Tag Archives: Treasury

Liquidity Premia on Treasuries?

In an NBER working paper, Matthias Fleckenstein and Francis Longstaff argue that Treasuries do not trade at a premium:

It is widely believed that Treasuries trade at premium prices because of their safety and money-like properties. In reality, this is only true on a relative basis when compared to other bonds, but is often not true on an absolute basis. Many Treasuries have repeatedly traded at substantial discounts to their intrinsic fair values for extended periods during the past 25 years. Since 2015, Treasuries have consistently been priced at an aggregate discount of $100 to $300 billion below their fair values. Treasuries often actually become cheaper following crises. These results provide new perspectives on safe-asset theories.

Treasury Direct

A common argument against retail central bank digital currency (CBDC) is that CBDC would undermine financial stability by allowing the general public to swiftly move funds from banks to a government account. But in several countries such swift transfers are possible already today—in the US through Treasury Direct.

(The argument also has conceptual flaws, see the paper On the Equivalence of Public and Private Money with Markus Brunnermeier.)

Treasury Report on “Nonbank Financials, Fintech, and Innovation”

The Treasury’s recommendations fall into four categories:

Adapting regulatory approaches to changes in the aggregation, sharing, and use of con- sumer financial data, and to support the development of key competitive technologies;

Aligning the regulatory framework to combat unnecessary regulatory fragmentation, and account for new business models enabled by financial technologies;

Updating activity-specific regulations across a range of products and services offered by nonbank financial institutions, many of which have become outdated in light of techno- logical advances; and

Advocating an approach to regulation that enables responsible experimentation in the financial sector, improves regulatory agility, and advances American interests abroad.

Fact sheet: PDF. Report: PDF.

Financial Sanctions, the USD, and the EUR

On Moneyness, JP Koning discusses the ability or not of the U.S. treasury to enforce financial sanctions overseas. Focusing on the Iran sanctions that ran from 2010 to 2015 (with strong international support) and are scheduled to be reimposed soon (without such support) Koning compares the U.S. sanctions regime to an exclusivity agreement that a large retailer imposes on a manufacturer.

Foreign banks in places like Europe were free to continue providing transactions services to Iran, but if they did so they would not be able to maintain correspondent accounts at U.S. banks. To ensure these rules were enforced, U.S. banks were to be fined and U.S. bank executives incarcerated if found guilty of providing accounts to offenders. Fearful bank executives were very quick to comply by carefully vetting those that they offered correspondent banking services to.

Having a U.S. correspondent account is very important to a non-US bank. If a European bank has a corporate customer who wants to make a U.S. dollar payment, the bank’s correspondent relationship with a U.S. bank allows it to effect that payment. Since the revenues from U.S. dollar payments far exceeds revenues from providing Iranian agencies and corporations with payments services, a typical European bank would have had no choice but to abandon Iran in order to keep its U.S. correspondent account.

But what would happen if Iran were to invoice in EUR rather than USD and make payments using an account at a European bank, bank X say, without direct links to the U.S. and no U.S. correspondent account? The answer to that question depends on whether the U.S. treasury would be prepared to sanction a third financial institution, bank Y say, that collaborates with bank X (or a business partner of bank X) and relies on a U.S. correspondent account. In the most extreme scenario bank Y would be the European Central Bank.

One scheme would be to set up a single sanctions-remote bank that conducts all Iranian business. To defang the U.S. Treasury’s threat “do business with us, or them, but not both!”, this bank should not be dependent on U.S. dollar business. Without a U.S. correspondent, the Treasury’s threat to disconnect it from the correspondent network packs no punch. … Crude oil buyers from all over Europe could have their banks wire payments to [bank X’s] account via the ECB’s large value payments sytem, Target2. [Bank X] could also open accounts for companies in India, China, and elsewhere who want to buy Iranian crude oil with euros.

… There is also the extreme possibility that the U.S. would impose travel bans on the ECB itself, in an effort to force ECB officials to remove [bank X] from Target2. Here is one such threat: “Treasury this week designated the governor of Iran’s central bank—does any European country think Treasury can’t designate their own central bank governor too?” Look, the idea of preventing Mario Draghi from travelling to the U.S., or blocking his U.S. assets, sounds so unhinged that it’s not even worth entertaining.

The reason Iran and its trading partners were not able to break sanctions between 2010 and 2015, according to Koning, is that Europe (specifically the German chancellor Angela Merkel) supported the U.S. administration and imposed its own sanctions on bank X, cutting it off the SWIFT and Target2 networks.

How Problematic Is a Large Central Bank Balance Sheet?

On his blog, John Cochrane reports about a Hoover panel including him, Charles Plosser, and John Taylor.

Cochrane focuses on the liability side. He favors a large quantity of (possibly interest bearing) reserves for financial stability reasons. Plosser focuses on the asset side and is worried about credit allocation by the Fed, for political economy reasons. Taylor favors a small balance sheet. Cochrane also talks about reserves for everyone, but issued by the Treasury.

Roger Farmer’s “Prosperity for All”

On his blog, Roger Farmer advertizes his new book, “Prosperity for All,” and argues that governments should stabilize asset prices:

Following the Great Stagflation of the 1970s, economists backtracked and revived the classical economic theory that had dominated academic economics for a hundred and fifty years, beginning with Adam Smith in 1776 and culminating in the business cycle theory described by Keynes’s contemporary Arthur Pigou in his 1927 book, Industrial Fluctuations. That backtrack was a big mistake. It is time to realize that much, but not all, of Keynesian economics is correct. …

In my book Prosperity for All: How to Prevent Financial Crises, … I do not conclude that more government spending is the right way to cure a depression. Instead, I argue for a new policy in which central banks and national treasuries systematically intervene in financial markets to prevent the swings in asset prices that have such debilitating effects on all of our lives.

The control of asset prices will seem like a bold step to some, but so too did the control of the interest rates by the Open Market Committee of the Federal Reserve System when it was first introduced in 1913. We do not have to accept hyperinflations of the kind that occurred in 1920s Germany. Nor should we be content with the 50% unemployment rates that plague young people in Greece today. By designing a new institution, based on the modern central bank, we can and must ensure Prosperity for All.

And in another post:

The New Keynesian agenda is the child of the neoclassical synthesis and, like the IS-LM model before it, New Keynesian economics inherits the mistakes of the bastard Keynesians. It misses two key Keynesian concepts: (1) there are multiple equilibrium unemployment rates and (2) beliefs  are fundamental. My work brings these concepts back to center stage and integrates the Keynes of the General Theory with the microeconomics of general equilibrium theory in a new way.

Could the Fed have Rescued Lehman Brothers?

In a paper, Larry Ball argues that

inadequate collateral and lack of legal authority were not the reasons that the Fed let Lehman fail. …

… the primary decision maker was Treasury Secretary Henry Paulson–even though he had no legal authority over the Fed’s lending decisions. … evidence supports the common theory that Paulson was influenced by the strong political opposition to financial rescues. … Another factor is that both Paulson and Fed officials, although worried about the effects of a Lehman failure, did not fully anticipate the damage that it would cause.

James Stewart comments in the New York Times.

Helicopter Drops of Money

In his blog, Ben Bernanke discusses the merits of “helicopter drops” as a monetary policy tool.

[A] “helicopter drop” of money is an expansionary fiscal policy—an increase in public spending or a tax cut—financed by a permanent increase in the money stock.

… the Fed credits the Treasury … in the Treasury’s “checking account” at the central bank, and those funds are used to pay for the new spending and the tax rebate.

… it should influence the economy through a number of channels, making it extremely likely to be effective—even if existing government debt is already high and/or interest rates are zero or negative. … the channels would include:

  1. the direct effects of the public works spending on GDP, jobs, and income;
  2. the increase in household income from the rebate, which should induce greater consumer spending;
  3. a temporary increase in expected inflation, the result of the increase in the money supply. Assuming that nominal interest rates are pinned near zero, higher expected inflation implies lower real interest rates, which in turn should incentivize capital investments and other spending; and
  4. the fact that, unlike debt-financed fiscal programs, a money-financed program does not increase future tax burdens.

[Debt financed spending programs lack channels 3 and 4.]

[Helicopter drops are subject to various] practical challenges of implementation, including integrating them into operational monetary frameworks and assuring appropriate governance and coordination between the legislature and the central bank.

Not Guilty of Money Laundering, but Out of Business Anyway

The Economist continues to report critically on US regulatory pressure abroad and possible double standards.

The Financial Crimes Enforcement Network (FinCEN), part of America’s Treasury, [has] rescinded a devastating finding against a European bank suspected of facilitating money-laundering. The withdrawal, less than a year after the designation, looks like a climbdown. …

Some suspect the bank was a pawn in a tussle between governments: miffed that Andorra was slow to adopt American-style anti-money-laundering rules … America decided to show who was boss by selecting a bank to pick on. There is some evidence to support this sacrificial-lamb theory. … an American diplomat suggested that America chose to “use the hammer” on BPA as a way of resolving wider concerns about Andorra. …

These cases highlight two problems with FinCEN’s money-laundering cudgel. The first is double-standards. It tends to go after only small banks in strategically unimportant countries … The second is its lack of openness. It faces no requirement to make detailed evidence public, or even available to a court, at the time of action. By the time any challenge is heard, it may be too late for the bank in question.

Government Debt Management

In his FT blog, Larry Summers argues for a “quite radical” change in government debt-management. He proposes several lessons:

  • “Debt management is too important to leave to Federal debt managers and certainly to leave to the dealer community. … when interest rates are near zero, it has direct implications for monetary and fiscal policy and economic performance … and … financial stability.”
  • “… it is fairly crazy for the Fed and Treasury, which are supposed to serve the national interest, to pursue diametrically opposed debt-management policies. This is what has happened in recent years, with the Fed seeking to shorten outstanding maturities and the Treasury seeking to term them out.”
  • “Standard discussions of quantitative easing … are intellectually incoherent. It is the total impact of government activities on the stock of debt that the public must hold that should impact on financial markets.”
  • In the US, “the quantity of long-term debt that the markets had to absorb in recent years was well above, rather than below, normal. This suggests that if QE was important in reducing rates or raising asset values it was because of signalling effects … not because of the direct effect of Fed purchases.”
  • “The standard mantra that federal debt-management policies should seek to minimise government borrowing costs is … wrong and incomplete. … it is risk-adjusted expected costs that should be considered. … it is hard to see why the effects of debt policies on levels of demand and on financial stability should be ignored.”
  • “The tax-smoothing aspect, which is central to academic theories of debt policy, is of trivial significance.”
  • Rather than providing opportunities for carry trade, “[t]reasury should reverse the trend towards terming out the debt. Issuing shorter term debt would also help meet private demands for liquid short-term instruments without encouraging risky structures such as banks engaged in maturity transformation.”
  • “Institutional mechanisms should be found to insure that in the future the Fed and Treasury are not pushing debt durations in opposite directions.”

Fed and Treasury Maturity Policies

In a recent paper, Robin Greenwood, Sam Hanson, Josh Rudolph and Larry Summers discuss the joint effect of Fed and Treasury policy on the maturity structure of government liabilities in the hands of the private sector. John Cochrane commends the paper in a blog post.

Greenwood, Hanson, Rudolph and Summers make several points. First, “monetary and fiscal policies have been pushing in opposite directions in recent years.” In spite of QE, long-term government debt held by the private sector increased, mostly due to government deficits but also because the government lengthened the maturity of its debt. Second, Fed and Treasury policies largely are uncoordinated. They argue that this is suboptimal, in particular when the Fed strongly intervenes as it did in the recent QE episodes.

The Federal Reserve has focused purely on the effects that its bond purchases were expected to have on long-term interest rates and, by extension, the economy more broadly. … it completely ignored any possible impact on government fiscal risk, even though the Federal Reserve’s profits and losses are remitted to the Treasury. Conversely, Treasury’s debt management announcements and the advice of the Treasury Borrowing Advisory Committee (TBAC) have focused on the assumed benefits of extending the average debt maturity from a fiscal risk perspective, and largely ignored the impact of policy changes on long-term yields. To the extent that the Federal Reserve and Treasury ever publicly mention the other institution’s mandate, it is usually in the context of avoiding the perception that one institution might be helping the other achieve an objective. Specifically, the Fed does not want to be seen as monetizing deficits, while the Treasury has been reluctant to acknowledge the Fed as anything more than a large investor.

Third, they argue that from a consolidated government policy perspective, the optimal debt maturity structure is rather short. This saves on interest payments to the private sector (on average) and reduces “liquidity transformation” by the financial sector with dangerous consequences for financial stability. They downplay the risk sharing benefits of longer-term debt and argue that short-term debt has additional advantages at the zero lower bound.

Pages 11-12 contain the following figure, among others:

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