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

18 A World Without Treasuries?new issues by reference to the prices of existing private substitutes.The markets would manage. The repo markets already were acceptingthe substitute agency issues as collateral along with high gradecorporates. On the other hand, it was expected that long term portfoliomanagers at pension funds and insurers would have a hardertime finding a substitute. They were already shifting in more corporates,but were not happy about it. So they sent out the BondMarket Association to lobby in Washington with the suggestion thatthe Treasury should go right on issuing the 30 year bond, whether ornot the government needed to borrow any money. As for the hedgingfunction of Treasuries, it was thought that the swap market would bethe substitute. Stepped up volume would mean more liquidity there.Of course, there was counterparty risk to worry about. But didn’t thebig market makers set up special AAA subsidiaries?Finally, there was the shock absorber function. Some questionedwhether we really needed the safe haven in bad times, suggesting thatthe flight to quality is itself distortionary and caused larger swingsin the value of riskier assets than otherwise would be the case. Yes,Treasuries had been the anchor security for a broad range of financialactivity. But the markets would adapt by shifting the anchor. Agencydebt, high grade corporates, and bank liabilities would substitute.To go back and look at these arguments today is to get the sense thatthose who made them thought of the projected shift of the anchor asa species of privatization—markets would be better off when weanedoff their dependence on government borrowing. With the benefitof hindsight, we can see that privatization was not in the cards. Ifone removes high-grade corporate bonds from the list of substitutes,the remaining alternatives all derived their credibility from either theagencies’ implicit federal guaranty or too big to fail assumptions respectinglarge financials.The opposite view was that there are no substitutes for Treasuries inperiods of stress. Actors in markets take risks on the assumption thatTreasuries are there in the event they ever need to shed risk, and theU.S. government needed to take these market benefits into accountin setting fiscal policy.