US Government Debt Different - Finance Department - University of ...

16 A World Without Treasuries?nancial engineering could conceivably take up the slack and completethe markets in a world without Treasuries.Treasuries in Debt and Money MarketsThe question whether the markets could find a substitute investmentto play Treasuries’ unique role takes us to the main body of concernin the year 2000, which was not the role of Treasuries in asset pricinggenerally but their more particular functions in the debt and moneymarkets.Treasuries perform a bundle of significant functions in the markets:(1) They benchmark pricing and quotation in the bond markets; (2)they provide a key component of global bond indices used by moneymanagers; (3) they are major instruments for hedging fixed -incomepositions in the U.S. dollar and in international markets; (4) theyserve as collateral for financial transactions and (5) they are a primarytool in bank liquidity management.Treasuries’ minimal credit risk figures importantly in this functionalpicture, but financial markets and institutions also rely on Treasuries’deep, transparent, and cheap market structure along with the denseand broad yield curve they produce. Because, in normal markets,treasury prices change in response to public information, they providea benchmark that allows the credit risk of other debt obligationsto be distinguished from interest rate fluctuations. In normal times,there is also a high correlation between Treasury yields and privateyields, which makes them useful for hedging. And as regards liquiditymanagement, Treasuries provide a good substitute for depositsbecause they are auctioned every week with a very narrow bid-askspread.A combination of factors caused Treasuries to lose some of these reliablecharacteristics during the years in question.Recall that 1998 saw a flight to quality triggered by a Russian debtdefault and then further stoked by the collapse of Long Term CapitalManagement. No sooner had those shocks worked their way through