The Demand for Risk-Free Assets

What Are the Risks of Quantitative Easing, Really? by DeLong

Not fully versed in this fascinating subject. Mortgage-backed securities (MBS) filled this need during the "global savings glut." But S&P and Moodys were shown to be frauds.

My guess is that 4 percent inflation would help the situation but that's a no-go because Bernanke is afraid that the Fed my lose its street cred and we'd quickly turn into Weimar/Zimbabwe.

Creditors don't like seeing their contracts devalued.

What were "maestro" Greenspan's arguments in favor of the Bush tax cuts? What were the dangers of a budget balanced by his dot-com bubble? That it would morph into a housing bubble which would eventually pop with disastrous consequences? No I don't think that was it.
 

Shadow banking system

Time’s Foroohar Responds to Treasury: Our Financial System Is Not Stronger

Treasury's Anthony Cole blogged:

Point Four: Shadow Banking

The risk in the so-called “shadow banking system” – the financial firms that operated outside of the protections and constraints we impose on banks – has fallen substantially since the crisis.

Assets in the “shadow banking system” are roughly half the level seen in 2007. Funding through tri-party repurchase agreements has fallen 40 percent from its peak in 2007, and asset-backed commercial paper outstanding – which was often used to fund leveraged off-balance sheet vehicles – is a third of what it was in 2007.

​We now have the authority to subject, through designation by the Council, major financial companies operating in the United States to consolidated supervision and adherence to heightened prudential standards, such as enhanced capital, liquidity, and risk management requirements. That represents a dramatic change from before the crisis, when there was no authority for such regulation of such institutions, which comprised more than half of the financial activity in the nation.

Since the housing bubble popped, business people are now gun-shy. But the assets levels in the shadow banking system will rise again as the crisis fades from view and people become complacent yet again. They'll need to be risky in order to compete. There needs to be an FDIC system for the shadow banking system as there is for the regular banking system. But that will make it less profitable. Instead it depends on the regulators.

As Konczal reports, Jack Lew is not regulating very well. And he's a Democrat.

AIG failed because its derivatives position became impossible for it to manage. The Commodity Futures Trading Commission (CFTC) has made major progress in bringing the light of transparency to the over-the-counter derivatives market, making sure collateral and price transparency clean up the market.

They have hit resistance, though. As the economist Alan Blinder wrote earlier this week, the CFTC’s Gary Gensler “ran into a wall of resistance from the industry, from European regulators, and from some of his American colleagues when he tried to implement even the weak Dodd-Frank provisions for derivatives.”

It’s important to name the actual agents involved. Instead of a nebulous and nefarious blob of interests called “the industry,” there’s an actual human being putting pressure on Gensler to stop these cross-border regulations that tie U.S. firms in Europe to U.S. regulations. And, as Silla Brush & Robert Schmidt reported in a great Bloomberg piece, his name is Jack Lew, and he’s the Treasury secretary of the United States. 

It's possible Larry Summers will be a good regulator as Fed Chair. It could happen. But my bet would be that he'll turn out to be like Jack Lew here. More of the same.

THE ASTONISHING INCREASE IN HOLDINGS OF U.S. TREASURY DEBT: YET MORE "YES, SIR JOHN HICKS TOLD ME SO" WEBLOGGING by DeLong

commenter Rajiv Sethi:

Brad, by mid-2008 the size of the shadow banking sector exceeded 12 trillion. Much of this was short term financing (via repo, money market mutual funds, asset backed commercial paper, etc.) of long dated but highly rated asset backed securities. Once these securities started to look risky, they had to be funded in the capital market since they were no longer acceptable as collateral in the money market. Money market investors wanted cash or genuinely safe collateral, that is, Treasuries. There simply wasn't enough cash to satisfy the demand for redemptions, so the Fed intervened with cash injections (via the Primary Dealer Credit Facility) and exchanges of Treasuries for ABS (via the Term Securities Lending Facility). 

The newly issued Treasuries have just replaced the formerly highly rated ABS as collateral in the money market. From this perspective, one way to ask the debt capacity question is to ask how much long dated, highly rated debt the money markets were funding in mid-2008? The answer is about 12 trillion. So we may be reaching the limits of debt capacity.

Makes sense to me. Money left the shadow banking system and moved into Treasuries.

My half-baked response:

This makes sense to me as a non-economist. Money moved out of the shadow banking system into Treasuries. Some of the money in the shadow banking system winked out of existence too after the housing bubble, right? And the economy has grown slightly since 2008. 

"and we are on track to have $10.7 trillion early 2014," According to graph $4 trillion securities in 2008 plus 12 trillion in shadow banking system in 2008. So $16 trillion is the "monetary base"? And interst rates are lower now than in 2008.

and of course the Fed pumped money into the financial sector via cash injections etc.

Anne responds:

"Who I wondered back in 2008 would buy these things? [Treasuries]
-- Brad DeLong 

[ What we do not know from the data given is what the duration of the Treasury securities that are being bought by the public as opposed to the Federal Reserve are. Judging from Vanguard which is either the largest or next to the largest American bond investor, there has been no meaningful demand for Treasuries apart from inflation protected and mortgage or GNMA bonds since 2011. Other than for speculation, the idea of buying a relatively long duration Treasury has made no sense since 2011, but from 2008 through 2010 there was every reason to buy relatively long duration Treasuries to take advantage of a profound bull market in bonds as longer term yields declined closer to the near zero short term yields. ]