Darrell Duffie, a Stanford University professor who’s been closely involved for years in efforts to address liquidity concerns in the world’s largest debt market, warned in the paper of risks including financial instability if current weaknesses aren’t resolved.
With the US government’s debt burden on track to hit all-time records in a decade’s time, dealers will be faced with a steady increase in supply. Rising issuance has been an increasing focus of investors in recent weeks, sending yields on longer-dated notes to 16-year highs. “The quantity of Treasury securities that investors may wish to liquidate in a crisis is growing far more rapidly than the size of dealer balance sheets,” Duffie warned. Risks stemming from dealers’ limited intermediation capacity include “losses of market efficiency, higher costs for financing US deficits, potential losses of financial stability, and reduced save-haven services to investors,” he wrote.
One continuing constraint on dealers, which include the nation’s largest banks, is the so-called supplementary leverage ratio rule — which compels financial institutions to hold capital against their portfolios, including inventories of Treasuries.
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