Providing Safety in a Rush: How Did Shadow Banks Respond to a $1 Trillion Shock

During financial crises, investors demand large amounts of government-backed assets. What constitutes an orderly flight-to-liquidity? Studying how suppliers of government-backed safe assets respond to heightened demand during a crisis is challenging due to a multitude of confounding factors. In contrast, the 2014 money fund reform prompted a flight-to-liquidity in otherwise calm market conditions, with $1 trillion flowing from prime to government funds. Using this regulatory change together with fund-level and security-level data, we show the vital role of a flexible provider of safe assets. The Federal Home Loan Banks (FHLBs) supplied government funds with large quantities of safe assets when the supply of Treasuries was sluggish to respond. Moreover, the flexible mix of FHLBs’ supply of safe assets was crucial for government funds’ risk management. FHLB debt was not only a substitute for Treasuries but also a complement.