Wave of New Regulations Stokes Fears of Treasuries Shortage
By Joe Adler
The next crisis may arise not from a rash of sick banks but rather a shortage of medicine. The onslaught of new federal regulations, including everything from Basel capital and liquidity rules to Dodd-Frank Act margin requirements for swaps traders, is helping drive banks’ demand for Treasury bonds and other safe collateral. While government debt is now plentiful, some worry demand could someday exceed supply, making such assets costlier and leading to private-sector alternatives reminiscent of the securitization boom. “Historically, when there are not enough government bonds as collateral, the private sector creates ‘safe debt.’ In the last 30 years this has taken the form of AAA”-rated asset-backed securities, said Gary Gorton, a professor at the Yale School of Management. “Bank regulators ought to focus on overseeing the production of private collateral … [to] try to ensure that it is safe.” To comply with higher capital requirements, banks can opt to reduce risk on the asset side of their balance sheet instead of just raising equity. That makes government securities appealing, and having less-risky assets is also essential for implementing liquidity rules. A paper released in May by the Bank for International Settlements suggested the risk of demand exceeding supply was low. The paper estimated about $4 trillion in additional demand for high-quality assets resulting from new liquidity rules and derivatives reforms, but added that “outstanding amounts of AAA- and AA-rated government securities alone … increased by $10.8 trillion between 2007 and 2008.” And some economists believe an “overcollateralized” system should breed confidence, not fear. After the release of the BIS paper, Karen Shaw Petrou, managing partner of Federal Financial Analytics, said in a memo to clients that “a locomotive is barreling down the tracks pulling freight cars loaded with rule after rule requiring banks to hold lots more sovereign debt and similarly ‘safe’ collateral.”