The sum and substance, in a couple of slides: HQC stands for "High Quality Collateral," and FTQ is "Flight to Quality." The charts are from a special presentation included in the fiscal Q2 report by the Treasury Department's Office of Debt Management. The presenters conclude that there will be sufficient high quality collateral to satisfy new regulatory demands in the coming years unless the developed world experiences another "stressed environment" (financial crisis). In that case, the breach will again have to be filled by fiscal policymakers or central banks, either through new issuance of safe assets or by raising the perceived safety of existing assets. A central bank can accomplish the latter, for instance, by agreeing to lend against collateral that previously would have been ineligible. And if you prefer your takeaways in text form: Supply/Demand Conclusions In non-stressed market environments, new regulatory requirements will likely not create a macro shortage in [High Quality Collateral]. However, pro-cyclical demand for HQC in stressed markets could cause major macro market issues. Incremental demand in stressed markets could approach $10tt when considering clearing, bilateral margining, and [Flight to Quality] flows This pro-cyclical impact will be greatest after "full phase-in" of all incremental regulation, i.e. 2020+ Certain market participants will be disproportionately-affected by new HQC demand. Those with low HQC allocations and large net long or short derivative portfolios (for example, insurers) Non-directional derivative users and dealers will likely be less directly affected Market development and financial innovation may help to fill incremental HQC demand Collateral transformation, tri-party repo market development, release of more custodial-held HQC assets, etc. Policy Conclusion 1: Collateral Cycles are Policy Relevant Collateral moneyness is pro-cyclical, and has a major impact on money demand and monetary equilibrium. Policymakers must cautiously observe private shadow money growth during booms and busts An asset which will not depreciate is good collateral, but markets often mistakenly make judgments of the likelihood of depreciation based on extrapolating recent price trends rather than assessing historical valuations. The moneyness of the stock of collateral is just as important of the total amount of collateral or "usable collateral." In a collateral shortage, some form of government or central bank facility would likely be needed to meet demand (e.g. Australia) Policy Conclusion 2: Liquid Private Collateral is a Good Thing (usually) Private sector generation of moneylike collateral helps policymakers over long periods by: Slowly reducing the demand for money Increasing financial deepening Supporting financial globalization The more restricted the private sector's ability to create safe, liquid, and moneylike collateral, the harder the public sector must work to supply it through deficits and easy monetary policy. This too has risks! This is material we've covered more times on this blog than we care to count. (Some of the charts and analysis used by the Treasury are quite obviously taken straight from the work of Jonathan Wilmot and James Sweeney that we discussed here, and the Hayek quote can be seen in an earlier research note by Wilmot & Sweeney that you can read here. Treasury omitted any attribution to the Credit Suisse strategists, oddly.) But it is a wonderfully detailed presentation. Our own writing on collateral shortages has focussed more on their role in financial stabilisation and economic recovery. This presentation is more about the pro-cyclical demand for collateral that comes with new regulatory regimes. And this also matters, especially because these demands arrive at a time when economic recovery has yet to accelerate anywhere in the developed world, and with Europe now in double-dip. Until recently, such calculations were considered on the cutting edge of economic research - the province of economists and analysts trying to understand the role of collateral in the recent crisis. Some private-sector strategists had performed individual estimates for, say, the additional collateral that will be required as over-the-counter derivatives are moved to central counterparties. But the macro analyses have mainly been done by Manmohan Singh, Peter Stella, Paul McCulley, Zoltan Pozsar, the Wilmot & Sweeney team, and maybe a select few others that we've forgotten. The basic principles involved have been understood for a very long time, but only now are we getting a sense of what they mean in the modern financial landscape, with its shadow banking, opacity and gruesomely tangled connectedness. In addition to the Treasury presentation, a recent speech by Jeremy Stein about the coming implementation of new liquidity requirements for banks (the Liquidity Coverage Ratio and the Net Stable Funding Ratio) included a footnote that caught our attention: In particular, quantitative impact studies released by the Basel Committee estimate that the worldwide incremental demand for HQLA coming from both the implementation of the LCR and swap margin requirements might be on the order of $3 trillion. This is a large number, but it compares with a global supply of HQLA-eligible assets of more than $40 trillion.* Committee on the Global Financial System (forthcoming), Asset Encumbrance, Financial Reform and the Demand for Collateral Assets (Basel: Bank for International Settlements). We're downright giddy about this " (forthcoming) " paper by the CGFS. More to the point, we interpret this is as a sign that the trends will continue to be more widely studied and measured, both by official sector institutions and by a more diverse roster of economists. That these themes, so poorly understood before the financial crisis, are going mainstream is a welcome development indeed. Related links: Office of Debt Management, Fiscal year 2013 Q2 Report - US Treasury Department When safe assets return - FT Alphaville What Bagehot said - FT Alphaville It's not a collateral shortage, it's a scarcity of collateral - FT Alphaville