Arnold Kling  

A Shortage of Safe Assets?

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Timothy Taylor discusses this hypothesis. He quotes from a paper by Gary Gorton and others.

Over the past sixty years, the total amount of assets in the United States economy has exploded, growing from approximately four times GDP in 1952 to more than ten times GDP at the end of 2010. Yet within this rapid increase in total assets lies a remarkable fact: the percentage of all assets that can be considered "safe" has remained very stable over time. Specifically, the percentage of all assets represented by the sum of U.S. government debt and by the safe component of private financial debt, which we call the "safe-asset share", has remained close to 33 percent in every year since 1952.

Other observers talk about a "shortage" of safe assets. That strikes me as an unfortunate formulation.

First, any time you talk about a shortage, you should ask about pricing. If there were a shortage of safe assets relative to risky assets, why doesn't the price of safe assets rise and the price of risky assets fall in order to bring the markets into balance?

Once again, I prefer to start with the thesis that the nonfinancial sector of the economy wants to issue risky, long-term liabilities while holding riskless, short-term assets. The financial sector accomodates this desire by doing the reverse. The financial sector can do this in three ways:

1. Diversify risky assets to make them less risky.
2. Select risky projects carefully and monitor them closely to make them less risky.
3. Send out signals that indicate low risk. "AAA-rated." "FDIC insured." "Sovereign debt." "Too big to fail."

A lot of the phenomena that are talked about in the papers that Taylor discusses represent fluctuations in (3). Until 2008, financial intermediaries expanded by exploiting signals of safety. These signals were closely linked to government policy. When the signals were discredited, the market put pressure on the financial sector to shrink. However, so far, governments have tried to prevent this shrinkage. Whether that is good public policy is doubtful.

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COMMENTS (5 to date)
David Beckworth writes:

Thanks for the paper link. Here is my take on the importance of safe assets:

Jack writes:

I agree entirely. To talk about a "shortage of safe assets" makes even less sense than to say the crisis was caused by "a sudden increase in greed". Any shortage is due to regulation (or in some cases, social norms acting effectively as regulation). Now, if investors have in mind a specific reference point for the return on safe assets, they will be unhappy if the market return on those assets is lower than the reference point. But that is not a shortage of safe assets. It is simply the result of a severe recession. Perhaps as with labor markets, there is some stickiness and markets don't clear as they should. But that's a weak story.

Kevin writes:

I think governments have been schizophrenic in their response to market pressure to shrink the financial sector. Certainly many of their activities have shrunk it, and others have worked against the shrinkage. The sector itself has definitely shrunk by most measures (revenue, profit, and employment to name 3).

Also, the discrediting of the signals in (3) is the one legacy of this period that will stay with and benefit humanity for decades.

Yancey Ward writes:

Does it make sense to anyone that "total assets" can more than double what they were 60 years ago when measured against actual economic output? So, even if the percentage of safe assets vs total assets has remained the same, this still means that safe assets have also more than doubled vs economic output.

MMJ writes:

There might be a shortage of assets rated "AAA" by a rating agency but that is not the same as a shortage of "safe assets".

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