SPEAKER_02: Support for NPR comes from ADP. Say you're in HR and a solar flare adds an extra hour to each day. How would this impact business? ADP designs forward-thinking solutions to help your business take on the next anything. ADP. Always designing for people.
SPEAKER_03: This is Planet Money from NPR.
SPEAKER_04: Hey, it's Mary Childs. It is the season of giving, as you may know. And in that spirit, here at Planet Money, we thought we could give you something you'd actually maybe really like. No, not cash. That is a good idea though. We have picked our very favorite episodes that are normally just for Planet Money Plus supporters and we're making those favorite episodes available for everyone this month. If you are a Planet Money Plus listener, you got a chance to hear today's episode a while back and we are so, so grateful for your support. Steady, dependable contributions really matter in a world of public media, especially now. And if you are not a supporter and you're interested in hearing more episodes like this one, you can sign up at plus.npr.org and you will also hear all of our regular episodes without sponsor messages. Okay. So do you remember the big messy fights this year over the U.S. debt limit?
SPEAKER_03: The U.S. has hit its debt ceiling.
SPEAKER_04: Congress and the White House are in a standoff.
SPEAKER_00: The impasse could end in a federal default and economic disaster.
SPEAKER_04: Here is what Yaysha Yadav, a professor at Vanderbilt University's law school, told me about it at the time. We look like idiots to the rest of the world.
SPEAKER_03:
I mean, I think there's no other way to put it that we are playing with our own national economy.
SPEAKER_04: Luckily, that will never happen again. I'm just kidding. The debt limit was suspended until 2025.
So year after next, we might be watching the very same fight again. And for economists and market experts like Yaysha Yadav, it's a hard fight to watch because it could compromise something hugely important to the economy, the safety and security of the U.S. Treasury market.
Treasuries are U.S. government debt. They're called treasuries because they come from the Treasury Department. Do you get it? When the U.S. government sells a treasury, it's saying, hey, you give me some money, I'll pay you back later and I'll give you these little interest payments along the way to make it worth your while.
SPEAKER_03: So we have an asset that's supposed to be default free that the U.S. will always pay its debts on time. It's an asset you can trade super in and out of, which means you can turn it into cash whenever you want. And the U.S. uses the money to fund? Basically everything. The interstate, the post office, the different water sources that you use. We're using the money to essentially fund our daily lives.
SPEAKER_04: Treasuries, U.S. government debt, they make life as we know it possible. They also help fund our big, beautiful bailouts and our Federal Reserve lending programs. On top of all of that, treasuries are crucial to keeping the entire financial system functioning. They are a super powerful and important tool, but also the market for them may be more fragile than we know. In this episode, we are going to talk about why. This conversation is like many that we bring you in Planet Money Plus bonus episodes. It's the kind that we have with many really smart people all the time. Portions go into our regular episodes, but our supporters get to hear a much longer version. So here is my conversation with Yezha Yadav.
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SPEAKER_04: Can you tell me what benefit we derive from having treasuries be so risk free? We derive just this superstar ability to borrow.
SPEAKER_03:
You know, this is a way in which we can reliably finance ourselves without looking to taxpayers to foot the bill. And it's also super helpful in situations where every other part of the financial architecture is falling apart. Because treasuries are risk free, it means that people pile into them whenever there's a problem. And it means that we can borrow super cheaply when everything else is really expensive. And we saw that during COVID, we saw that during the financial crisis, where it was essentially free for the government to borrow. And that privilege is so powerful because it means we can finance ourselves that much cheaply out of disasters that the rest of the world faces a much more expensive job having to deal with.
Okay, so treasury markets, you mentioned that these things are traded a lot.
SPEAKER_03: These things are traded a lot. The standard spiel that you will read on any New York Fed or any US Treasury document about the Treasury market is that it's the deepest and most liquid market in the world. That is a spiel. What that means is that when you buy a treasury, when you lend money to the US government, you should be able to trade that claim super easily, super cheaply and at very, very stable prices. And that means that no one is taking on a whole bunch of worry when they lend money to the US government. They know that if they need to liquidate it, if they need to turn it into cash, they can do that super easily.
SPEAKER_04: And because of how easy it is to get out of these things, how easy it is to trade in and out of treasuries. That makes them useful, right? They start to show up other places. Can you help me understand where treasuries show up that's not just their own market?
SPEAKER_03: It's an incredible question. So the entire financial system stability that we have today depends on US treasuries. It is the most incredibly powerful asset that is the anchor for the global financial markets to stay in one piece is the way to describe it, essentially. So regulators have felt that this is the perfect asset to make into the safest asset that financial firms can keep. And so since 2008, 2010, they have really doubled down on this assumption and they have made essentially every regulated financial firm keep a whole buffer of treasuries within their coffers in order to maintain their own institutional stability. That's a key part of the post-crisis financial architecture. I don't think I really understood that as like, it is a doubling down.
SPEAKER_04: Like before it was sort of like the market had agreed to some extent, it was more that the market had agreed that we all love this asset the most and it's the riskiest free asset. And we benchmark everything off of it. But in the post-crisis regulation, if that became more codified.
SPEAKER_03: That became incredibly codified. So the Dodd-Frank Act, for example, has a number of provisions that speak to firms maintaining high quality liquid assets. The best kind of HQLA it's called, high quality liquid asset, alongside cash is the treasury. It's treated equivalent to cash, even though it's not equivalent, but it's treated equivalent to cash, which means that banks, hedge funds, mutual funds, you name it, fund has to keep a bunch of treasuries in order to comply with that regulation. And that's not all essentially. What has also happened is in the case of the private agreements that financial firms meet with each other. So Mary, if you and I are financial firms and we are borrowing and lending to each other, we don't want to do a whole bunch of due diligence because we don't have the time. So we're like, you know what, I'll lend you that money and you give me treasuries as collateral, which means I don't have to do a whole bunch of investigation on you. I don't have to spend a ton of time looking at your FICO score and whatnot. I'll just know that I have the treasuries as collateral, I can sell them and I'll be A-OK in the event that you default. So treasuries as collateral have become a key part of how private interactions within the financial markets are conducted and how private parties keep themselves safe in credit relationships. Now, there's one market in particular that's very, very, very powerful at doing this, and it's called the market for repurchase contracts or the repo market. And that's a lifeline for financial firms where they are lending to each other on a very short term basis. It's how they live every single day. And this market is not regulated in a very prescriptive way. It's regulated through the fact of having collateralization, and that's dependent on the U.S. Treasury being default free and being highly liquid. OK, so how many trillions of dollars are we talking in the repurchase market?
SPEAKER_03: It's shrunk a little bit, but last time I checked, it was approximately $4.5 trillion in the bilateral repo market where they're interacting with each other. Different components vary in how much they use treasuries, but approximately it's around 67 to 70 percent of all transactions in this market are collateralized through treasuries.
SPEAKER_04: How many treasuries are there outstanding and how many are used as collateral and how does it like are they floating around? Where are they? That is a... Impossible question?
SPEAKER_03:
Very hard question. And the reason for that is that we don't really know. And I would tell you something that might freak you out a little bit, which is that regulators themselves don't monitor how treasuries are collateralized within this different borrowing and lending market that financial firms use, the repo market.
And in fact, what tends to happen is that a single treasury is collateralized multiple times. Oh, no. So one treasury... Yes. So one treasury is used multiple times for multiple different debts. Now there's great work coming out of the IMF, Manmohan Singh, Dr. Manmohan Singh does this work. What he has posited is that one treasury is being used three times to collateralize debt.
SPEAKER_04:
Like at once, like at one time.
SPEAKER_03: Potentially at once. Yeah.
SPEAKER_04: Doesn't that mean if one person defaults, they're like, give me that treasury and the other person's like, oh, I don't actually have it. It's over there. And then the other person's like, I too don't have it.
SPEAKER_03:
And there's no reporting mechanism. So no one really can trace these things either. For once I'm like pro blockchain all of a sudden I've become...
SPEAKER_04: I was thinking the same thing.
SPEAKER_03: I was like, wait, you know what, let's just put it in the blockchain. It would really solve something for once. I don't know why no one says this. We have a use case. Finally. People are going to be so excited when they hear this.
SPEAKER_04:
Okay. So without the blockchain. So that seems bad and like an inherent fragility that we don't know about. Are there other ways? Like the thing that I feel like about treasuries and you've sort of talked about this already a little bit, but like it seems to me like they're everywhere in ways that I don't know. Like they're collateralized. They're like showing up in other like repo. Like are there other places that I don't know about that they're sneaking around?
SPEAKER_03: You know, when you have your 401k, the mutual fund invests a whole shizzle ton in treasuries. They put a whole bunch of the money that they get into these prime funds, which are treasury funds. And the reason why a whole bunch of these mutual funds do that kind of thing is because it's safe. Right. And so what that means is that it's safe and it's liquid. Treasuries are also desirable so they can lend them out if they have to. But you know, this is the way in which we provide our financial services and we take for granted the fact that we can use treasuries to balance our portfolios, have this super safe layer here. And ultimately what this is doing is unlocking the credit, unlocking the liquidity that we all need in order for the banks to give us the loans, for the mutual funds to then be able to invest in potentially riskier assets because they have the segment that is also super safe that we can then, you know, have this borrowing within the marketplace that allows us to essentially get our life the way that we have it and that we become used to. So treasuries is the linchpin that unlocks that credit. That makes so much sense.
SPEAKER_04: So it's kind of it feels like it's like this invisible agreement that we've all made that like if we can just agree that a treasury is a treasury is a treasury and we all think it's perfectly safe, then we can operate in our day to day. But if we have to start questioning a treasury, the whole thing falls down.
SPEAKER_03: If we're starting to question the treasury, this officially becomes like the Avengers blip, right? Like, you know, this is the only way that I can envision it, that we're just blipped. And the world as we know it does not look the same. And if we have politicians that are potentially playing, you know, pickleball with a nuclear weapon economically, then we are not safe.
SPEAKER_04: Thank you again to Yasha Yadav at Vanderbilt Law. We make episodes like this one every other week for our Planet Money Plus supporters. Two extra episodes a month. Usually they're a little bit more wonky, a little bit more in the weeds, but not always. Sometimes they're goofy. We go behind the scenes and open up our process. You can sign up for Planet Money Plus at plus dot NVR dot o RG. And the real reason isn't the sponsorship free listening or the bonus episodes even. It's actually supporting public media journalism. Direct membership support helps us stay independent and strong, especially in turbulent times. And plus you do get a discount on merch. Okay, okay. That is Planet Money Plus at plus dot NVR dot org. I'm Mary Childs and we are back with a new regular episode in a few days about advertising and why the 1990s saw so many of the most memorable ads of all time. Thank you for listening to Planet Money from NPR.
