Primary dealers have added $100 billion of Treasuries against Bowman's $5 trillion of eSLR headroom

Bowman's Thursday speech at an Atlantic Council event in Washington ^[2] gives two measures of how much of the new room banks have used, and one is nine times the other ^[7]. Against the $5 trillion, the $100 billion rise in dealer Treasury positions ^[1] is 2% ^[2]. It is also a 17% gain on the $600 billion dealers held before ^[6]. The $900 billion increase in GSIB leveraged exposure is 18% of the same $5 trillion ^[3]. The two figures cover different groups (primary-dealer holding companies in one case, the global systemically important banks in the other), and the speech as reported does not reconcile them. If $900 billion was half of the GSIBs' old capacity, that capacity was about $1.8 trillion ^[4].

Some of the new exposure is a position hedge funds used to run. Banks are holding more cash Treasuries and hedging them by shorting Treasury futures ^[9]. Those are the two legs of the basis trade. "This increase in dealer holdings has likely absorbed some positions previously held predominantly by hedge funds as part of the cash-futures basis trade," Bowman said ^[10]. Her case is that this leaves the market less fragile. "These conditions are likely to lessen the influence in Treasury markets of investors holding highly leveraged trading positions that are particularly vulnerable to adverse shocks in funding, cash, or derivatives markets," she said ^[11]. The speech does not put a figure on how much of the trade moved.

A selloff can settle her claim three ways. In one, dealers buy into the unused room and keep spreads tight. Bowman expects that: she said the reforms' true benefits will show during market stress, when dealer balance sheets are most likely to be overwhelmed ^[13]. In another, dealers hold steady with headroom to spare, and some limit other than the eSLR turns out to have been the one binding in stress. In a third, the basis positions banks now carry need unwinding, and the new capacity goes to shedding inventory before it goes to buying from sellers.

I think the evidence supports the narrow version of what she said. The largest increases came at the banks the old rule constrained most ^[5], and a lifted constraint should produce exactly that pattern. "This pattern suggests that the sharp increase in positions was driven by dealers taking advantage of additional headroom created by the eSLR modification," Bowman said ^[6]. The counter-case is about timing. The buying came in a year of heavy government issuance that banks helped absorb ^[17], with funding conditions she described as calmer ^[12]. Dealers adding inventory into orderly auctions says little about whether they will add it into a falling market. The thesis is wrong if, in the first real selloff, dealer positions shrink and bid-ask spreads widen while most of the $5 trillion sits unused.

The eSLR dates to 2014 and the Basel III accord, and it was designed to be risk-insensitive ^[15]. "The impact of this recalibration has been encouraging," Bowman said in her prepared remarks ^[16]. During the question-and-answer session that followed, she said the initial view was very heartening, and that the eSLR is functioning as intended and will help ease any market conditions that could become stressful before they occur ^[14].