The Impact of Treasury Supply on Financial Sector Lending and Stability

We present a theory in which the key driver of short-term debt issued by the financial sector is the portfolio demand for safe and liquid assets by the non-financial sector. This demand drives a premium on safe and liquid assets that the financial sector exploits by owning risky and illiquid assets and writing safe and liquid claims against those. The central prediction of the theory is that government debt (in practice this is predominantly Treasuries) should crowd out financial sector lending financed by short-term debt. We verify this prediction in U.S. data from 1875-2014. We take a series of approaches to rule our “standard” crowding out via real interest rates and to address potential endogeneity concerns.