Consent Preferences


Future Challenge: America’s Growing Debt

Washington’s efforts to control US debt are centered on the regular auctions of new Treasury bills. Ideally, these are unnoticed events for all parties concerned.

One frequently mentioned explanation is the relentless tightening of monetary policy, which has driven interest rates to a 22-year high and given investors more avenues to pursue bigger profits. Another is conventional bond purchasers, who would be less confident in US Treasuries as a shelter after many downgrades of US creditworthiness.

Moody’s Analytics chief economist Mark Zandi warns that the scenarios may “quickly engulf the stock market and mortgage rates and lending rates and it could have much significant, broader implications.” He believes they get dangerous quickly.

The current state of affairs, he says, has “all the earmarks of a problem,” comparing it to a yellow flare that might turn red if reforms are not implemented.

Beyond the pressures of the market today, however, there is an increasing amount of discussion over the bond market’s structure and the suitability of the “plumbing” that the US government uses to keep its books in order. It is unclear if a combination of these elements would cause financially disastrous auctions to go down in the future.

“It’s a matter of national economic security,” argues Stanford professor Darrell Duffie, whose study on dealer balance sheets suggests that “Treasury market functionality” may be diminished in the coming years.

His study, which includes a presentation at the Jackson Hole Symposium this summer, has drawn the attention of Washington policymakers because he compares the issue to a much-needed but long-delayed public works project.

In a recent interview, he said, “This is how the government finances itself.” “And if you don’t fix it soon, then you’re inviting a disaster.”

As Stanford researcher Darrell Duffie puts it, “It’s a matter of national economic security,” given that his study on dealer balance sheets suggests that “Treasury market functionality” may be diminished in the coming years.

Washington authorities have taken notice of his work, which included a presentation at the Jackson Hole Symposium this summer. He has compared the issue to a much-needed but long-delayed public works project.

He said, “This is how the government finances itself,” in a recent interview. “And if you don’t fix it soon, then you’re inviting a disaster.”

One move by the SEC, which was completed this week, would force more bond trading into central clearing platforms.

Proponents claim that because these platforms require extra support for deals between market makers, the markets are safer.

Another concept being discussed is a potential regulation that is primarily directed at hedge funds, who have become more and more significant players in the bond markets. If certain companies wish to continue operating in the market, the modification would force them to register as broker-dealers and submit to stricter capital and liquidity criteria. This March, it was originally suggested.

Tim Scott (R-S.C.), the ranking member of the Senate Banking Committee, expressed fears that the reforms might make the plumbing problems worse and might drive some people out of the Treasury markets completely.

“Fewer participants in the Treasury markets will also lead to a potentially dangerous reduction in liquidity in those markets,” he stated.

The question is whether the additional rules would apply to a big segment of the market or to a smaller group of companies that serve as large-scale liquidity providers but are not now covered by the regulations.

Transparency in the bond markets is a bigger problem; Zandi lists the market’s opaqueness as a structural concern. “If something goes wrong [you could see a quick succession of failures] and that only happens in opaque markets that are not transparent,” according to him.

The latest modification represents a significant increase in transparency, with the possibility of more detailed public release of secondary market trade data in the coming months after a review procedure.

According to Professor Duffie, more drastic measures may be required, particularly in the area of price transparency.

He claims that because purchasers are forced to rely on dealers for price estimates without any kind of benchmark, the current system may deter traders.

“You might end up not trading as much as you would if you could see the prices,” he states, describing this as “another positive for market liquidity.”

After analyzing the results of the most recent modifications, Liang informed market participants in October that “we’ll consider possible next steps for additional transparency” with regard to future system modifications.

The president of the Committee for a Responsible Federal Budget, Maya MacGuineas, noted in a recent interview that “this is suddenly on our radar much more than it was before,” citing worries that little tremors in this area might swiftly grow.

She also states that “shifts could happen very abruptly so I sit on the edge of my seat in a way that I never have before about how the Treasury issuances are going to go.”

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