News

Stability Concerns in the U.S. Government Debt Market

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4.3

Andrew R. Michaud

• December 13, 2023

The Biden administration has expressed concerns about the stability of the market for U.S. government debt. To address these concerns, the Securities and Exchange Commission (SEC) is implementing new rules aimed at preventing a crisis in the event of a major player in the U.S. Treasury market failing.

Increasing Central Clearing of Government-Debt Trades

One of the new rules being enacted by the SEC is designed to boost the proportion of government-debt trades that are centrally cleared. This process involves a clearinghouse that ensures the validity of trades and guarantees that buyers and sellers fulfill their obligations. By reducing risk in the market and bringing more stability to the financial system, central clearing is seen as a crucial measure.

The SEC will vote on adopting this rule during a scheduled meeting set to commence at 10 a.m. Eastern time.

Factors Contributing to Growing Debt Loads

Over the past few decades, the debt loads of the U.S. government have increased significantly due to various factors. The federal government has dealt with the economic aftermath of the 2008 financial crisis and the ongoing COVID-19 pandemic, all while facing greater spending on healthcare and Social Security due to an aging population.

As a result of these factors, the market for U.S. Treasurys has expanded exponentially to over $26 trillion in size, a nearly tenfold increase over the past 20 years. However, regulatory changes have hindered the ability of some bank-owned dealers of government debt to expand their purchases.

Liquidity Crunches and Market Challenges

These dynamics have led to several liquidity crunches in the market. In 2014, there was a notable "flash rally" in Treasurys, followed by pressures in the Treasury repo market in September 2019. Additionally, a liquidity crisis occurred in March 2020 as a direct result of the COVID-19 outbreak.

The implementation of new rules by the SEC aims to address these challenges and ensure the stability and resilience of the U.S. government debt market. Through increased central clearing and careful regulatory oversight, the Biden administration and the SEC are taking proactive measures to prevent potential crises.

Increasing Liquidity and Certainty in the Treasury Market

SEC Chair Gary Gensler has emphasized the importance of increasing the number of trades that are centrally cleared in order to bring more liquidity and certainty to the Treasury market. Gensler's recent speech highlighted the market's susceptibility to "jitters" and the need for regulatory attention.

One of Gensler's main concerns is the use of high levels of debt by hedge funds and other market participants to finance their activities in the Treasury market. He believes that excessive leverage can lead to instability when stress enters the system.

In an effort to address these issues, Gensler proposed a rule last year that would require clearinghouses to change their rules and mandate that all eligible secondary market transactions be submitted for clearing. This rule, set for adoption on Wednesday, aims to increase the proportion of trades that are centrally cleared. According to a recent study by the Treasury Market Practice Group, currently only 13% of trades are executed in this manner.

The proposed rule is just one part of a series of Treasury market reform measures. The SEC is also considering a proposal that would require any financial firm trading more than $25 billion per month in Treasurys to register as a dealer with the agency. Additionally, platforms that provide marketplaces for Treasurys would need to register as broker dealers.

Furthermore, the Treasury Department itself is taking steps to bring greater stability to the market. They plan to launch a buyback program next year, which will help dealers offload older and less desirable government bonds.

Overall, these reform measures, along with increased central clearing, aim to enhance liquidity and certainty in the Treasury market while addressing potential sources of instability.