On Wednesday, July 28, 2021, the Working Group on Treasury Market Liquidity of the Group of 30 issued a Report entitled “U.S. Treasury Markets: Steps Toward Increased Resilience” (the “Report”), which warned of material market fragility, especially with respect to the level of confidence in the market for U.S. Treasuries, which are generally seen as the global “risk-free asset.” The Working Group was chaired by Timothy F. Geitner, former U.S. Secretary of the Treasury; its eight other members included William C. Dudley, former President of the Federal Reserve Bank of New York, Lawrence H. Summers, former Secretary of the Treasury, and Kevin Warsh, a former member of the Board of Governors of the Federal Reserve System (the “Fed”).

U.S. Treasury Markets

The Report points particularly to the disruptions caused by the worldwide “dash for cash” in March 2020, which forced the Board of Governors of the Federal Reserve System to inject hundreds of billions of dollars over just a few days to prevent a “meltdown in financial markets.” I have previously written about still-unaddressed uncertainties in the U.S. Treasury Market. See my December 1, 2020, blog post, “Treasury Transparency: Enhanced Regulations for Trading Government Securities” and my February 23, 2021, blog post, “Bucking the Break: SEC Requests Comments on MMF Reforms.”

The Report states that “the U.S. Treasury market plays a central role in the global [financial] system, with Treasury rates providing the fundamental benchmark for pricing most financial assets. Continued confidence in the market, and in its ability to function efficiently in times of stress, is critical to the stability of the global financial system.” The Report identifies several key problems afflicting the integrity of the market for Treasuries – each of the government’s own making.

First, there are now so many more Treasury securities. According to the U.S. Congressional Budget Office in a Spring 2021 report, marketable Treasury debt more than tripled from 2008 to 2020; and it is projected to double again by 2035. Second, there are far lower amounts of allocated resources to finance the marketplace for Treasury securities. To quote the Report, the “aggregate amount of capital allocated to market-making by bank-affiliated dealers has not kept pace with the very rapid growth of marketable Treasury debt outstanding, in part because leverage requirements that were introduced as part of the post-global financial crisis bank regulatory regime have discouraged bank-affiliated dealers from allocating capital …to market-making.” Moreover, as the Report also points out, “regulation of the U.S. Treasury market is balkanized” with the regulators often failing to act in concert.

The Fed Responds to the Group of 30

Despite their occasional differences, the Fed, the U.S. Securities and Exchange Commission (“SEC”), and the U.S. Department of the Treasury have long recognized that the health of financial markets is especially tied to liquidity, specifically the ability to buy or sell Treasuries without concerns that the market may suddenly become illiquid. A great deal of this is reflected in both money market mutual funds and in the pricing and availability of short-term (often overnight) transactions. Much of these are in turn dependent on the pricing and behavior of overnight repurchase (“repo”) agreements.

As the Report notes, the Fed had to dramatically intervene in March 2020 to prevent the repo market from freezing up. Something similar also happened in 2008 when the Fed changed the market rules on an emergent basis in the interest of preserving the market. Too few people recall that once again, in September 2019, the market also stalled, with interest rates on overnight repos rising from 2.43% to 5.25% from September 16 to September 17 (and reaching 10% during the trading day). This forced the Fed to inject over $80 billion in liquidity to keep the short-term market for Treasury transactions from coming unglued.

The Fed, both following a key recommendation in the Report and interpreting that recommendation in a global way, July 28, 2021, announced the establishment of NOT one, but TWO standing repo facilities. The facilities would essentially guarantee repo financing backed by Treasuries to a range of investors at a predetermined rate. The Report said that this would restore confidence in the ability to buy and sell Treasuries “during times of stress.” The Fed’s announcement stated that these “facilities will serve as backstops in money markets to support the effective implementation of monetary policy and smooth market functioning.”

Standing Repo Facilities

One of the repo facilities, the “SRF,” will serve as a domestic standing facility with a maximum operation size of $500 billion. The minimum bid rate for repos will initially be set at 25 basis points (which the Fed notes is somewhat above current overnight interest rates). Counterparties will include primary dealers and, it is expected, eventually “additional depository institutions.”

The other facility, the FIMA repo facility, will serve foreign and international monetary authorities. Under the FIMA facility, the Fed will enter into overnight repurchase agreements “as needed” with foreign official institutions secured by their holdings of Treasury securities in the custody of the Federal Reserve Bank of New York. The initial rate for this facility will be 25 basis points, with a counterparty limit of $60 billion. The Fed announcement states, “by creating a temporary source of dollar liquidity…, the facility can help address pressures in global dollar funding markets that could otherwise affect financial market conditions in the United States.” Interestingly, the FIMA facility was NOT specifically recommended in the Report, nor does the Fed announcement provide any further explanation of why the U.S. should take on the counterparty risks for foreign governments in times of financial stress.

Improving the Plumbing

The Report also contains a number of recommendations to improve both the transparency and the regulatory understanding of trading in Treasuries, especially those involving repo agreements. First, the Report urges that all trading in Treasuries be centrally cleared, and strongly suggests that the Fixed Income Clearing Corporation (“FICC”) be adapted to serve that role. I have previously written about the potential for expanding the role of FICC in this area. See my June 8, 2021, blog post, “Fixing FICC: Agency Proposes Rule Changes to Encourage More Repo Clearing.” In addition, the Report emphasizes the importance of having complete and timely information about Treasury transactions, including those that support repos. Hence, the Report extols the expansion of the TRACE system operated by the Financial Institutions Regulatory Authority to be more inclusive.

In my February 4, 2021, blog post, “Tracking Treasury Trading: The Fed to collect the TRACEs,” I make the same arguments. It is not yet clear how many of the Report’s recommendations will be adopted, or how soon that may occur. But the Report and the new Fed repo facilities do make clear that concerns about market fragility, especially involving U.S. Treasuries, continue to concern both applicable regulators and quasi-governmental “think tanks” like the Group of 30. One might ask, if one were told that he or she was as “sound as a dollar,” how SOUND that might be.