US Treasury securities are to financial markets what carbon is to life on Earth—ubiquitous, foundational, indispensable, and acting very scary of late. “The Treasury market is the biggest, deepest and most important bond market in the world and acts as a benchmark that is used to price trillions of dollars of assets globally,” says the Financial Times, an authority on these matters—yet you would be hard-pressed to find half a dozen law review articles on the subject. A pair of papers by Yesha Yadav, most recently with (her dad) Pradeep K. Yadav, deserves much praise for starting to fill the gap. The papers properly frame the subject at the intersection of law, finance, and economics, while public and private sector “grandees” and “heavyweights” sound financial stability alarms and try to patch the fraying market architecture.
We have it on good authority that carbon is a relatively recent arrival in our universe; more so the US Treasuries. As recently as a century ago, the US Treasury Department was hawking versions of bespoke project bonds and struggling to emerge from Britain’s shadow in the financial markets. A succession of design choices in response to 20th century upheavals helped transform the US Treasury market from a fringe contender into the undisputed center of global financial gravity. Its centrality was on full display in October 2008 when frightened humans gorged on sticky pudding while the markets supplying their carbs scrambled for their own comfort food, the US Treasury securities.
Market response to the COVID-19 shock cast doubt on the Treasuries’ place as a safe haven. Governments and institutions scrambled for US dollars to meet essential needs and insulate themselves from turmoil—but they demanded cash and would no longer settle for the US government IOUs. With financial markets on the fritz, the US Federal Reserve intervened, buying $1.5 trillion in US Treasuries with crisp new cash in March and April 2020. Following its recent crisis playbook, the Fed launched, revived, and extended dollar liquidity facilities for all manner of wholesale market participants and foreign central banks. Implicitly recognizing that the risk of another “dash for cash” was here to stay, the Fed established standing repurchase facilities in July 2021 to reassure domestic, foreign, and international investors that their Treasuries were as good as cash. But there is not one magic pill to restore Treasury greatness.
Yadav’s two articles focus on the elaborate and apparently fragile institutional design underpinning the Treasuries’ global role. The first puts some of the dysfunction to the long history of opacity, regulatory fragmentation, and misaligned incentives in the US government debt market. It argues for better interagency coordination through the Financial Stability Oversight Council (FSOC) and central clearing, a form of mutualization that should incentivize market participants to do the right thing. The second article (joint with P.K. Yadav) highlights Treasury market fragmentation and the increasingly problematic role of primary dealers, the large financial institutions that serve as the New York Fed’s counterparties in buying and selling Treasury securities. The article’s recommendations include more and better information reporting, more robust consolidated oversight, and constraints on primary dealers’ ability to quit in bad times.
The information and coordination problems the authors identify seem right, and some of their prescriptions are ahead of the curve.1 I see the most valuable contribution of both papers in helping disentangle questions about the government debt contract and its safety from questions about the safety of the market in which it trades.
Answers to the contract questions are mostly straightforward. As a debt contract, the US Treasury looks goofy (the promise to repay is filed under “Miscellaneous”); like all government debt, it would be very hard to enforce. Indeed, the crucial bottom-line question of whether the US Treasury could default (stop paying its debt) gets an emphatic answer – of course it can, and it has, and everyone knows it. The 2021 debt limit drama adds an unnecessary data point for extra credit.
The more interesting questions concern the market – how the United States managed to grow a market where questioning its debt was taboo, and to invest vast networks of people and institutions around the world in maintaining the legal and market fiction of the debt’s absolute safety, the original and ultimate too-big-to-fail. The answers are long and complex.
Even when the United States was, in today’s terms, a frontier market in default, Hamilton and allies had sought to make its debt more than a funding instrument. It was supposed to be money, political glue, and a social and economic organizational device rolled into one. From the start, the Treasury cultivated a mix of domestic elites and foreign investors. Foreigners, most notably foreign central banks, today hold about a third of all tradable Treasury debt, tied to the US dollar’s role as the global reserve currency. Tax administration, monetary policy, bank and market regulation, and even bankruptcy laws were designed around Treasury circulation. The shadow banking system, collateralized with Treasury debt, grows out of the original design. The Treasuries’ “safety” has always been about their many functions in the broader institutional and political context—more than the present value of future cash flows. By the same token, Treasury market regulation is not about the issuer; it is all about the scaffolding around the hollow core.
The Federal Reserve has intervened to buy Treasury securities before, when it got especially worried about gaps between cash and Treasury securities—notably when Hitler invaded Poland in 1939. Is today’s persistent Treasury market turbulence the start of something different? Who knows? Curiously, foreign central banks were among the biggest sellers of US Treasury securities in March of 2020. Although the Fed responded on a massive scale, the jitters keep coming, along with big storms, and sticky pudding is back in vogue.
Professor Yadav’s two articles and the research agenda they set are perfectly timed. I hope law scholars stay engaged in this space, preferably across disciplines – extra points if you can get your family to come along.
- I may not be on board with all of them: I am sour on FSOC; I am on the fence about a debt market regulated by the debtor (Treasury) and its fiscal agent (the New York Fed); and I worry about primary dealers bolting preemptively for fear of getting trapped. But my disagreements on policy particulars are beside the point for my purposes here—we need to be having a far broader and deeper debate on the subject in the legal academy.