Inside Safe Assets
PDF Download“Safe assets” is a catch-all term to describe financial contracts that market participants treat as if they were risk-free. These may include government debt, bank deposits, and asset-backed securities, among others. The International Monetary Fund estimated potential safe assets at more than $114 trillion worldwide in 2011, more than seven times the U.S. economic output that year.
To treat any contract as if it were risk-free seems delusional after apparently super-safe public and private debt markets collapsed overnight. Nonetheless, safe asset supply and demand have been invoked to explain shadow banking, financial crises, and prolonged economic stagnation. The economic literature speaks of safe assets in terms of poorly understood natural forces or essential particles newly discovered in a super-collider. Law is virtually absent in this account.
Our Article makes four contributions that help to establish law’s place in the safe asset debate and connect the debate to post-crisis law scholarship. First, we describe the legal architecture of safe assets. Existing theories do not explain where safe assets get their safety. Understanding this is an essential first step to designing a regulatory response to the risks they entail. Second, we offer a unified analytical framework that links the safe asset debate with post-crisis legal critiques of money, banking, structured finance and bankruptcy. Third, we highlight sources of instability and distortion in the legal architecture, and the political commitments embedded in it. Fourth, we offer preliminary prescriptions to correct some of these failings.
Precisely because there are no risk-free contracts, state intervention supplies the essential infrastructure to let people act as if some contracts were risk-free. The law constructs and maintains safe asset fictions, and it places them at the foundation of institutions and markets. This project is unavoidably distributive and fraught with distortions.
