effectively a two - way repo transaction, whereby it gives the dealer its junk bonds as collateral, borrows the treasury securities, and agrees to unwind the transaction at some point in the future. now the insurance company can go ahead and pledge the borrowed treasury securities as collateral for its derivatives trade. of course, the dealer may not have the spare treasury securities on hand, and so, to obtain them, it may have to engage in the mirror - image transaction with a third party that does – say, a pension fund. thus, the dealer would, in a second leg, use the junk bonds as collateral to borrow treasury securities from the pension fund. and why would the pension fund see this transaction as beneficial? tying back to the theme of reaching for yield, perhaps it is looking to goose its reported returns with the securities - lending income without changing the holdings it reports on its balance sheet. there are two points worth noting about these transactions. first, they reproduce some of the same unwind risks that would exist had the clearinghouse lowered its own collateral standards in the first place. to see this point, observe that if the junk bonds fall in value, the insurance company will face a margin call on its collateral swap with the dealer. it will therefore have to scale back this swap, which in turn will force it to partially unwind its derivatives trade – just as would happen if it had posted the junk bonds directly to the clearinghouse. second, the transaction creates additional counterparty exposures – the exposures between the insurance company and the dealer, and between the dealer and the pension fund. see hanson and stein ( 2012 ). bis central bankers ’ speeches as i said, we don ’ t have evidence to suggest that the volume of such transactions is currently large. but with a variety of new regulatory and institutional initiatives on the horizon that will likely increase the demand for pristine collateral – from the basel iii liquidity coverage ratio, to centralized clearing, to heightened margin requirements for noncleared swaps – there appears to be the potential for rapid growth in this area. some evidence suggestive of this growth potential is shown in exhibit 8, which is based on responses by a range of dealer firms to the federal reserve ’ s senior credit officer opinion survey on dealer financing terms. 21 as can be seen, while only a modest fraction of those surveyed reported that they were currently engaged in collateral transformation transactions, a much larger share reported that they had been involved in discussions of prospective transactions with their

alan greenspan : economic outlook and current fiscal issues testimony by mr alan greenspan, chairman of the board of governors of the us federal reserve system, before the committee on the budget, us house of representatives, 2 march 2005. * * * mr. chairman, ranking member spratt, and members of the committee, i am pleased to be here today to offer my views on the federal budget and related issues. i want to emphasize that i speak for myself and not necessarily for the federal reserve. the u. s. economy delivered a solid performance in 2004, and thus far this year, activity appears to be expanding at a reasonably good pace. however, the positive short - term economic outlook is playing out against a backdrop of concern about the prospects for the federal budget, especially over the longer run. indeed, the unified budget is running deficits equal to about 3 - 1 / 2 percent of gross domestic product, and federal debt held by the public as a percent of gdp has risen noticeably since it bottomed out in 2001. to be sure, the cyclical component of the deficit should narrow as the economic expansion proceeds and incomes rise. and the current pace of the ramp - up in spending on defense and homeland security is not expected to continue indefinitely. but, as the latest projections from the administration and the congressional budget office suggest, our budget position is unlikely to improve substantially in the coming years unless major deficit - reducing actions are taken. in my judgment, the necessary choices will be especially difficult to implement without the restoration of a set of procedural restraints on the budget - making process. for about a decade, the rules laid out in the budget enforcement act of 1990 and in the later modifications and extensions of the act provided a framework that helped the congress establish a better fiscal balance. however, the brief emergence of surpluses in the late 1990s eroded the will to adhere to these rules, which were aimed specifically at promoting deficit reduction rather than at the broader goal of setting out a commonly agreed - upon standard for determining whether the nation was living within its fiscal means. many of the provisions that helped restrain budgetary decisionmaking in the 1990s - in particular, the limits on discretionary spending and the paygo requirements - were violated ever more frequently ; finally, in 2002, they were allowed to expire. reinstating a structure like the one provided by the budget enforcement act would signal a renewed commitment to fiscal restraint and help restore discipline to the annual budgeting process. such a step would be