Safety by Designation

Abstract

We show that safe-asset status is shaped not only by fundamental risk but also by regulatory designation. We identify this effect from sequential changes in the regulatory treatment
of U.S. municipal and Treasury securities. Designating qualifying municipal bonds as highquality liquid assets substantially increases their co-movement with Treasuries, particularly
for highly rated securities and relative to assets whose regulatory treatment remains unchanged. Conversely, temporarily exempting Treasuries from the Supplementary Leverage
Ratio reduces their co-movement with near-safe assets, with the effect reversing when the
exemption expires. Cross-asset and within-municipal-bond tests, together with decompositions of yields, show that these effects operate through convenience yields rather than credit
risk, taxes, or aggregate financial conditions. Our evidence establishes regulatory treatment
as a distinct determinant of the convenience services and safe-asset properties of securities.

JEL Classification Codes: C3, E44, F34, G12, G15, H63
Keywords: municipal bonds, credit risk, liquidity, fiscal capacity, scarcity