The paradox of safe assets: hedge funds, leveraged finance and treasury market instability

This article explains a paradox at the heart of contemporary finance: the very properties that make U.S. Treasuries safe – liquidity, low volatility, and privileged collateral status – also make them ideal instruments for extreme leverage and therefore a recurrent source of market instability. It examines the deep entanglements between hedge funds, leveraged finance, and the U.S. Treasury market by tracing the rise of relative-value strategies that have turned safe assets into engines of leveraged speculation and absolute returns. It argues that top hedge funds’ market power derives less from their assets under management than from their capacity to gain leveraged exposures through derivatives, repos, and basis trades, making bond markets unusually sensitive to leveraging and deleveraging. The article thus outlines a ‘leveraged finance complex’ linking top hedge funds, private equity firms, dealer banks, and shadow-banking vehicles such as CLOs. This complex reshaped corporate credit markets during the 2010s by increasing indebtedness, eroding credit quality, and securitising risky corporate debts. The 2019 repo-market panic – the ‘Repocalypse’ – is treated as a revelatory case in which repo-financed Treasury speculation collided with fragilities across this wider infrastructure.