SACHA PFEIFFER, HOST:
One way the U.S. government is able to pay for things like interstate highways and health care for the elderly is by selling bonds. And for decades, those U.S. Treasurys have been among the safest investments. But in recent months, trust in U.S. Treasurys has felt shakier, especially due to some of the Trump administration's trade and fiscal policies. But Planet Money's Mary Childs says trust in Treasurys has actually been fraying for a long time.
MARY CHILDS, BYLINE: Yeah. It's kind of invisible. Like, when you set down a bowl and you can hear the crack, but you can't see it yet.
PFEIFFER: But, Mary, people in institutions and central banks around the world have seen Treasurys as the safest bet around for a long time. So why that erosion of trust?
CHILDS: You're exactly right. And for more than half a century, this has been kind of a win-win-win. All those people and institutions have had a safe place to store their money. The U.S. government can spend more than it makes every year by issuing more and more bonds, more and more debt. And unlike a household budget, that's been fine because it was super cheap. Our lenders have charged us very low interest rates. And investors are so comfortable with us because our debt is basically backed by our extraordinary economic strength. We have strong institutions, and we have rich citizens paying taxes. And we've basically never defaulted.
PFEIFFER: So explain what's causing these little cracks now.
CHILDS: There are basically two main worries. One's probably pretty familiar. It's the traditional worry of fiscal conservatives. It's just the sheer volume of debt. And that has become more pronounced in the wake of the new spending bill, which cuts taxes and increases spending. So that degrades trust in our fiscal health, which then means we will probably have to pay more in interest, which can start to snowball.
PFEIFFER: You said two main worries. What's the other one?
CHILDS: So the less familiar worry is a crack that's harder to see. It's something that more and more economists, regulators and policymakers have been talking about in the past five years. It's about the structure. It's kind of the plumbing of the financial system, meaning, do Treasurys flow nicely from one place to another, or do they get gummed up?
PFEIFFER: And do for us what Planet Money is so good at doing. Break down for us that structure, that flow, that gumming up of the flow.
CHILDS: Happily. So the seeds of this are back in the 2008 financial crisis, actually. After that, lawmakers instituted a lot of new regulations that kind of unintentionally made it less profitable for banks to hold Treasurys. So the banks started selling them, and hedge funds saw this opportunity. They figured out a way to make money by buying Treasurys while also selling bets against them via futures contracts. And this trade has a nickname. It's the basis trade. And it has gotten huge. So now we have this situation where hedge funds are basically propping up the American bond market.
PFEIFFER: And that poses some kind of risk.
CHILDS: Right. So hedge funds are more loosely regulated. The government does not control them or even really have good visibility into what they're doing. Hedge funds will just change their minds whenever they want. So the fear is if the hedge funds decide all at once to sell their treasuries, the markets would break.
PFEIFFER: And what does a market breaking look like? Doesn't sound good.
CHILDS: Right. So because Treasurys are special because they've been seen as risk-free for so long, everyone uses them across the financial system as collateral. It's kind of like the diamond ring at the pawnshop. It's just not supposed to lose value. So if those hedge funds all freak out and sell Treasurys, suddenly, a lot of people all over the world - central banks, investors, anyone with a retirement account - would wake up and their supposedly risk-free Treasury wouldn't be worth what they thought. It's just this huge worldwide market that people have trusted all this time without even really thinking about it. And economists are saying, hey, maybe we should start thinking about it.
PFEIFFER: Mary Childs from NPR's Planet Money podcast. You can read more about risks in the Treasury market in the article Mary just wrote in Harper's Magazine. Thank you.
CHILDS: Thank you.
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