Thinly capitalized hedge funds’ growing role in the enormous and rapidly expanding market for U.S. Treasury securities poses a clear and present danger to financial stability that warrants a new approach from the Federal Reserve during times of extreme market stress, suggests a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 28.
In their paper, “Treasury Market Dysfunction and the Role of the Central Bank,” the authors examine changes in the Treasury market since March 2020, when the Federal Reserve purchased more than $4 trillion of Treasuries and government-backed mortgage securities to calm turmoil in those markets triggered by the COVID pandemic.
“These problems threatened to spill over into other markets as well, potentially interrupting the smooth flow of credit and impairing the implementation of monetary policy,” write the authors, Anil K Kashyap of the University of Chicago, Jeremy C. Stein and Jonathan L. Wallen of Harvard University, and Joshua Younger of Columbia University. “It is natural to wonder whether such episodes of fragility will become more frequent and/or more severe as the Treasury market continues to grow.”
Here is the link to the summary, here is the link to the paper and slides. Via Julian Gough.
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