The Failed Regulation of U.S. Treasury Markets

Abstract

Trading the preeminent risk-free security, the $21 trillion U.S. Treasury market supports the country’s borrowing needs, financial stability, and investor appetite for a safe asset. Straddling the nexus between a securities market and a systemically essential institution, the Treasury market must function at all costs, even if other markets fail.

This Article shows that Treasury market structure is fragile, weakened by a regulatory model poorly suited to match its design. First, public oversight of Treasuries is fragmented, divided between five or more agencies. The rulebook for Treasuries is sparse, lacking basic guardrails common to other markets. Without effective rules and institutional cooperation, regulators are ill-equipped to develop a taxonomy of risks and strategies to mitigate them. Secondly, private self-regulation cannot fill the gap. Comprising a rival mix of heavily regulated banks and lightly regulated algorithmic firms, major Treasuries traders lack incentives to cooperate. Instead, traders are motivated to take risks where the costs of detection and discipline are low. These deficiencies leave the market vulnerable to failure and risk-taking as traders lack a sufficient economic interest to maintain market integrity.

This Article concludes with two proposals to introduce stronger public and private oversight: (i) formalized coordination between regulators, led by the Financial Stability Oversight Council; and (ii) mandatory clearing for Treasuries trades that forces traders to monitor each other. As the country’s economic lifeline, regulatory neglect of the Treasury market constitutes an exceptionally reckless administrative gamble with the potential to damage the country’s preeminence in global finance.

Keywords: Treasuries, Financial Stability, Exchanges, Fragmentation, Manipulation, Fraud, Self-Regulation, Public Debt, Interest Rates, Macroeconomy, Too-Big-to-Fail