Price of Assets Seen As ‘Safe’ to Increase

Demand for "safe assets" is growing, supply shrinking

Price of safety will rise

Appropriate policy implementation should be gradual

Growing demand and shrinking supply of safe assets—typically predominantly government bonds—could have negative effects on global financial stability, according to the IMF’s latest analysis in the Global Financial Stability Report.

To make sure these pressures don’t destabilize financial markets:

• reforms of financial regulation should gradually seek to differentiate better across assets based on underlying risks;

• governments in danger of losing their securities’ safe asset status need to place themselves on a sustainable debt path;

• The private sector should be encouraged to issue safe assets following transparent and sound methods.

The global economic crisis and rising government debt concerns in some advanced economies have shown that no asset can be viewed as truly safe, the IMF said.

Absolute safety—implicit in credit rating agencies’ highest ratings and embedded in financial regulations and investor mandates—created a false sense of security prior to the crisis.

Demand on the rise, supply scarce

Before the crisis, the excess demand for assets categorized as safe was driven by booming emerging economies that had accumulated reserves and used these to buy large amounts of safe assets.

Now, the demand for safe assets faces pressures due to new financial regulations that require banks to hold more safe assets; higher collateral needs for over-the-counter derivatives transactions or their transfer to centralized counterparties; and the increasing use of safe assets in monetary policy operations, such as purchases of government securities by central banks, according to the IMF.

On the supply side, concerns about high government debts and deficits in some advanced economies have reduced the perceived safety of government debt. Recent rating downgrades of sovereigns, previously considered to be virtually riskless, show that even highly-rated assets are subject to risks.

The number of sovereigns whose debt is considered safe has fallen. IMF estimates show that safe asset supply could decline by some $9 trillion—or roughly 16 percent of the projected sovereign debt—by 2016. Private sector issuance of safe assets has also contracted sharply on poor securitization practices in the United States.

Safe asset scarcity will increase their price, with assets perceived as the safest affected first...