What Pawnbrokers Can Teach Central

Banks
By Gillian Tett
Three decades ago, the club of triple A-rated American corporate borrowers was a busy
place. About 60 big companies, ranging from Pfizer to General Motors, were deemed so
safe that they held this coveted tag from the credit rating agencies.
No longer. Standard & Poors has just stripped the mighty ExxonMobil of its triple-A rank
because of understandable concerns about falling oil prices and mounting energy sector debt.
This leaves just two - yes, two - American companies still in that triple-A club: the unlikely duo
of Microsoft and healthcare giant Johnson & Johnson.
Does this matter? Not for company executives, perhaps. Some Wall Street economists, such as
Henry Kaufman, fear American companies are becoming feckless with debt; but in practical
terms, the cost of funding triple-A debt today is roughly the same as that of double-A debt. For
Exxon, in other words, the pain is primarily symbolic.
The much more interesting question is what this shrinkage means for investors. If you are a riskaverse private investor - or a nervous public pension fund - who favours ultra-safe bonds, your
choices in the corporate world are now very small. And this highlights a much bigger point: what
has happened in corporate debt is just one tiny sign of a global shortage of safe assets.
Think about it. A couple of decades ago, risk-averse investors seeking triple-A bonds had three
routes to pursue. First, there was the club of triple-A corporate debt. Second - and the most

important source of safe debt albeit a shrinking one - was sovereign debt. Then, from the late
1990s, financiers produced another option: repackaged mortgage-backed bonds.
Since 2007, those triple-A mortgage-backed securities have disappeared. Meanwhile, less of that
sovereign debt is now deemed super safe; just look at what has happened to bonds from Italy,
Greece and Portugal.
Indeed, economics professors Ricardo Caballero and Emmanuel Farhi calculate, using data from
Barclays, that between 2007 and 2011, the value of safe assets fell from $20.5tn to $12.2tn,
equivalent to a drop from 36.9 per cent of global gross domestic product to a mere 18.1 per cent.
That is startling - doubly so since investor demand for safe assets has exploded. The financial
crisis prompted investors to dash into havens. Meanwhile, post-crisis regulatory reforms have
forced financial institutions to load up with safe assets, too, to be used as collateral for deals.
And what has made this imbalance worse - and government policy even more perverse - is that
regulators are tightening the screws at the same time as central banks have gobbled up safe assets
with the aim of loosening monetary policy.
The net result is a dire squeeze on safe assets. Indeed, Prof Caballero and Prof Farhi argue the
imbalance is so severe that the problem confronting the world today is not a liquidity trap but a
safety trap: the shortage is creating a self-reinforcing, panicky cycle that is contributing to
stagnant growth.
Is there a solution? In the long term, the only sensible option would be for central banks to stop
sucking up those government bonds so voraciously; this is distorting the system to such a degree
that it is harming, not helping, investor psychology.
Another option, which is favoured by economists such as Paul Krugman, and has been supported
by some economists at the Bank for International Settlements, would be for the government to
sell more safe debt.
In the long run that might seem self-defeating; if debt loads rise, ratings will slip. But, in the
short term, higher issuance would at least reduce the squeeze, enabling the safe asset market to
feel less distorted.
However, there is a third option: regulators could stop forcing private institutions to gobble up
safe debt. Mervyn King, the former British central bank governor, for example, suggests in his
book, The End of Alchemy, that instead of forcing banks to load up on safe assets, central banks
should act like pawnbrokers, lending against a wide range of collateral at preset discounts.
But none of those three policies seems likely to emerge soon. As a result, the risk is that the
imbalance between supply and demand will grow worse, not better.

Little wonder, then, that global interest rates remain so astonishingly low. This is a symptom and not a cause - of a deeply distorted financial world; an era where the idea of safety is creating
dangers that nobody could have imagined three decades ago.