A Blueprint for Reforming US Treasury Markets

Abstract

The U.S. Treasury market is foundational for the economic health of the nation and its ability to weather crises like Covid-19. Since the 2008 Financial Crisis, the U.S. has deployed its unparalleled borrowing power to raise around $15 trillion in tradable government bond debt at record-low rates. As of end-October 2020, outstanding marketable Treasury debt stood at around $20.1 trillion. The strength of the Treasury market rests on two defining features: (i) that claims against the credit of the U.S. are risk-free, meaning that they will never be in default; and (ii) that these claims can be easily and cheaply traded in a deeply liquid market. Owing to these characteristics, the U.S. Treasury market represents a safe-haven for investors that promises to remain resilient at all times. Yet, as my research argues, the structure of the Treasury market and its system of oversight rests on fragile foundations. Events in March 2020 – when investors struggled to buy and sell Treasuries in the midst of widespread panic about Covid-19’s economic effects – showed that the Treasury market is vulnerable to serious structural breakdown. While March 2020 represented a particular low-point, trading in Treasuries has been vulnerable to various types of disruption. These events point to fundamental dislocations in the regulatory framework for overseeing Treasuries as well as in the mechanisms by which risk and liquidity are managed within the market’s trading structure. This policy note provides a short blueprint to progress thoroughgoing reform of U.S. Treasury market structure and its regulation. It summarizes and builds on my existing research to propose a series of recommendations that can address the multiple and serious weaknesses within this market. The costs of neglecting reform in this area are incalculable. If the Treasury market becomes systematically vulnerable to failure, it is unlikely to retain its status as the premier safe haven that can anchor financial stability in good times and bad. As a result, the U.S. will likely have to pay more to borrow and will consequently face constraints on its ability to fund expansive and ambitious national policies.