WHY WOULD A FINANCIAL SHOCK CAUSE A SELL OF TREASURY COLLATERAL

The short answer is that holders of T-Bonds don’t want to hold T-Bonds They want cash T-Bonds are “collateralized” in that the government really does have collateral for the T-Bonds In the event of a default, the government would be able to seize that collateral So this is what the Fed is doing It’s buying up T-Bonds in order to support the price of T-Bonds The stated goal is to keep the price of T-Bonds from falling too far If the price of T-Bonds falls too far, then the government will have to pay higher interest rates on its debt If the government has to pay higher interest rates, then it will have less money to spend on programs that it wants to spend money on It’s a vicious circle If you have to pay higher interest rates on your debt, then you have less money to spend If you have less money to spend, then you have to raise taxes more If you have to raise taxes more, then people have less money to spend And so on The government needs to keep the price of T-Bonds from falling too far But why would the price of T-Bonds fall too far? Well, imagine that the US economy got into trouble Then it would be less likely that people would want to buy US T-Bonds They would instead want to buy other things People would buy fewer T-Bonds, and the price would fall The government would have to pay higher interest rates on its debt, and it would have less money to spend That’s what’s happening here The economy is getting worse and worse, and so people are less likely to want to buy US T-Bonds So the price is falling If the price falls too far, then the government will have to pay higher interest rates on its debt So the Fed is buying up T-Bonds in order to support the price We’re in the worst financial crisis in history The economy is getting worse and worse This is a sign of how bad things are But it’s also a sign that