What they find is the financial system seems to require the same percentage of safe assets over time, regardless of underlying conditions. Of course, this placid result conceals a far more volatile picture of the changing composition of the safe assets.
The findings are preliminary but one implication may be that the dearth of federal government securities in the era when Bill Clinton was president and Newt Gingrichwas House Speaker contributed to the buildup of “safe assets” like agency debt, mortgage-backed securities and other financial products. This buildup, in turn, contributed to the financial crisis when these assets suddenly lost their safe status.
To put it differently, the Gorton-Lewellen-Metrick paper suggests the United States economy has a persistent demand for savings —t hat is, non-speculative, low-risk financial investment. If deprived of government securities — that is, Treasury bonds — it finds new types of securities to fill this void.
Take a look at this chart showing GDP compared to the total amount of federal government debt held by the public. What you’ll see is that the two rise together on similar trend lines, with federal debt lagging a bit. But in the mid nineties, the federal debt breaks the trend line and actually declines. It doesn’t return to trend until after the financial crisis.