Central clearing improves market safety by lowering exposure to defaults. When all trades are with one counterparty, they can be netted against each other, requiring far less commitment of dealers’ balance sheets. Under central clear in g, the original buyer and seller would no longer be exposed to each other for settlement risk - they instead would deal with the central counterparty, also known as a clearinghouse. Under the current system, it is usually up to the buyer to pay the seller, and to the seller to deliver the Tre a suries to the buyer. In this working paper written for the Hutchins Center on Fiscal and Monetary Policy, Darrell Duffie of Stanford’s Graduate School of Business proposes a study of the costs and benefits of requiring central clearing of the Treasury transactions of all firms that are active in the market. Treasuries and increase the cost to taxpayers of financing growing federal deficits. Without changes, the size of the Treasury market will outstrip the capacity of dealers to safely intermediate the market on their own balance sheets, causing more frequent bouts of market illiquidity that will raise doub ts over the safe haven status of U.S. Since 2008, growing federal deficits have caused the stock of marketable Treasuries to grow significantly relative to dealer balance sheets, and growth of those balance sheets has been constrained, in part, by regulatory reforms imposed after the 2008- 200 9 crisis. B id-offer spreads widened dramatically, the yields of similar-maturity Treasuries were no longer close to each other, and the number of failures to settle jumped.Īlthough the Fed, through an unprecedented quantity of Treasury purchases and other actions, was able to restore market liquidity, the episode revealed the Treasury market to be overdue for an upgrade. Over several tense days in March, yields rose sharply, calling into question the longstanding view that Treasuries are a reliable safe haven in a crisis. That presumption was questioned when the C OVID -19 c risis triggered heavy investor demands for trading that overwhelmed the capacity of dealers who usually serve as middlemen in this market.
Treasuries has long been viewed as the world’s most liquid and deepest financial market.
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