Exposed to the ultimate 'black hole': Banks throw up their hands as they brace for a crash — The catalyst

The US bond market appears to be walking on a tightrope, with experts issuing warnings of a "financial earthquake" lurking in the shadows of Wall Street. Major US banks, which traditionally act as intermediaries in the government bond market, no longer possess the necessary liquidity to handle the massive volume of transactions, leaving the market exposed to severe risks. In fact, even before recent geopolitical tensions, there were clear signs of strain in the functioning of government securities.

The announcement late last year that the Federal Reserve would buy $40 billion in short-term Treasuries every month to support bank deposits was the clearest sign of concern over systemic fragility. While the Fed provides temporary relief with these purchases, it does not address the deeper issue: bank balance sheets are insufficient to intermediate in the massive government bond market and in repo transactions, where banks lend to one another using Treasuries as collateral. According to the Bank Policy Institute, the current value of the US bond market reaches approximately $30 trillion, while since 2007, the balance sheets of primary dealers have decreased nearly fourfold relative to outstanding bonds.

During the crises of September 2019 and February/March 2020, banks lacked the space on their balance sheets to absorb serious liquidity problems, leaving the Fed to "clean up" the mess. The question is now obvious: if primary dealers do not have the balance sheets to make bond purchases, who besides the Fed will intervene when the market collapses?

Political solutions

Proposed policy solutions, such as easing the supplementary leverage ratio for banks, offer only limited relief. The goal is to exempt US bonds from required capital ratios, but banks will likely use the available balance sheet space for more profitable services, such as prime brokerage or derivatives trading. Similarly, clearing more US bonds through central counterparties may have side effects, creating oversized organizations that, in the event of a crisis, would trigger a catastrophic market shock.

Another proposal, the creation of digital securities known as Perpetual Overnight Rate Treasury Securities (Ports) with settlement via blockchain, may reduce demand for long-term Treasuries and repos, causing collateral damage to the futures markets and the efficiency of financial flows. The prolonged regulatory inaction has so far allowed for the avoidance of immediate political costs, as there is currently no alternative to US bonds.

A harsh trial

However, this approach is now being tested severely: the smaller bond markets of Switzerland and Germany, considered safe havens, are negligible in size compared to Treasuries, yet they may see increased demand due to geopolitical tensions. Meanwhile, China's sovereign debt market is emerging as an alternative, with bonds accepted as collateral in Hong Kong and potential use through the London Clearing House in euros, dollars, and renminbi.

The crisis in the Treasuries market does not appear to be receding. With the "Big Beautiful Bill" allowing the US Treasury to borrow up to $5 trillion, primary dealers will face a massive volume of debt, while geopolitical uncertainty may push governments to sell Treasuries, reduce their investments, or seek alternatives. Volatility is a given.

The conclusion is clear: the US government bond market urgently needs a boost in liquidity and infrastructure resilience. The risk to Wall Street is not theoretical—it is here and threatens to trigger a crisis that could affect the entire global economy.

Chevalier Noir
www.bankingnews.gr