Inside Safe Assets

Abstract

“Safe assets” is a catch-all term for financial contracts that market participants treat as if they were risk-free. These may include government debt, AAA corporate debt, bank debt, and asset-backed securities, among others. The International Monetary Fund estimated potential safe assets at more than $114 trillion worldwide in 2011, over 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, financial crises have only raised the policy and academic profile of safe assets, invoked to explain global imbalances, shadow banking, 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. First, we describe the legal architecture of safe assets. Existing theories do not explain where safe assets get their safety. Understanding how legal and regulatory tools help make, label, and guarantee safe assets is an essential first step to managing 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 in the legal architecture, and the political commitments embedded in it. Fourth, we offer preliminary prescriptions to address some of the failings we identify.

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.

Keywords: Financial stability, safe assets, macroprudential regulation, legal fiction, financial crisis, bankruptcy, debt

JEL Classification: E02, F33, G01, G10, G18, G20, G33, H63, K12, K22