The Failed Regulation of U.S. Treasury Markets
63 Pages Posted: 4 Apr 2019 Last revised: 25 Sep 2020
Date Written: April 4, 2019
Trading the world’s preeminent risk-free security, the $20 trillion dollar U.S. Treasury market supports the country’s expansive borrowing needs, financial stability and investor appetite for a safe asset in times of crisis. Straddling a unique nexus between a securities market and systemically essential institution, the Treasury market is relied upon to function at all costs even, indeed especially, if other markets suffer failure.
Despite this unshakable reputation, this Article shows that the foundations of Treasury market structure are fragile, weakened by a public and private regulatory model that is ill-suited to match its design. First, public oversight of Treasuries is unusually fragmented, divided between five or more agencies, none of which has a lead or primary status. With these coordination costs, the rulebook for Treasuries is sparse, lacking basic guardrails common to other markets. In the absence of effective rules and institutional cooperation, regulators are hobbled in their ability to develop a taxonomy of risks for the market and strategies to mitigate them. Secondly, private self-regulation cannot fill the gap. Comprising a rival mix of more heavily regulated banks and lightly regulated algorithmic securities firms, major Treasuries traders lack incentives to cooperate. Instead, each trader is motivated to take risks in a market where the costs of detection and discipline are low. These deficiencies in public and private regulation leave the Treasury market vulnerable to failure, risk-taking and an insufficient economic interest on the part of traders to maintain market integrity. This Article concludes with two proposals to introduce stronger public and private oversight: (i) formalized coordination between public regulators, led by the Financial Stability Oversight Council; and (ii) mandatory clearing for Treasuries trades that forces traders to monitor themselves and each other. As the economic lifeline for the U.S., regulatory neglect of the Treasury market constitutes an exceptionally reckless administrative gamble with the potential to permanently 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
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