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Business
Review
Federal Reserve Bank o f Philadelphia
N o v e m b e r • D ecem ber 1992




ISSN 0007-7011

Where Has All the Paper Gone?
Book-Entry DeliveryAgainst-Payment Systems
James J. McAndrews

Business

Review

The BUSINESS REVIEW is published by the
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2


NOVEMBER/DECEMBER 1992

CAN THE GOVERNMENT
ROLL OVER ITS DEBT FOREVER?
Andrew B. Abel
The enormous federal deficit has led the
government to resort to rolling over its
debt: issuing new debt to cover interest on
existing debt. Can the government go on
doing this forever? Can it go on doing this
without resorting to the politically im­
politic act of raising taxes or cutting ex­
penditures? Can the government, or any
entity, run a Ponzi game? Read Andy
Abel's article for some answers to these
provocative questions.
WHERE HAS ALL THE PAPER GONE?
BOOK-ENTRY DELIVERY-AG AINSTPAYMENT SYSTEMS
James ]. Me Andrews
Throughout history, whenever money or
valuables of any kind have changed hands,
security and various types of risk have
presented problems. The formation of
depositories provided a solution to at
least some of these problems. Deposito­
ries are still around, and modern securi­
ties markets use them to effect "paperless"
trades: a depository records a security
trade by debiting the account of the seller
and crediting the account of the buyer. No
paper changes hands. This system has
reduced the costs and changed the risks of
settling trades. James Me Andrews' ar­
ticle examines how these systems work
and discusses what advantages are in­
volved and what risks remain.

FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government
Roll Over Its Debt Forever?
Andrew B. Abel*
I n the past dozen years, the federal govern­
ment has regularly run large deficits, usually
well in excess of $100 billion per year. The
amount of federal government debt outstand­

*Andrew B. Abel is Robert Morris Professor of Banking,
Department of Finance, Wharton School, University of Penn­
sylvania, and a Visiting Scholar, Research Department, Fed­
eral Reserve Bank of Philadelphia. Andy thanks Thomas
Stark for extremely capable research assistance. He also
thanks Henning Bohn, Satyajit Chatterjee, Dean Croushore,
Jamie McAndrews, Steve Meyer, and Stephen Zeldes for
helpful discussions, and Sally Burke for valuable editorial
advice.




ing has quadrupled during this time, from a
value of $908 billion at the end of fiscal year
1980 to a value of $3,665 billion at the end of
fiscal year 1991. Even after correcting for infla­
tion, the amount of government debt has grown
by a factor of 2.5 over this period. This apparent
explosion in the amount of government debt
has led to spirited and protracted public debate
about federal tax policy and federal expendi­
tures. Despite the widely professed desire to
reduce the federal deficit and to limit the growth
of federal government debt, a consensus about
how to achieve these alleged goals has not yet
emerged. Faced with continuing deficits, the
3

BUSINESS REVIEW

government has resorted to rolling over its
debt— that is, issuing new debt to pay the
interest on existing debt and to pay off holders
of maturing debt.
Is rolling over the debt the solution that we
have been looking for? Can the government
simply roll over its debt forever without having
to take the politically costly steps of raising
taxes or cutting expenditures in the future?
This article discusses the feasibility of rolling
over government debt forever. As we will see,
this question is related to another important
question about the future of the economy: Is the
economy as a whole saving an appropriate
amount for the future? In addition, both of
these questions are related to the question of
whether an entity can run a Ponzi game.
THE SIMPLE ARITHMETIC OF
GOVERNMENT DEBT ACCUMULATION
To address the question of whether the gov­
ernment can roll over its debt forever, we need
to quantify the factors that contribute to the
growth of government debt over time. We
begin by specifying the relationship between
government deficits and the growth rate of
government debt. Then we examine whether
the public would be willing to hold ever-increasing amounts of government debt, thereby
permitting the government to roll over its debt
forever.
Primary and Total Deficits. Although it is
tempting to think of both "debt" and "deficits"
as representing the "D word," there is an im­
portant distinction between debt and deficits.
Government debt is the liability of the govern­
ment owed to holders of government bonds at
any particular moment; it is measured in dol­
lars as of a particular date, such as $3,665 billion
as of September 30,1991. A government deficit
is the excess of government expenditures over
government receipts during a particular pe­
riod. The government deficit equals the in­
crease in the amount of government debt dur­
ing a particular interval; it is measured in terms
4




NOVEMBER/DECEMBER1992

of dollars per unit of time, such as $320.9 billion
per year during fiscal year 1991 (October 1,1990
- September 30, 1991). In terms of familiar
accounting concepts, government debt is a bal­
ance sheet concept, whereas the government
deficit is an income statement concept.
Although the definition of the government
deficit as the excess of government expendi­
tures over government receipts during a par­
ticular period seems fairly unambiguous, actu­
ally two different deficit concepts are widely
used. The difference between these two deficit
concepts lies in whether interest payments on
government debt are included as part of gov­
ernment expenditure. One deficit concept,
known as the primary deficit, does not include
interest payments on the government debt as
part of government expenditure. Thus, the
primary government deficit is calculated as all
noninterest expenditure by the government
minus government receipts. The primary gov­
ernment deficit was "only" $34.9 billion in fiscal
1991 (Table 1).
The other deficit concept, known as the total
deficit or simply the deficit, includes interest
payments by the government as part of govern­
ment expenditure. Thus the total deficit equals
total government expenditure, including inter­
est payments, minus government receipts. In
fiscal 1991, interest payments by the govern­
ment amounted to $286.0 billion, so that the
total government deficit of $320.9 billion ex­
ceeded the primary government deficit by $286.0
billion.
Why are there two different deficit con­
cepts? The reason economists and policymakers
look at both of these deficit concepts is that each
concept provides the answer to a different
question. Specifically, the primary deficit an­
swers the question: Are current taxes sufficient
to pay for spending on current government
programs? More precisely, the primary deficit
measures the extent to which spending on cur­
rent programs exceeds the taxes currently col­
lected. The total deficit answers a different
FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

Andrew B. Abel

The historical behavior of
the debt-GNP ratio over the
last century in the United
Government Deficit
States is shown in Figure 1.
Fiscal Year 1991
Notice that the debt-GNP
(October 1,1990 - September 30,1991)
ratio rose sharply during
World War I and World War
Government Expenditures
II, and then fell gradually
Noninterest expenditures3
$795.3 billion
after these wars (and also
Interest payments by government11
$286.0 billion
fell gradually for about a
half century after the Civil
Total expenditures0
$1,081.3 billion
War). In addition to the
increases in the debt-GNP
Government Receipts0
$760.4 billion
ratio during wars, the debtGNP ratio also rose sharply
during the Great Depres­
Primary Deficit = $795.3 billion - $760.4 billion = $34.9 billion
sion of the 1930s and during
Total Deficit = $1,081.3 billion - $760.4 billion = $320.9 billion
the 1980s.
What causes the debt-GNP
aSource: calculated as total expenditures minus interest payments by
ratio to increase from one
government.
year to the next? Just as a
matter of simple arithmetic,
bSource: Treasury Bulletin, March 1992.
the debt-GNP ratio will rise
cSource: Economic Report of the President, 1992, Table B-75.
whenever the growth rate
of the numerator, i.e., the
growth rate of government
question: How much will the government have
debt,
is
higher
than
the growth rate of the
to borrow to pay for its expenditures? The total
denominator,
i.e.,
the
growth
rate of GNP. As
deficit during a year measures the increase in
we
have
discussed
earlier,
the
increase in gov­
government debt during that year.
ernment
debt
during
a
year
equals
the total
The Debt-GNP Ratio. How do we gauge
deficit,
which
in
turn
equals
the
primary
deficit
whether a government's debt is too large? One
plus
interest
payments
by
the
government.
way to gauge the size of a government's debt is
by the government's ability to repay the debt. Thus, the debt-GNP ratio tends to increase
Governments that have access to larger tax when (1) the primary government deficit is
bases would be able to support larger amounts large; (2) interest payments by the government
of debt than governments with smaller tax are large; and (3) the growth rate of GNP is
bases. For the federal government, we can small. The following equation, which is an
gauge the size of the tax base by some measure approximation derived in Appendix A, cap­
of national income, such as Gross National tures the simple arithmetic of government debt
Product (GNP) or Gross Domestic Product accumulation:
(1) growth rate of debt-GNP ratio =
(GDP). In this article, we will use GNP as the
primary deficit/debt
measure of national income, and thus we will
+ interest rate
use the ratio of g ov ern m en t debt to
growth rate of GNP
GNP— known as the debt-GNP ratio—to gauge
Note
that
when the growth rate of the debtthe size of government debt.



TABLE 1

5

BUSINESS REVIEW

NOVEMBER/DECEMBER1992

in the debt-GNP ratio
during the Great De­
FIGURE 1
pression resulted from
Debt-GNP Ratio
large declines in GNP
during the early 1930s
and from large primary
Percent
deficits beginning in
1932. The decline in the
debt-GNP ratio during
the three-and-a-half dec­
ades following World
War II resulted from a
combination of factors:
(1) a small—indeed usu­
ally negative— primary
deficit; and (2) an inter­
est rate that was usually
smaller than the growth
rate of GNP. However,
during the 1980s the
debt-G N P ratio d e­
Sources: Ratio of government debt to GNP. Source of government debt (end
parted from its typical
of fiscal year): 1869-1939 from Historical Statistics of the United States, series
pattern of peacetime be­
y338; 1940-1969 from Banking and Monetary Statistics, 1941-1970, Table 13.1, C;
havior and began to rise.
1970-1979 from Federal Reserve Board Annual Statistical Digest, 1970-1979,
Arithmetically, the posi­
Table 27; 1980-1989 from Federal Reserve Board Annual Statistical Digest, 19801989, Table 26; 1990-1991 from Treasury Bulletin, March 1992, Table FD-1.
tive growth rate of the
Source of GNP: 1869-1958, Balke, Nathan S. and Robert J. Gordon, Appendix B
debt-GNP ratio was ac­
Historical Data, in The American Business Cycle: Continuity and Change, Robert
counted for by a rela­
J. Gordon (ed.), Chicago and London: The University of Chicago Press, 1986;
tively large ratio of the
1959-1991 from Data Resources Incorporated (1960 GNP is 2 percent higher in
primary deficit to gov­
DRI than in Balke and Gordon).
ernment debt in the early
1980s and by the fact that
GNP ratio is positive, this ratio is growing, and the interest rate exceeded the growth rate of
when the growth rate of the debt-GNP ratio is GNP for most of the 1980s.
negative, the debt-GNP ratio is falling.
Rolling Over Government Debt. Our dis­
The three components of the growth rate of cussion of the debt-GNP ratio was motivated
the debt-GNP ratio on the right-hand side of by the desire to gauge the size of government
equation (1) explain, in an arithmetic sense at debt relative to the government's ability to
least, the historical behavior of the debt-GNP repay that debt. What problems might be
ratio shown in Figure 1. The sharp increase in associated with a high value of the debt-GNP
the debt-GNP ratio during both world wars ratio? If the debt-GNP ratio were to become too
resulted from sharp increases in the primary large, the public might begin to suspect that one
deficit (Figure 2). Of course, the increase in the day the government would default on its debt,
primary deficit reflects the large increase in and this suspicion might make the public un­
military expenditure during wartime. The rise willing to buy additional government debt.
6



FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

Andrew B. Abel

There are many ways the
FIGURE 2
government could default
on its debt. The govern­
Components of
m ent could sim p ly re ­
Debt-GNP Growth Rate
nounce its liabilities and
Percent
refuse to pay holders of gov­
ernment bonds. Alterna­
tiv ely , the gov ernm en t
could heavily tax the princi­
pal and/or interest on gov­
ernment bonds, effectively
defaulting on at least a frac­
tion of its liabilities. More
subtly, the governm ent
could print money and cre­
ate inflation, which reduces
the real purchasing power
of its dollar liabilities repre­
sented by gov ernm en t
bonds. Another problem
with a very high debt-GNP
Sources: Primary deficit calculated as total deficit minus interest pay­
ratio is that the interest pay­
ments by the government. Source of total deficit: 1869-1939 from Historical
ments on government debt
Statistics of the United States, series y337; 1940-1991 from Economic Report
of the President, February 1992, Table B-74, on-budget. Source of interest
become a very large frac­
payments: 1869-1969: from Historical Statistics of the United States, series
tion of GNP. If the debty461; 1970-1991 from Treasury Bulletin, various issues, Table FFO-3. Interest
GNP ratio becom es ex­
rate calculated as interest payments in current fiscal year divided by govern­
tremely large, the increase
ment debt at end of previous fiscal year (see note to Figure 1 for source of data
in government debt needed
on government debt). Growth rate of GNP calculated from GNP data
described in note to Figure 1.
to pay the interest on the
outstanding governm ent
debt could become larger
than all of GNP,1 and the public would not be come unwilling to buy the government debt
offered for sale and the rollover policy would
able to buy this debt.
The willingness or unwillingness of the pub­ have to terminate. However, if the debt-GNP
lic to buy additional government debt when the ratio falls forever when the government is pur­
debt-GNP ratio gets large determines whether suing a rollover policy, it would be possible to
the government can roll over its debt forever. If roll over government debt forever.
a policy of rolling over government debt for­
But how could the debt-GNP ratio fall for­
ever would cause the debt-GNP ratio to grow ever while the government is rolling over its
forever without bound, the public would be­ debt? To answer this question, we will first
precisely define a policy of rolling over the debt
in terms of the primary deficit, and then we will
use equation (1) to see how the debt-GNP ratio
1
If the debt-GNP ratio exceeds the reciprocal of the
changes over time under a policy of debt
interest rate on government bonds, interest payments on
government debt would exceed GNP.
rollover.



7

BUSINESS REVIEW

Quite simply, a government is rolling over
its debt if its primary deficit is zero, so that its
total deficit equals its interest payments on
government debt. In this case, the government
sells additional government bonds (debt) to
pay the interest on government debt and to pay
off holders of maturing government debt. If
the government can run a zero primary deficit
forever, selling bonds to cover the total deficit,
then it can roll over its debt forever. Whether
the government is able to run a zero primary
deficit forever depends on whether the debtGNP ratio eventually becomes too large when
the government runs a zero primary deficit
year after year.
To see if a government can run a zero pri­
mary deficit forever, we simply set the primary
deficit in equation (1) equal to zero and observe
that in this case the growth rate of the debt-GNP
ratio equals the interest rate minus the growth
rate of GNP. If the interest rate is higher than
the growth rate, the debt-GNP ratio grows
forever without bound, and eventually the gov­
ernment would lose its ability to roll over its
debt. However, if the interest rate is smaller
than the growth rate of GNP, the growth rate of
the debt-GNP ratio would be negative, and the
government could roll over its debt forever.
For instance, if the interest rate is 3 percent per
year and the growth rate of GNP is 4 percent per
year, interest payments amount to 3 percent of
government debt. If the government sells new
bonds to pay these interest payments, the sup­
ply of government debt will increase by 3 per­
cent per year, which is less than the 4 percent
annual growth rate of GNP. Thus, the debtGNP ratio would decline.
For most of the last century in the United
States, the interest rate on government debt has
been lower than the growth rate of GNP (Figure
2). In fact, the average interest rate on govern­
ment debt was 4.12 percent per year, and the
average growth rate of GNP was 5.86 percent
per year over the period 1869-1991. If this
pattern with the average interest rate below the
8



NOVEMBER/DECEMBER1992

average growth rate were to continue to hold
forever, it would appear that the U.S. govern­
ment could roll over its debt forever.
WHAT HAPPENS WHEN
THE INTEREST RATE IS LESS THAN
THE GROWTH RATE OF GNP?
We have seen that over the last century the
average interest rate on government debt was
lower than the average growth rate of GNP.
One important implication of having an inter­
est rate lower than the growth rate of GNP is
that the government can roll over its debt
forever. In this section, we discuss two other
important—and surprising—implications of
having an interest rate lower than the economy's
growth rate.
The Economy Has Too Much Capital. The
most important factor determining the stan­
dard of living of future generations is the longrun rate of economic growth. One of the pri­
mary ways that an economy can help promote
economic growth is to save for the future by
increasing the capital stock of productive equip­
ment and structures. This process of capital
accumulation combines a present sacrifice in
the form of reduced present consumption with
a future benefit in the form of increased future
output and consumption. At various times in
recent history, policymakers have made the
judgment that the future gain is worth the
present sacrifice, and national economic policy
focused directly on stimulating capital forma­
tion by providing tax incentives in the form of
accelerated depreciation allowances and the
investment tax credit.
Is it possible for an economy to overdo it?
More precisely, is it possible for an economy to
accumulate and maintain a level of capital that
is unambiguously too high? Surprisingly, the
answer is yes. An economy can accumulate so
much capital that the current sacrifice associ­
ated with current investment actually leads to
a future sacrifice in the form of reduced future
consumption. In this situation, the present
FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

sacrifice associated with capital formation is
clearly not worth undertaking. An interest rate
smaller than the growth rate of the economy
signals that such a situation exists.
To see how it would be possible to have too
much capital, suppose a piece of capital re­
quires $5 worth of resources every year to
maintain it in working order, but the capital
contributes additional output worth only $4
per year. The economy would be suffering a net
loss of $1 per year and would be better off
without the capital.2 At the level of the national
economy, we can say that an economy has too
much capital if in every year the amount of
resources devoted to creating new capital and
maintaining old capital is greater than the con­
tribution to total output of the total capital
stock. To put this condition in the language of
national income accounting, an economy has
too much capital if in every year gross invest­
ment (the amount of resources devoted to new
capital formation and replacement of depreci­
ated capital) exceeds gross capital income
(which measures the contribution of capital to
total output). We write this condition as:
(2) too much capital if:
gross investment >gross capital income
in every year.
Now we can relate the condition for too
much capital to the relationship between the
interest rate and the growth rate. This relation­
ship is clearest for an economy growing at a

Andrew B. Abel

constant rate year after year, so let's suppose
that the economy is growing at constant rate g
every year. Thus, for example, GNP is growing
at the rate g and the total capital stock, K, is also
growing at the rate g. With the capital stock
growing at the rate g per year, the amount of net
capital formation during a year is gK. In addi­
tion, some resources are devoted to replacing
capital that depreciates during the year. Let­
ting d be the fraction of the capital stock that
depreciates during a year, the total amount of
depreciation during a year that must be offset
by capital formation is dK. Gross investment is
the sum of net capital formation and deprecia­
tion:
(3) gross investment = gK + dK = (g + d)K
The contribution of capital to total output is
measured by gross capital income. Letting R
denote the gross rate of return on capital, we
have:
(4) gross capital income = R K
Comparing gross investment in equation (3)
with gross capital income in equation (4), we
see that the economy has too much capital if
(g + d)K > R K in every year, or equivalently:
(5) too much capital if:
g+d>R
in every year

To see the role of the interest rate in this
condition, we observe that in an economy in
which there is no uncertainty, the interest rate
r would equal the net rate of return on capital,
which is the gross rate of return R minus the
2
In this numerical example, net investment is zero, but
rate of depreciation. In symbols we have:
the same principle applies when there is positive net invest­
(6) r
=
R -d
ment. For example, consider a firm that operates a factory
(interest rate) (net rate of return on capital)
with a work force that grows by 2 percent per year. If the
firm maintains a constant ratio of capital to labor, the firm's
capital stock would grow by 2 percent per year. However,
if the contribution to total output of each unit of capital is
only 1 percent of the value of the capital stock, then the firm
would be pouring more resources into the factory than it
gets out of the factory, and it would be better off closing that
factory.




Finally, we obtain the condition for too much
capital in terms of the interest rate and the
growth rate by subtracting the depreciation
rate d from both sides of equation (5) and using
the fact that r = R - d to obtain:
9

BUSINESS REVIEW

(7) too much capital if: g > r
in every year.
Thus, we can see that in the absence of
uncertainty, an economy growing at a constant
rate has too much capital if the interest rate is
less than the growth rate. An economy in this
situation could realize both a present gain and
a future gain by permanently reducing the
amount of investment. Present consumption
would increase as the economy's current re­
sources shifted from investment to consump­
tion. Future consumption would increase as
fewer resources were, on net, poured into the
formation and maintenance of capital. As a
result of the reduction in investment, the capi­
tal stock would fall, and as capital became less
abundant, the rate of return on capital would
increase. When the rate of investment has
fallen enough, the net rate of return on capital
and the interest rate will rise above the growth
rate of the economy, so that the symptom of too
much capital will disappear.
Recall that during the period 1869-1991 the
average interest rate in the United States was
smaller than the average growth rate. Thus,
equation (7) would seem to suggest that the
United States has too much capital. We will
take another look at this provocative implica­
tion later in this article.
Ponzi Games. In the early 20th century,
Charles Ponzi promised investors the opportu­
nity to double their money in 90 days by invest­
ing in international postal coupons. Over the
course of eight months, Ponzi acquired about
$15,000,000 from 40,000 investors. Not surpris­
ingly, Ponzi's promises proved to be too good
to be true, and Ponzi was arrested in August
1920.3 Economists now use the term "Ponzi
game" to describe a situation in which an entity
(a person, business, or government) sells secu­
rities to investors and never uses any of its own

3 See O'Connell and Zeldes (1992).

Digitized for 10
FRASER


NOVEMBER/DECEMBER1992

money to pay dividends or interest or to repay
the principal. Any subsequent payments (such
as dividends, interest, or return of principal) to
holders of these securities are financed by sell­
ing additional securities. Our discussion will
focus on rational Ponzi games, which are Ponzi
games in which there is no fraud or deceit on the
part of the seller of securities and no lack of
understanding or foresight on the part of buy­
ers of these securities.
As a simple example of a rational Ponzi
game, consider an entity that sells $100 million
of long-term bonds, promising to pay an inter­
est rate of 4 percent per year. At the end of one
year, when it is time to pay investors $4 million
in interest, the entity sells an additional $4
million of bonds to investors, bringing total
bonds outstanding to $104 million. Then at the
end of two years, when $4.16 million of interest
(4 percent of $104 million) is due, the entity sells
an additional $4.16 million of bonds, and so on.
The amount of bonds outstanding grows at the
rate of interest, which is 4 percent per year in
this example. For this Ponzi game to be feasible,
the public must be willing to hold the everincreasing amount of bonds issued. If inves­
tors' wealth is growing at, say, 5 percent per
year, there would be sufficient demand by the
public for newly issued bonds, and thus the
entity would be able to sell additional bonds to
pay the interest on its debt without having to
use any of its own resources.
In the Ponzi game described above, suppose
that the entity selling the bonds is the govern­
ment. Then the Ponzi game amounts to rolling
over government debt forever. The Ponzi game
will be feasible, that is, the government will be
able to roll over its debt forever, provided that
the growth rate of aggregate wealth exceeds the
interest rate. The growth rate of aggregate
wealth is not readily measured, but in the
absence of a trend in the ratio of wealth to GNP,
the growth rate of aggregate wealth can be
proxied by the growth rate of GNP. Thus, the
government will be able to roll over its debt
FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

Andrew B. Abel

THE IMPORTANCE OF UNCERTAINTY
Recent research into the questions of whether
an economy has too much capital and whether
a government can roll over its debt forever has
shown that simply comparing the average in­
terest rate and the average growth rate of the
economy can produce misleading answers to
these questions. Much of this research is ongo­
ing and many important questions remain un­
answered, but this research has yielded some
important insights.
Another Look at Whether an Economy Has
Too Much Capital. In a world without uncer­
tainty, we can compare the interest rate and the
growth rate of the economy to determine
whether the economy has too much capital. In
deriving equation (7) we used the fact [equa­
tion (6)] that in the absence of uncertainty, the
net rate of return on capital, R - d, equals the
interest rate, r, on government debt. However,
in the presence of uncertainty, the rates of
return on different assets, in particular the rates
of return on capital and on government bonds,
can in general differ. Thus, the comparison of
the interest rate and the growth rate in equation
(7) is no longer appropriate for assessing
whether an economy has too much capital.
In the presence of uncertainty, the appropri­
ate criterion for determ ining whether an
economy has too much capital is equation (2):
If gross investment exceeds gross capital in­
come in every year, the economy has too much
capital. If gross investment is less than gross
capital income in every year, we conclude that
4
The discussion in this article ignores distortions arising
the economy is not plagued by too much capi­
from taxes or from externalities. In a recent paper, Ian King
(1992) has argued that with endogenous growth arising
tal. A recent study5has examined gross invest­
from externalities in the stock of knowledge, it is possible for
ment and gross capital income in the United
Ponzi games to be feasible even though the economy does
States for the period 1929-1985 and found that
not suffer from overaccumulation of capital. This result

forever if the growth rate of GNP exceeds the
interest rate.4
To summarize, if the interest rate is lower
than the growth rate of GNP, (1) the economy
has too much capital; (2) entities can run ration­
al Ponzi games; and (3) in particular, the gov­
ernment can roll over its debt forever. As we
have seen, over the last century in the United
States, the average interest rate has been lower
than the average growth rate of GNP. Thus, it
might seem that the United States has too much
capital, that entities can run rational Ponzi
games, and that the government can roll over
its debt forever. However, these three results
do not strike most observers as plausible de­
scriptions of the U.S. economy. The implausibility of these results stimulated new research
into these questions in the past several years. A
point of departure for much of this research is
the fact that the results presented above were
derived under the assumption of a constant
interest rate and a constant growth rate, but, as
is evident in Figure 2, the interest rate, and
especially the growth rate, have displayed sub­
stantial variability in the United States. Recent
research has focused on uncertainty as the
source of variation in the interest rate and the
growth rate and has found that the results
summarized above need to be substantially
altered when uncertainty is incorporated into
the analysis.

arises because the private and social returns to capital differ
in the presence of externalities. Capital overaccumulation
occurs if the social rate of return to capital is lower than the
growth rate of the economy, and Ponzi games are feasible if
the private rate of return to capital is lower than the growth
rate of the economy. In King's model, the social rate of
return can be higher than the growth rate, which can be
higher than the private rate of return.




5
Andrew B. Abel, N. Gregory Mankiw, Lawrence H.
Summers, and Richard J. Zeckhauser, "Assessing Dynamic
Efficiency: Theory and Evidence," Review o f Economic Stud­
ies, 56 (January 1989), pp. 1-20.
11

BUSINESS REVIEW

in every year, including the Great Depression
of the 1930s, gross investment was less than
gross capital income. Thus, despite the fact that
the average interest rate was less than the
average growth rate of the economy, we can
conclude that the United States was not af­
flicted with too much capital.6 This study also
examined six other countries, including Japan,
which is often cited as a country with high rates
of saving and investment. For all of these
countries, including high-investing Japan, gross
investment was always less than gross capital
income, and hence, none of these countries had
too much capital.
Debt Rollover When the Average Interest
Rate Is Lower Than the Average Growth Rate.
We have just seen that the introduction of
uncertainty invalidates the comparison of the
average interest rate and the average growth
rate for the purpose of determining whether an
economy has too much capital. Now we will
see that the introduction of uncertainty also
invalidates the comparison of the average in­
terest rate and the average growth rate for the
purpose of determining whether a Ponzi game
is feasible. We focus this discussion on a par­
ticular Ponzi game, namely rolling over gov­
ernment debt forever. This section presents a
numerical example with the following surpris­
ing feature: despite the fact that the interest rate
on government debt is lower than the average
growth rate of GNP, the expected value of the
debt-GNP ratio grows without bound. Eventu­
ally, the government would become unable to
roll over its debt.
Before presenting this example it is useful to
calculate an exact expression for the growth
rate of the debt-GNP ratio when the govern­
ment is following a rollover policy. (Equation

6 This conclusion is based on the implicit assumption
that the fact that gross investment has always been smaller
than gross capital income will continue forever.
12



NOVEMBER/DECEMBER 1992

(1) is an approximate expression.) Remember
that a rollover policy means that the primary
deficit is zero in every year. If the current
amount of government debt is B and if the
government has a zero primary deficit, its total
deficit is rB, where r is the interest rate. Thus,
the government must sell an additional rB
bonds, and the amount of bonds next year rises
to (l+r)B. If the current level of GNP is Y and
if the growth rate of GNP over the next year is
g, the level of GNP next year is (l+g)Y. Thus,
the value of the debt-GNP ratio next year is
[(1+r)/(l+g)][B/Y], which is (l+r)/(l+g) times
as large as the current debt-GNP ratio, B/Y.
Thus, if r is larger than g, so that (1+r)/(1+g) is
larger than one, the debt-GNP ratio grows
between this year and next year. Alternatively,
if r is smaller than g, so that (l+r)/(l+g) is
smaller than one, the debt-GNP ratio falls be­
tween this year and next year. These results are
consistent with the approximation in equation
(l ).7
Now we can discuss the numerical example
presented in Table 2, which has the following
features: the interest rate r is constant and is
smaller than the average value of g, the growth
rate of GNP. However, g varies in such a way
that the average value of (l+r)/(l+g) is greater
than 1, so that the expected value of the debtGNP ratio in the next period is always greater
than the current value of the debt-GNP ratio. In
this example, the uncertainty comes from the
fact that GNP growth is unpredictable from one
period to the next. To make the example
simple, suppose that GNP growth is deter­
mined by the flip of a fair coin each period. If
the coin comes up heads, GNP grows by 60
percent during the next period, and if the coin

7
The approximation involved in equation (1) is that the
growth rate of a ratio is approximately equal to the growth
rate of the numerator minus the growth rate of the denomi­
nator. (See Appendix A, Derivation of the Growth Rate of
the Debt-GNP Ratio.)
FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

Andrew B. Abel

TABLE 2

A Growing Debt-GNP Ratio
with the Interest Rate
Below the Average Growth Rate
period
debt

1

2

3

$100

$104.70

$109.62
$360
(25%)

$960
(25%)
GNP

$1000

$960
(25%)

$2560
(25%)
expected GNP

$1000

$1100

$1210

debt/GNP

(25%)
expected
debt/GNP




0.1000

0.1200

0.1439

comes up tails, GNP falls by
40 percent.8Thus, if GNP is
currently $1000, there is a 50
percent chance that next
period's GNP will be $1600
and a 50 percent chance that
next period's GNP will be
$600. Thus, the average, or
expected, value of next
p e rio d 's GNP is $1100
( ($1600+$600)/2 ), which
represents a 10 percent ex­
pected growth rate.
Now suppose that the
interest rate on government
debt is always 4.7 percent
per period, which is less than
the average growth rate of
the economy, and let's see
how the debt-GNP ratio
behaves in this economy.
Suppose that in period 1 the
amount of government debt
is $100. Thus, the debt-GNP
ratio is $100/$1000 = 0.10.
The first panel of num­
bers in Table 2 shows the
evolution of government
debt over time. With a 4.7
percent interest rate, the

8 These large changes in GNP in
this example were chosen to make
the effects very apparent. To make
the example seem more realistic,
think of a period as being a decade
rather than a year. Notice that be­
tween 1929 and 1933 in the United
States real GNP fell by 30 percent
and nominal GNP fell by 46 per­
cent, so a 40 percent drop in GNP
during a decade is not inconceiv­
able. However, the probability of
such a bad decade is almost surely
much less than the value of 50 per­
cent assumed in this example.
13

BUSINESS REVIEW

amount of government debt grows at the rate of
4.7 percent per period. Thus, government debt
equals $104.70 in period 2 and $109.62 in period
3.
The second panel of numbers in Table 2,
which shows GNP, requires a little additional
explanation. As shown in the first column,
GNP is $1000 in period 1. The second column
shows that there is a 50 percent chance that
GNP in period 2 will be $600 and a 50 percent
chance that GNP in period 2 will be $1600, so
that the expected value of GNP in period 2 is
($600 + $1600)/2 = $1100. The third column of
numbers shows the possible values of GNP in
period 3. If GNP in period 2 is $600, there is a
50 percent chance it will fall by 40 percent, to
$360, in period 3, and a 50 percent chance it will
rise by 60 percent, to $960, in period 3. Alterna­
tively, if GNP in period 2 is $1600, there is a 50
percent chance it will fall by 40 percent, to $960,
in period 3, and a 50 percent chance it will rise
by 60 percent, to $2560, in period 3. Taking
account of all of these possibilities for the value
of GNP in period 3, there is a 25 percent chance
it will be $360, a 50 percent chance it will be
$960, and a 25 percent chance it will be $2560.
The average, or expected, value of GNP in
period 3 is $1210.
The third panel of numbers in Table 2 shows
the possible values of the debt-GNP in each of
the three periods. These numbers are calcu­
lated by dividing the value of debt in the first
panel by the value of GNP in the second panel.
For example, in period 2, debt will equal $104.70.
There is a 50 percent chance GNP will equal
$600, in which case the debt/GNP ratio will be
$104.70/$600 = 0.1745, as reported in the third
panel; there is a 50 percent chance GNP will
equal $1600, in which case the debt/GNP ratio
will be $104.70/$1600 = 0.0654. The average, or
expected, value of the debt-GNP ratio in period
2 is (0.1745 + 0.0654) /2 = 0.1200, which is higher
than the debt-GNP ratio in period 1. Despite
the fact that the interest rate is smaller than the
average growth rate of GNP, the risk of a sharp
14



NOVEMBER/DECEMBER1992

drop in GNP makes the expected value of the
debt-GNP ratio in period 2 higher than the
value of the debt-GNP ratio in period 1. As
shown in the third column, the expected value
of the debt-GNP ratio in period 3 is 0.1439. In
fact, the expected value of the debt-GNP ratio
will grow at a rate of approximately 20 percent
per period forever. Eventually, the expected
value of the debt-GNP ratio would become so
large that the government would be unable to
roll over its debt despite the fact that the inter­
est rate on government debt is lower than the
average growth rate of the economy.
W HAT CAN WE CON CLUDE ABOUT
UNITED STATES FISCAL POLICY?
We have shown that in the presence of un­
certainty it may be impossible for the govern­
ment to roll over its debt forever, even though
the average interest rate is lower than the aver­
age growth rate of GNP. So, how then do we
empirically assess whether the government can
roll over its debt forever? This question is at the
frontier of economic research and has not yet
been fully resolved. Nevertheless, recent re­
search has yielded some insights and some
speculation about future findings.
One important insight is that if an economy
has too much capital, Ponzi games are possible
and the government can roll over its debt for­
ever. However, a recent study cited earlier9
found that none of the countries studied, in­
cluding the United States, is afflicted by too
much capital.
Does the finding that an economy does not
have too much capital imply that Ponzi games
are not possible and, in particular, that the
government cannot roll over its debt forever?
In a world without uncertainty, the answer to
this question would be “yes," as we illustrated
earlier. Unfortunately, the answer is ambigu­

9 Abel, Mankiw, Summers, and Zeckhauser (1989).
FEDERAL RESERVE BANK OF PHILADELPHIA

Can the Government Roll Over Its Debt Forever?

ous in the presence of uncertainty: in some
economies that do not have too much capital, it
is possible for the government to roll over its
debt forever, while in other economies that do
not have too much capital, it is impossible for
the government to roll over its debt forever.10
The current state of economic research sug­
gests that the crucial issue for determining
whether a government can roll over its debt
forever is whether there is a rich enough set of
existing securities in the economy. If the set of
existing securities is not rich enough in the
relevant sense, government debt might be such
a sufficiently different and attractive security
that investors would welcome the opportunity
to hold it in their portfolios and would allow the
government to roll over its debt forever. How­
ever, if the set of existing securities is suffi­
ciently rich, government debt may not be suffi­
ciently different or attractive for investors to
allow the government to roll its debt over
forever.11 Unfortunately, the current state of
economic research does not allow a convincing
empirical test to distinguish between these two
cases, so we cannot yet test whether an actual
government can roll over its debt forever.12

10Technically, under certainty, capital overaccumulation
is a necessary and sufficient condition for Ponzi games and
for rolling over government debt forever. Under uncer­
tainty, capital overaccumulation is a sufficient, but not
necessary, condition for Ponzi games and for rolling over
government debt forever.
11 Blanchard and Weil (1992) present examples of econo­
mies that do not have too much capital. In some of these
examples, the set of securities is not sufficiently rich, and the
government can roll over its debt forever. In other ex­
amples, the set of securities is sufficiently rich, and the
government cannot roll over its debt forever.
12 A related— and also unresolved—question is why the
average interest rate on government debt is so much lower
than the average rate of return on capital. One potential
explanation is that there is a very rich set of securities
available but investors are very risk averse and essentially




Andrew B. Abel

Although we cannot yet empirically test
whether an economy can roll over its debt
forever, we are not left entirely in the dark
about the future course of U.S. fiscal policy.
Recently, Henning Bohn (1991a) has developed
and implemented a test of whether a govern­
ment is following a sustainable policy. This is
not a test of whether a zero primary deficit
accompanied by rolling over the debt is perma­
nently sustainable. Rather it is a test of whether
the historical tax and expenditure policies of
the government can be permanently maintained
without a major shift in the conduct of policy.
Applying this test to data on U.S. fiscal policy,
Bohn finds that this policy is sustainable. An
important component of this conclusion is the
finding that, on average, U.S. fiscal policy pro­
duces a smaller primary deficit (or a larger
primary surplus) when the debt-GNP ratio
becomes larger. This tendency of the govern­
ment to run smaller (or even negative) primary
d eficits as the d eb t-G N P ratio gets larger is a

means of keeping the debt-GNP ratio from
growing too large.
While Bohn's result that U.S. fiscal policy is
sustainable may appear comforting, this find­
ing focuses attention on potentially painful
choices. If the United States is to follow its
historical pattern of reducing primary deficits
when the debt-GNP ratio rises, the increase in
the debt-GNP ratio over the past dozen years
would seem to require a reduction in the pri­
mary deficit. Such a reduction in the primary
deficit would require an increase in tax rev­
enues and /or a cut in government expenditure,
neither of which will be universally popular.

pay a large premium for the opportunity to hold safe gov­
ernment debt. In this case, the government would not be
able to roll over its debt forever. Another potential explana­
tion is that the set of securities is not sufficiently rich and
that investors find government debt sufficiently different
and attractive that they willingly hold it at a low interest
rate. In this case, the government might be able to roll over
its debt forever. See Bohn (1991b).
15

APPENDIX A

BUSINESS REVIEW

NOVEMBER/DECEMBER 1992

Derivation of the Growth Rate of the Debt-GNP Ratio
Let B be the amount of government bonds outstanding, and let Y be the measure of
national income, such as GNP. Thus the debt-GNP ratio is B/Y. The growth rate of any ratio
is approximately equal to the growth rate of the numerator minus the growth rate of the
denominator so that
A(B/Y)
(A i)

--------------

AB
=

B/Y

................

AY
-

B

--------------

Y

where the symbol A denotes the change from one period to the next. The change in
government bonds, AB, equals the total deficit, which equals the primary deficit plus
interest payments:
(A2)

AB

=

primary deficit + rB

where r is the interest rate on government bonds, so that rB is the amount of interest
payments by the government. Now divide both sides of (A2) by the amount of government
bonds B to obtain
(A3)

AB/B

=

primary deficit/B + r

Now let g denote the growth rate of income so that
(A4)

AY/Y

=

g

Substituting (A3) and (A4) into (A l) yields
A(B/Y)
------------ =
primary deficit/B + r - g
B/Y
which is equation (1) in the text of the article.
(A5)

Digitized for 16
FRASER


FEDERAL RESERVE BANK OF PHILADELPHIA

Andrew B. Abel

APPENDIX B

Can the Government Roll Over Its Debt Forever?

An Economic Model of the Interest Rate
and the Growth Rate
This appendix presents a general equilibrium model underlying the example presented
in Table 2. Suppose that consumption equals output in every period as in the widely used
Lucas (1978) asset pricing model. The standard condition determining the riskless interest
rate r in a representative consumer economy is
(B l)

( l+ r ) P E t{u'(ct+1)/u'(ct)) = 1

where Et{ } is the expectation conditional on information at time t, c{ is consumption per
capita at time t, u'(ct) is the marginal utility of consumption at time t, and P > 0 is the time
preference discount factor (so that P ’- l is the rate of time preference). Assume that the utility
function is logarithmic so that u'(c() = l/ c(. In this case, equation (B l) becomes
(B2)

l + r = [ p E tl(ct/ct+1) } ] 1

Now let gt+1 = (ct+1/ct) -1 be the growth rate of consumption and output between time
t and time t+1, and assume that gt+] is i.i.d. over time. Under this assumption we have
(B3)

l + r = [pE {l/(l+gt+1))]-1

The ratio of the debt-GNP ratio in period t+1 to the debt-GNP ratio in period t is (1+r)/
(l+ g t+1) and the expected value of this ratio is
(B4)

E {(l+r)/(l+g

)} = E {l/ (l+ g

)} [pE{l/(l+gt+1)}]-1 = 1/p

Notice that if p< l,th e n l/ p > 1 and the expected value of the debt-GNP ratio grows over
time. The example in Table 2 is based on the following assumptions: P = 0.8333; and
P r{l+gt+1 = 0.6} = P r{l+ g t+1 = 1.6} = 0.5. These assumptions imply that 1+r = 1.0473, E {l+ gt+1}
= 1.1, and E {(l+ r)/ (l+ gt+1)} = l/p= 1.2.




17

REFERENCES

BUSINESS REVIEW

NOVEMBER/DECEMBER 1992

Abel, Andrew B., N. Gregory Mankiw, Lawrence H. Summers, and Richard J. Zeckhauser.
"Assessing Dynamic Efficiency: Theory and Evidence," Review of Economic Studies, 56
(January 1989), pp. 1-20.
Blanchard, Olivier J., and Philippe Weil. "Dynamic Efficiency, the Riskless Rate and Debt
Ponzi Games Under Uncertainty," National Bureau of Economic Research Working
Paper No. 3992, February 1992.
Bohn, Henning. "O n Testing the Sustainability of Government Deficits in a Stochastic
Environment," Rodney L. White Center for Financial Research Working Paper No. 1991, August 1991(a).
Bohn, Henning. "Fiscal Policy and the Mehra-Prescott Puzzle: On the Welfare Implica­
tions of High Budget Deficits with Low Interest Rates," Wharton School of the
University of Pennsylvania, April 1991(b).
King, Ian. "Ponzi Games, Dynamic Efficiency and Endogenous Growth," Department
of Economics, University of Victoria, British Columbia, mimeo, 1992.
Lucas, Robert E. Jr. "Asset Prices in an Exchange Economy," Econometrica, 46 (November
1978), pp. 1429-45.
O'Connell, Stephen A., and Stephen P. Zeldes, "Ponzi Games," in The New Palgrave
Dictionary of Money and Finance, 1992 (forthcoming).

Digitized for18
FRASER


FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone?
Book-Entry Delivery-AgainstPayment Systems
James J. McAndrews*
I n the late 1960s the New York Stock Exchange reduced the number of days and hours
of trading in an attempt to decrease the volume
of stock trading. The reason was the "paper
crisis": the trading firms could not manage to
deliver and receive promptly the huge volume
of securities traded each day. The highest daily
volume of trade in 1968 was just over 21 million
shares. In 1990 the highest daily volume of
trade was 292 million shares. Yet this extraor-

* James Me Andrews is a Senior Economist in the Phila­
delphia Fed's Research Department. He thanks Dan
Weckerly for the Indiana Jones example.




dinary increase in trading activity was accom­
modated without a crisis of any sort. What has
allowed Wall Street to manage the huge in­
crease in volume?
Many forms of automation contribute to the
ability to settle the increased volume of trading
in financial markets. Probably the most impor­
tant consideration, however, is that today most
securities listed on the New York Stock Ex­
change (and many others as well) never have to
be moved at all. They are immobilized in a
depository and therefore do not have to be
delivered after a trade. Instead of the timeconsuming and laborious task of delivering,
examining, and counting the traded securities,
19

BUSINESS REVIEW

a seller simply transfers ownership to the buyer
by instructing the depository to debit its secu­
rity account and to credit the account of the
buyer. The "back office" where trades are
settled has become, in an important sense,
paperless.
The immobilization of securities in a deposi­
tory has reduced the costs of settling trades and
also has changed the risks that are always
present in completing agreed-upon transac­
tions. By combining the transfer of the security
on the books of the depository with simulta­
neous transfer of payment for the security, the
depositories have made it possible to eliminate
the risk that the seller would lose its security
after delivery but before payment was made.
However, settling trades through a depository
requires that the depository and its system for
ensuring completion of trades be safe; other­
wise the users of the depository would be at
risk of losing expected settlement payments or
securities.
Efficient and safe settlement of trades is
important in lowering the costs of financing
investment and in fostering ease of access to
our economy's financial markets. Trading vol­
ume typically peaks at times of stress in finan­
cial markets as many people wish to trade
securities. During the 1987 market break, for
example, over 608 million shares changed hands
on one day on the New York Stock Exchange. If
the system of settlement were unable to man­
age such a large volume of trade, especially at
such a critical time, investors might lose confi­
dence in the safety and integrity of our financial
markets. Such a belief could increase the costs
of funds to our nation's firms and govern­
ments. In this article, we will examine the
security depositories, their methods of com­
pleting trades, and their role in reducing the
costs and risks of transacting securities.
BOOK-ENTRY DEPOSITORIES
A book-entry depository is a specialized
financial institution that accepts securities for



NOVEMBER/DECEMBER1992

safekeeping and maintains transferable ac­
counts of those securities. Book-entry transac­
tions can be completed more easily and at lower
cost than transactions in which the securities
are in paper form for two reasons. First, immo­
bilizing the securities in one location is the least
costly method of safekeeping securities, since it
saves on the duplication of vault, security, and
maintenance costs. Second, book-entry trans­
fer of securities is quicker and cheaper than the
physical transfer of securities. Book-entry trans­
fer is accomplished by electronically debiting
the account of the seller of securities and credit­
ing the account of the buyer, while physical
transfer requires that both the buyer and seller
count the securities and verify that the right
bundle of securities is delivered. Furthermore,
physical transfer of securities requires expen­
sive security and insurance arrangements to
protect against theft, loss, and fire.
The growth in book-entry deposits of secu­
rities has been rapid. As shown in the figure on
page 21, over 98 percent of U.S. Treasury secu­
rities are now in book-entry form at the Federal
Reserve System. Indeed, all U.S. Treasury
securities are now issued only in book-entry
form; that is, there are no paper securities in the
first place, and the securities exist only as en­
tries in the Fed's computer system. Other U.S.
government securities, such as those issued by
government-sponsored enterprises and fed­
eral agencies, as well as the securities of many
international organizations also are in bookentry form at the Federal Reserve System.
Many other securities, including corporate
stocks and bonds, municipal bonds, and the
mortgage-backed securities of the Government
National Mortgage Association (GNMA, or
Ginnie Mae) are on deposit in private deposito­
ries. (See Book-Entry Depositories on page 22.)
For example, in 1990,66 percent of the shares of
all U.S. companies listed on the New York Stock
Exchange were held in book-entry form at the
Depository Trust Company, the largest private
book-entry depository. Corporate stocks and
FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems

Book-Entry Deposits
of Outstanding Securities
Billions of Dollars

Billions of Dollars

James J. McAndrews

and risk. In the great
trad in g cen ter of
Amsterdam, hundreds
of different types of
coins of many countries
circulated. Traders had
to be able to identify the
specific coin as well as
to determ in e
the
amount of the precious
metal in the coin. Each
merchant would have
to weigh the coins in
order to assess their
value—but who moni­
tored the accuracy of
the scales? Further­
more, the weight of the
coins imposed costs on
their movement, and
the risks of loss and theft
w ere sign ifican t.

The

solution to this increas­
ingly clumsy means of
payment was found in
the creation of the Bank
of Amsterdam—a de­
pository of coins.
Adam Smith, in
Wealth o f Nations,1 re­
Note: All dollar figures are in billions.
ports that "[i]n order to
remedy these inconve­
Source: U.S. Bureau of the Public Debt; Federal Reserve Bank of New York; NYSE
niences, a bank was es­
Fact Book, various years; AMEX Fact Book, various years; National Association of
tablished in 1609 under
Securities Dealers; Depository Company Annual Report, various years.
the guarantee of the city.
This bank received both
foreign coin, and the
bonds are often issued in paper form, then light and worn coin of the country at its real
registered, immobilized, and transferred to a intrinsic value in the good standard money of
book-entry system.
the country, deducting only so much as was
That a depository can economize on the necessary for defraying the expence [sic] of
costs and risks of the physical movement of a
commonly traded object is an old idea. In the
16th and 17th centuries, traders, who were paid
^ d a m Smith, Wealth o f Nations, Book IV, Chapter III
in gold and silver coins, faced problems of cost (The University of Chicago Press, 1976), pp. 504-05.



21

BUSINESS REVIEW

NOVEMBER/DECEMBER 1992

Book-Entry Depositories
The Federal Reserve, as fiscal agent for the U.S. Treasury, most federal agencies, and certain
international organizations, issues, maintains, and transfers ownership of debt securities issued by
these entities.
Started in 1971, the Fedwire book-entry safekeeping and transfer system now holds more than 98
percent of the marketable U.S. Treasury debt in book-entry form. The par value of the securities on
the system exceeds $3 trillion, and about 47,000 transfers are processed on an average day. The
system maintains accounts for approximately 8500 institutions that use these accounts to safekeep
and clear transfers for themselves as well as for their customers.
For securities not on deposit at a Federal Reserve Bank, private cooperative depositories have been
created, typically by market participants, to provide the benefits of book-entry deposit of securities.
These depositories have grown increasingly sophisticated and provide a host of services too
numerous to describe. All are members of the Federal Reserve system and so are examined and
supervised by the Fed. All are registered clearing agents and therefore are regulated by the Securities
and Exchange Commission.
The Depository Trust Corporation (DTC), begun in the late 1960s, is the largest private book-entry
depository. It holds corporate debt and equity securities on deposit, as well as municipal debt
securities. The market value of securities held by DTC at year-end 1990 was$4.1 trillion. Thisamount
included 66 percent of all the shares of U.S. companies listed on the New York Stock Exchange, 41
percent of all the shares issued over the counter, and 43 percent of the shares listed on the American
Stock Exchange. Some 87 percent of outstanding municipal bonds and 77 percent of the corporate
debt listed on the New York Stock Exchange are held by DTC for its participants. DTC is owned by
its participants.
The Philadelphia Depository Trust Company (PHILADEP) and the Midwest Securities Trust
Company (MSTC), in Chicago, also safekeep corporate debt and equity and municipal debt. At yearend 1990, they held on deposit securities whose value was 3 percent of the value of securities on
deposit at DTC. Both were created in the early 1970s. PHILADEP and MSTC are wholly owned
subsidiaries of the Philadelphia Stock Exchange and the Midwest Stock Exchange, respectively.
The Participants Trust Company (PTC) was formed in 1989 to provide a book-entry depository
for Government National Mortgage Association (GNMA) mortgage-backed securities. As of
February 1992 it had more than $627 billion in par value of such securities on deposit—about 90
percent of the outstanding issues. It has operated on a same-day funds settlement system from its
inception.

coinage, and the other necessary expence [sic]
of management. For the value which remained,
after this small deduction was made, it gave a
credit in its books. This credit was called bank
money... Bank money...has some other advan­
tages. It is secure from fire, robbery, and other
accidents: the city of Amsterdam is bound for
it; it can be paid away by a simple transfer,
without the trouble of counting, or the risk of
transporting it from one place to another."
Smith eloquently states the advantages of the
Digitized for22
FRASER


book-entry system for coin. Modern security
book-entry depositories have accomplished the
task of taking a m uch trad ed item — a
security—and, by immobilizing it and convert­
ing it to book-entry form, made transacting it as
easy as writing a check.
Our discussion reflects that the cost of bookentry delivery of securities is less than the cost
of physical delivery. One illustration of the
lower cost is the decline in the fail rate since the
introduction of book-entry depositories. A fail
FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems

is a failure by the seller to deliver the security at
the time of settlement. It can occur for any
number of reasons, such as an inability to find
the security or slow movement of the security
from the seller to the buyer. When a fail occurs,
both the buyer and seller incur a cost of delay in
receiving both funds and securities. In Ginnie
Mae security trades, for example, the fail rate
was estimated to be 25 percent as recently as
1985. Since 1989 most of these securities have
been immobilized by Participants Trust Com­
pany. Today the fail rate in Ginnie Mae trades
is about 6 percent.2 Another illustration is the
reduction in time required to complete a deliv­
ery electronically rather than physically. In a
joint U.S. Treasury-Federal Reserve study on
automating operations in government securi­
ties, it was found that "no more than two
minutes elapsed time is required to complete
an incoming telegraphic transfer as compared
with nearly two hours when physical delivery
is m ade."3
DELIVERY-AGAINST-PAYMENT
In addition to reducing the costs of transfer­
ring securities, book-entry deposit of securities
can reduce the risks of default by one party in
a trade because depositories can combine bookentry transfer of securities with transfer of
money. With the ability to transfer both money
and securities, the depository can match, si­
multaneously, a delivery of securities with the
payment for those securities. This method,
called delivery-against-payment, offers a way

2Reported in "Progress and Prospects: Depository Im­
mobilization of Securities and Use of Book-Entry Systems,"
Division of Market Regulation, U.S. Securities and Exchange
Commission, June 14, 1985, and by the Participants Trust
Company.
3"Joint Treasury-Federal Reserve Study of the U.S. Gov­
ernment Securities Market," Staff Studies-Part 3, December
1973.




James J. McAndrews

to complete or settle a previously agreed-upon
transaction by making payment if, and only if,
delivery of the security is made. Ordinary cash
transactions, such as the purchase of groceries
for cash, are made by delivery-against-pay­
ment.
D elivery-A gainst-Paym ent Elim inates
"Principal Risk." An ideal delivery-againstpayment system eliminates an important source
of risk in any transaction: if either payment or
delivery takes place before the other side of the
transaction is completed, the party that ful­
filled its obligations might lose the entire sum
(the principal amount) if the other party de­
faults and is unable to complete its side of the
transaction.
An example is the risk to a store owner who
accepts a check in exchange for some item, such
as clothing. The store gives the clothing to the
customer but will not receive payment until the
check clears. If the check is not honored by the
customer's bank because of insufficient funds,
for example, it may be impossible to retrieve
the clothing from the customer.
A more pertinent example is the risk of theft
when paper securities had to be delivered (in
advance of payment) before the advent of bookentry depositories. Brokerage firms would
send the securities by messenger at the end of
the day. It was common practice not to provide
a guard unless the messenger was carrying
over $1 billion worth of negotiable securities.
Theft insurance rates were escalating quickly in
1969-1970, leading to an insurance crisis in
1971, when the largest insurer of securities
announced that it would no longer offer the
coverage. The securities industry, the Federal
Reserve System, and other interested parties
worked quickly to implement a book-entry
system for U.S. Treasury securities in 1971 to
alleviate the crisis.
Book-entry depositories can implement de­
livery-against-payment in two ways. One way
is to transfer the money and the securities
simultaneously. By doing so, neither side of the
23

BUSINESS REVIEW

transaction is exposed to principal risk. This is
essentially the way the Federal Reserve oper­
ates its book-entry system.
The other way is to transfer securities provi­
sionally until payment is made later. Provi­
sional transfer of a security means that the
seller's securities account is debited even if the
buyer does not have enough money to pay for
the security at that moment. Later, perhaps at
the end of the day, the buyer is expected to have
sufficient funds to make payment. If payment
is made, the securities transfer is final; if not, the
securities transfer is reversed, and the seller
keeps the security. Alternatively, rather than
reversing the transfer, delivery can be provi­
sional upon the buyer's posting sufficient col­
lateral to ensure payment to the seller in the
event that the buyer cannot pay cash at the end
of the day. The private book-entry depositories
transfer securities in one of these two ways.
"Principal Risk" With Physical Delivery.
With physical transfer of securities, the seller
has to deliver the security before payment
because the buyer accepts the security subject
to count and examination. So simultaneous
transfer is not possible. If a third party, such as
a clearinghouse, would perform the examina­
tion and count, the physical security transfer to
the buyer could be made provisional on pay­
ment. But third parties are not always avail­
able, so settlement is often simply sequential.
As a result, the seller is at risk that the buyer
might default in the time after delivery but
before payment.
Indiana Jones provides us with a dramatic
example of the risks of sequential settlement. In
the movie "Raiders of the Lost Ark," Indiana
Jones and his South American guide, Satipo,
are attempting to escape the many traps in the
temple from which Indiana has taken a golden
idol. Satipo crosses a chasm in their path, but
in doing so, he breaks the rope used to swing
across it. Indiana is on the wrong side of the
chasm with the golden idol; Satipo is across the
chasm with Indiana's famous whip. "Give me

24


NOVEMBER/DECEMBER1992

the whip!" demands Indiana. "Throw me the
idol, I throw you the whip," replies Satipo.
Indiana hesitates as a stone door descends to
block their escape. "No time to argue!" insists
Satipo. Indiana has no choice but to comply.
He throws the idol, but Satipo defaults. He
drops the whip with a sneering " Adios, Senor."
As luck would have it, Indiana Jones proved
resourceful enough to manage his escape with­
out Satipo's completing his end of the transac­
tion, but the default in settling the sequential
whip-for-idol trade illustrates the pitfalls of
settling a trade without being able to count on
the fact that both ends of the transaction will be
completed. Indiana suffered principal risk in
settlement with Satipo, and Satipo intention­
ally defaulted. Default, however, is a risk even
when no one intends to default; rather, a firm
may find itself illiquid or insolvent in the middle
of the day after receiving securities but before
having paid for them.
BOOK-ENTRY DEPOSITORIES
AND THEIR DELIVERY-AGAINSTPAYMENT SYSTEMS
Several book-entry depositories exist: the
Federal Reserve System for Treasury and
agency securities and the four privately owned
book-entry depositories for stocks, corporate
and municipal bonds, and various other secu­
rities.4
The Fed's delivery-against-payment system
is a real-time, gross settlement system. It is a
real-time system because the transaction takes
place at the time of day when the seller notifies
the Fed of the transaction. For example, when
a bank sells Treasury securities to another bank,
it notifies the Fed on the settlement day to

4See Patrick Parkinson et al., "Clearance and Settlement
in U.S. Securities Markets," Staff Study 163, The Board of
Governors of the Federal Reserve System, for more informa­
tion on the settlement systems for securities.
FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems

transfer the securities to the buyer against a
payment. The Fed debits the buyer's reserve
account and transfers the funds to the seller's
reserve account; at the same time the Fed debits
the seller's security account and credits the
buyer's security account. The transfers occur
within seconds. It is a gross settlement system
because the gross amounts of both cash and
securities for each of a bank's transactions are
exchanged during the day. For example, it may
be that the buyer and the seller change roles in
a partially offsetting transaction later in the
day. That transaction would be treated sepa­
rately from the earlier transaction.
Unlike the Fed, the private depositories'
delivery-against-payment systems employ pay­
ment netting systems. During the day the
participant may buy and sell many securities.
The depository keeps track of the transactions
of its participants and at the end of the day it
nets all transactions—each participant simply
pays to or receives from the depository the
difference between total sold and total bought.
Even though the participant may have made
thousands of trades during the day, it will
either owe or be due only one amount of money.
Since later transactions may partially offset
earlier ones, netting can greatly reduce the total
value of transfers that have to be made.5 As a
result, netting reduces the liquidity costs of
settlement. It does so, however, at the expense
of increasing certain risks that all transactions
may be unable to settle because of the failure of
one participant.
Private depositories employ one of two types

5See Brian Cody, "Reducing the Costs and Risks of
Trading Foreign Exchange," this Business Review, November/December 1990; and R. Alton Gilbert, "Implications of
Netting Arrangements for Bank Risk in Foreign Exchange
Transactions," Federal Reserve Bank of St. Louis Review,
January/February 1992, for discussions of netting arrange­
ments. Netting also reduces bookkeeping costs in trades
with many participants.




James J. McAndrews

of payment: next-day funds settlement or sameday funds settlement. (See Same-Day Funds
Settlement on page 26.) In the former the pay­
ment at the end of the day is typically made by
certified check (payable the next day), while in
the latter, payment is made by wire transfer.
These two systems ensure delivery-againstpayment in different ways.
In the next-day funds settlement system,
deliveries of securities are made throughout
the day, but they are provisional until the final
settlement payment is received at the end of the
business day. If payment for a security is not
made because a party is illiquid—it neither has
the funds available to make payment nor can it
borrow to make payment— then the security
delivery is reversed. Since the security never
left the depository, reversal is accomplished by
a transfer from the defaulting party back to the
original seller.
In the same-day funds settlement system,
deliveries of securities are made throughout
the day and are provisional upon the buyer's
posting collateral of sufficient value to ensure
the payment necessary for the securities. Rather
than reverse security deliveries, the same-day
systems use the collateral to effect payment in
the event of a default. If the buyer defaults, the
depository will seize the collateral and sell it.
Since this will take time, the depository itself
must have sufficient liquidity to make the pay­
ment due to the seller of the securities.
POTENTIAL RISKS AND CONTROLS
IN DELIVERY-AGAINST-PAYMENT
SYSTEMS
Although the development of properly de­
signed delivery-against-payment systems has
substantially reduced principal risk, we have
seen that other risks arise in these systems. The
depositories have established extensive con­
trol measures intended to protect the deposi­
tory and its participants from these risks.
In the Federal Reserve book-entry system,
the Fed extends intraday credit to those institu25

NOVEMBER/DECEMBER 1992

BUSINESS REVIEW

Same-Day Funds Settlement
Same-day funds settlement requires that the payment for a security be made by wire transfer rather
than by certified check. Hence, same-day settlement means that funds are immediately available to
the seller; payments made by check are not available until the next day (and are therefore subject to
some small risk of overnight bank failure). U.S. securities markets are planning to move to same-day
funds settlement for all securities transactions. Currently, only some securities in the U.S. are settled
in same-day funds.
Same-day settlement requires greater monitoring than does next-day funds settlement to ensure
adequate liquidity. If a participant in a next-day funds system experiences an unexpected shortfall
in liquid balances at the end of the day, it has the opportunity to obtain liquidity the next day to fund
its liability. However, a same-day funds system allows little time to obtain liquidity to fund a
settlement shortfall. Therefore it is especially important for a same-day funds system to maintain
sufficient liquidity to fund the settlement payments at day's end, should a participant default occur.
The greater difficulty of obtaining funds on a same-day basis makes reversing securities deliveries
more problematic in the same-day funds settlement systems. When a security delivery is reversed,
the seller of the security is placed under increased liquidity pressures. Since the seller anticipates
payment at the end of the day, it may invest anticipated funds during the day, prior to settlement.
However, if the buyer of the security defaults and the security delivery is reversed back to the seller,
it must fund this addition to its portfolio. This is correspondingly more difficult when the cash to do
this must be paid on the same day. As a result, systems using same-day funds rely more on full
collateralization of security deliveries during the day (expecting to sell the defaulting party's
securities later) rather than reversal of security deliveries. In its policy statement on the desirable
features of same-day settlement systems, the Federal Reserve System actively discourages reversal of
security transfers in the event of a default. Because selling the securities takes time, this requires that
the same-day systems have greater liquidity on hand to fund the same-day payment of a defaulting
participant.
Two private book-entry depositories have same-day funds settlement systems: the Participants
Trust Company for GNMA securities and the Depository Trust Company for commercial paper and
various other securities. Their procedures to ensure adequate liquidity are similar. Most important,
these systems rely on full collateralization of any participant's net debit, debit caps that limit the risk
exposure of the system due to any one participant, and committed lines of credit to the depository
at least as large as the largest debit cap of any participant.
Full Collateralization. Full collateralization of a participant's net debit is achieved by marking to
the previous day's closing price the securities the participant is due to receive. These securities
themselves provide part of the participant's collateral, but they are valued at their market price minus
a "haircut." This undervaluation is intended to cover expected movements in the price of the security
in the next few days when the depository would liquidate the security in case of default. The rest of
the collateral must consist of a participant's fund, at least part of which must be in cash, and the rest
in short-term Treasury securities, a type of security that is easily sold.
Net Debit Caps. Net debit caps are imposed on each participant so that no one participant's
default would imperil the ability of the system to effect settlement payments for all other participants.
The cap is determined based on the liquidity resources of the participant.
Committed Line of Credit. The depositories that manage same-day funds settlement systems
attempt to ensure final settlement. By paying for committed lines of credit that are at least as large
as the largest net debit cap for any participant, the depository is able to complete settlement even in
the event that the system's largest net debtor would default.

Digitized for 26
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FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems

tions whose Fed accounts have insufficient
funds to pay for incoming securities at the time
of transfer. As a result, these participants incur
daylight overdrafts in their Fed accounts.
Should a participant fail during the time it has
a large daylight overdraft with the Fed, then the
Fed may lose the value of the overdraft. Be­
cause of this the Fed is exposed to credit risk
from its participants. We will discuss the pro­
cedures the Fed has put in place to control this
risk after considering the risks that arise in the
private settlement systems.
Because they net money payments through­
out the day and settle their transactions only at
the end of the day, the private delivery-againstpayment systems rely on participants that are
net debtors to be able to make final settlement
payment at the end of the day. The possibility
that a net debtor (of money or securities) would
be unable to settle at a designated time gives
rise to liquidity risk.
Because all firms wish to earn a high return,
each firm has an incentive to economize on cash
holdings. Cash (transactions accounts atbanks)
yields low returns but is necessary to make
payments. Firms constantly monitor their cash
positions to maintain sufficient cash to make
their payments, but not excess cash, which
would lower their return. Because firms econo­
mize their cash holdings, the failure to receive
an expected payment can easily cause a firm to
be "illiquid" and unable to make the settlement
payment on schedule. Hence all parties are
subject to liquidity risk.
Replacement-cost risk, or market risk, is a type
of credit risk. For example, in the same-day
settlement systems, if a participant defaults, its
collateral is seized and later sold to pay for its
obligations to the depository. Although the
collateral is set to cover losses as large as can be
expected in one to two days given the historical
record of price volatility, there is a risk that the
market value of the collateral could decline
precipitously by the time it is sold.
In a netting system, the failure of one partici­



James J. McAndrews

pant to make settlement payment imposes in­
creased liquidity pressures on the depository
and on other participants, since the defaulting
party was a net debtor to them. For example, in
a next-day settlement system, if a seller has a
security delivery reversed back to it and does
not receive its expected payment, it may be­
come unable to fulfill its own obligations, since
it then must fund a larger portfolio of securities
than it had anticipated. The risk arises that one
party after another will become illiquid and
unable to settle, and the payment system itself
will fail. This systemic risk would result in the
failure of all the transactions to be settled that
day. The participants would have to revert to
bilateral settlement, and the benefits of the
multilateral system would be lost, at least for a
time.
Risk Control Measures in Book-Entry De­
positories. Depositories have instituted sev­
eral risk-control measures to reduce the chance
of the failure of any individual settlement and,
more important, to reduce the chance of any
systemic failure of the settlement system.
Membership standards that restrict participa­
tion to firms with high levels of capital can
reduce the risk of failure. Well-capitalized
firms can better withstand unexpected short­
falls of funds, since they should be better able
than thinly capitalized firms to quickly borrow
to meet settlement payments and to absorb
credit losses without becoming insolvent. Pri­
vate depositories have explicit standards that
participants must meet in order to join the
system. For example, Participants Trust Com­
pany requires that its participants meet specific
capital requirements.
All book-entry depositories monitor their
participants for signs that the participant is
subject to especially severe liquidity or sol­
vency pressures or operational problems. De­
positories study the financial statements and
regulatory filings of participants to keep abreast
of changes in participants' financial conditions.
All book-entry depositories impose debit caps,
27

BUSINESS REVIEW

or limits on the amount of the debit position a
firm can build during the day, to limit the
exposure the system has from any one partici­
pant. The debit cap is determined on the basis
of the participant's liquidity resources and con­
tributions to the participant fund. In the Fed's
book-entry system, debit caps serve to limit
daylight overdrafts.
The Fed has proposed pricing daylight over­
drafts to restrain the incentive that a participant
has to overuse daylight credit from the Fed. By
charging a fee for each dollar of credit it extends
to a participant for a daylight overdraft, the Fed
expects that its participants will find ways to
reduce their current reliance on this source of
credit.6
All settlement systems require each partici­
pant to maintain a participant fund, or clearing
fund. This fund partly collateralizes the
participant's obligations to the organization
and can serve as a liquidity backstop in the case
of default of another participant. Typically,
cash and short-term Treasury securities are
acceptable for contributions to the participant
fund. The level of required contributions to
participant funds is not adjusted often.
In the same-day funds net settlement sys­
tems, participants are also required to post
collateral (see Same-Day Funds Settlement).
Collateral requirements are meant to fully cover
the obligations that a participant has to the
organization for all but the most extreme oneday changes in the value of the participant's
collateral.7 The collateral is adjusted (by mark­
ing the collateral to its market value) each time
a trade is entered into the system. Some of the

6See David B. Humphrey, "Market Responses to Pricing
Daylight Overdrafts," Economic Review, Federal Reserve
Bank of Richmond, May/June 1989.
7Because of the greater liquidity pressures in the sameday funds systems, the Federal Reserve discourages rever­
sal of security deliveries in these systems.


28


NOVEMBER/DECEMBER 1992

collateral must be in cash, while the bulk of it
may be in the security to be delivered in the
system.
The rules governing loss sharing among
nondefaulting participants in the event of a
default by a counterparty are part of the risk
control system in net settlement arrangements.
These rules vary by depository. An illustration
of a loss-sharing rule is that once a participant
defaults, the depository can seize the collateral
of that participant and later sell it. In the
meantime, the depository, using its liquidity,
makes the payment that the defaulting partici­
pant failed to make. Any losses incurred in this
operation may be recovered by first liquidating
the defaulting party's clearing fund.8 Next the
depository can charge the loss to its own re­
tained earnings; next it can charge losses to
other participants' clearing funds.
If the depository charges losses to the settle­
ment counterparties of the defaulting party,
this action encourages bilateral monitoring by
each participant of its counterparties. If the
losses are charged equally to all participants,
this action mutualizes risk and reduces the
participants' incentives for monitoring settle­
ment counterparties.
The depositories themselves typically main­
tain committed bank lines o f credit to provide
liquidity in the event of a participant's default.
Closing out a participant's position takes time,
and the depository, to prevent further liquidity
pressures on the system, must have access to
liquid funds. The two leading private deposi­
tories, Participants Trust Company and the

8In the next-day funds systems, reversal of security
transactions may not always be possible. For example, a
counterparty to a defaulting firm may be at its debit limit; a
reversal would not be permitted under the existing debit
caps. In this case, the depository may then decide to close
out the defaulting party's position (possibly incurring a
loss), in which case the loss-sharing rules become appli­
cable.

FEDERAL RESERVE BANK OF PHILADELPHIA

Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems

James /. McAndrews

Depository Trust Company, retain committed
bank lines of credit in an amount in excess of the
largest net debit allowed for any one partici­
pant.
Finally, operational safeguards are an impor­
tant part of depositories' risk control system.
Security of the data transmitted through the
system, adequacy of the system's size, alterna­
tive sources of power and communication net­
works, and backup of the automated facilities
are all important components of ensuring ac­
cess to the system, even in the case of loss of
power or some other major disruption to the
facilities. Off-site backup facilities are a mini­
mum requirement for major delivery-againstpayment systems.

group is to harmonize the methods of settle­
ment internationally as a greater flow of capital
across countries occurs and more firms are
listed on both domestic and foreign stock mar­
kets. Included among the group's recommen­
dations are the following:

PUBLIC POLICY TOWARD PRIVATE
DELIVERY-AGAINST-PAYMENT
SYSTEMS
Public policy has supported the develop­
ment of book-entry depositories, with the Fed
and the Treasury actively involved in creating
the book-entry system for U.S. Treasury and
agency securities. The Securities and Exchange
Commission (SEC) has sponsored workshops
for the securities industry to share ideas for
managing the book-entry systems. While the
SEC supports the immobilization of securities,
it believes that the individual investor should
be able to obtain a certificate if she so desires.9
The Working Committee of the Group of 30
Clearance and Settlement Project has adopted
a set of recommendations concerning settle­
ment of trades.10 One important goal of this

Payments associated with the settlement
of securities transactions and the servic­
ing of securities portfolios should be made
consistent across all instruments and
markets by adopting the " same day" funds
convention.11

9See "Progress and Prospects: Depository Immobiliza­
tion of Securities and Use of Book-Entry Systems," Division
of Market Regulation, U.S. Securities and Exchange Com­
mission, June 14,1985.
10The Group of 30 is an independent, nonpartisan, non­
profit international organization, composed of senior finan­
cial industry participants and researchers with interests in




Each country should have an effective
and fully developed central securities
depository, organized and managed to
encourage the broadest possible industry
participation (directly and indirectly)...
Delivery versus payment should be em­
ployed as the method for settling all secu­
rities transactions.

The Board of Governors of the Federal Re­
serve System has issued a policy statement
regarding private delivery-against-payment
systems that settle, directly or indirectly, over
Fedwire.12 The Board provides guidance re­
garding issues of intraday credit risks and
payment risk management arising from such
systems. It outlines liquidity, credit, and op-

economic policy issues. In 1988, the Group of 30 began a
project to improve the world's clearance and settlement
systems. The Working Committee of the Group of 30 Clear­
ance and Settlement Project was formed to further develop
the recommendations of the Group of 30.
n Group of 30 Clearance and Settlement Project, "YearEnd Status Report 1990," Group of 30,1990 M Street, N.W.,
Suite 450, Washington, D.C.
12This policy statement was issued on June 15,1989, and
is reprinted in Parkinson et al. (See footnote 4.)
29

BUSINESS REVIEW

erational issues that should be considered in a
same-day funds settlement system.
CONCLUSION
Book-entry deposits of securities, along with
the delivery-against-payment system book en­
try makes possible, have become an important
feature of the securities market in the U.S. In
these systems, the computerized technology
that makes this cost- and time-saving method

30



NOVEMBER/DECEMBER 1992

of safekeeping and transferring securities pos­
sible must be complemented by carefully crafted
control measures that limit the credit and li­
quidity risks that inevitably remain in any pay­
ment system. The primary regulators of the
securities industry and the industry itself have
identified further immobilization of securities
and the movement to same-day funds settle­
ment as important developments to pursue in
the future.

FEDERAL RESERVE BANK OF PHILADELPHIA

INDEX 1992
January /February
Paul S. Calem, "The Strange Behavior of the Credit Card Market"
Herb Taylor, "The Livingston Surveys: A History of Hopes and Fears"
March/April
Gerald A. Carlino, "Are Regional Per Capita Earnings Diverging?"
Stephen A. Meyer, "Saving and Demographics: Some International Comparisons"
May/June
Dean Croushore, "W hat Are the Costs of Disinflation?"
Loretta J. Mester, "Banking and Commerce: A Dangerous Liaison?"
July/August
Theodore M. Crone, "A Slow Recovery in the Third District: Evidence From New Time-Series Models"
Sherrill Shaffer, "Marking Banks to Market"
September/October
Robert P. Inman, "Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?"
Richard Voith, "City and Suburban Growth: Substitutes or Complements?"
November/December
Andrew B. Abel, "Can the Government Roll Over Its Debt Forever?"
James J. Me Andrews, "Where Has All the Paper Gone? Book-Entry Delivery-Against-Payment Systems"

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