury futures contract, including Pimco, demanded settlement - taking delivery of actual bonds - instead of, as usual, rolling their positions into the next contract. The scramble to find the necessary notes was made worse by the fact that one account, possibly the hedge fund Citadel, already held the bulk of the cheapest notes to deliver.

Whether or not Citadel, or Pimco's bond dealers, intended to make some extra money by squeezing out other bidders, it couldn't have happened if the structure of the futures contract had kept up with the times. The Chicago Board of Trade's 10-year T-note futures contract is one of the older financial derivatives around today.

That's good, in that it has been tested through a range of crises and cycles, and it's bad because it was designed based on the classic requirements of grain dealers, rather than the current requirements of interest rate markets.

The problem could become even more acute next year. There is talk that the re-introduction of the

30-year Treasury bond will be accompanied by cutting issuance of 10-year notes. That might be rational management from the point of view of the Treasury's cash management, but could lead to a bigger squeeze on bond market participants who have to deliver on futures contracts.

"I think it would be almost reckless and irresponsible to cut the 10-year now," says Jim Bianco of Chicago's Arbor Research. "This is definitely a case of unintended consequences. If they want to cut back on 10-year issuance, and leave 2m contracts in open interest [based on] illiquid notes, that would create tremendous problems."

The 10-year futures contract is based on a theoretical Treasury note that doesn't exist. Then the CBOT have formulas to convert the value of existing Treasuries into the theoretical ones. For example, the cheapest bond to deliver to settle the current September contract is the August 2012 bond. So you are really getting delivery of, and contracts are priced from, the seven-year stuff rather than 10-year stuff.

Another problem is that a few years back, the 10-year Treasury issuance was much smaller than it is today, meaning that there are fewer notes available to settle contracts. There is now about eight times the number of outstanding futures contracts as bonds eligible and available to fulfil them.

The obvious solution is to go to cash settlement. That would mean the exchange changing the terms of the 10-year contract, so that actual bonds would not be delivered. Instead, those now obliged to deliver would make cash payments equal to the value of a reference price. That is how Fed funds futures contracts are settled.

There are two problems with that solution. First, some people do want the opportunity, at least from time to time, to get actual bonds. If the contracts are cash-settled, then they would have to go through the extra step of taking the cash and buying actual bonds, which creates inconvenience and extra transaction costs. Second, the contract's users would have to agree on a single reference price in the market for actual 10-year bonds. There are a lot of suspicious people in the futures markets, since they know themselves well, and, consequently, there would be concern that the price of the reference issue or issues in the cash market could be manipulated.

So instead, dealers say, there will be a series of smaller fixes. For example, the theoretical coupon on the theoretical bond could be changed to be closer to the coupons on the more recent, bigger, and more liquid 10-year issues. That would further ease the squeeze.

The real problem is that the US economy is just too leveraged. Starting with the housing industry, the country is too dependent on derivatives markets to create the illusion that interest rate risk can be conjured away.

The technical problems of the 10-year are just another early warning sign of this fundamental weakness.