Central banks’ efforts to keep markets stable may be creating unintended risks. Emergency lending and market backstops have encouraged highly leveraged government bond trades, potentially lowering borrowing costs while increasing financial vulnerabilities that could require further intervention during the next crisis.
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Central banks may be accidentally subsidizing government borrowing through their efforts to prevent a repeat of past market blowups, and policymakers are starting to worry that anticrisis lending facilities could even be interfering with their own monetary policy.
The source of the problem is the switch from central banks being the lender of last resort to, in 2008 and 2020, also being market makers of last resort, ensuring corporate—and government—debt markets keep functioning. During a crisis, support is often essential to prevent a downward spiral that destroys the financial system.
But backstopping markets removes a key risk and encourages more borrowing—especially for the hedge funds that now own trillions of dollars of U.S. Treasurys.
“Ironically, vulnerability is created by mechanisms that were introduced to reduce vulnerability,” said Huw Pill, the Bank of England’s chief economist, one of those growing concerned, in an interview. “So, it’s a bit like a whack-a-mole kind of story.”
Offering either an explicit or implied guarantee that government-funding markets will remain open and liquid means hedge funds have less risk of being unable to finance highly leveraged trades. This is particularly true for the overnight repurchase, or repo, market, where borrowers pledge bonds for cash. The result has been a huge expansion of two popular government bond trades, arbitraging Treasurys or British gilts against bond futures or swaps.
The scale is extraordinary: The Dallas Fed estimates hedge funds ended last year with $2.4 trillion of Treasurys, up from $600 billion a decade earlier. Because the profits on each trade are tiny, hedge funds have to leverage as much as 100 times to get worthwhile returns, creating new risks.
This might sound abstruse. But in 2020, it was the Treasury basis trade blowing up that forced the Fed to intervene. In 2025, signs of trouble in the swap trade pushed President Trump to retreat from his tariff plan.
Pill worries that the reassurance central-bank policy provides bleeds into monetary policy by boosting borrowing. This, in turn, keeps government-debt yields lower than they otherwise would be.
“There’s lots of gilts to be bought,” he says. “How do you support that buying of gilts? You make it attractive. How do you make it attractive? Well, there are some imperfections in the market. So those imperfections create profit opportunities, but they’re not very big. So how do you make them more meaningful? You allow leverage to build up.”
“That’s good for the government because it gets to sell the gilts at a lower [yield] than it otherwise would. It’s good for the financial sector because they’re able to extract these rents effectively. And it’s good for the central bank because the market seems to be liquid and functioning. But all of those things are true until they’re not true.”
When it goes wrong, the more leverage, the worse the problem. And the worse the problem, the more likely it becomes that central banks have to create yet more special tools to address it. That then spurs the next buildup of leverage.
Pill thinks more effort is needed to come up with a modern version of the Bagehot Doctrine. Walter Bagehot, the 19th-century editor of the Economist magazine, summed up the role of the central bank as being to lend to banks freely, against good collateral, at a penalty rate. Access to instant cash helps banks withstand runs. The fact the central bank is offering a backstop should make the run less likely, and shareholders are penalized, through the penalty rate, if it is used.
Tools for saving markets from drying up are more haphazard. In 2020 the Fed, BOE and others just bought lots of government debt to inject liquidity into markets. That worked because, even though quantitative easing is also a monetary policy tool, they also wanted easier money.
Unfortunately, that created what Pill described as a tinderbox, ignited by the energy crisis after Russia invaded Ukraine. The excess money creation from left over from emergency QE then fanned the flames of inflation. This made it much harder to calibrate monetary policy when central banks decided to tighten (although policymakers were also, in my view, far too slow to recognize inflation).
Pill points to the “temporary, targeted” BOE buying of gilts amid the forced selling by leveraged pension funds after Britain’s botched tax-cut plan in September 2022 as a successful model. At a time when the BOE was trying to tighten monetary policy, it intervened in a way that stopped the pension fund selling spiral and stabilized gilts. Yet the central bank maintained tight monetary policy.
Bagehot would recognize the goal: Reduce the encouragement to take risk, known as moral hazard, that offering guarantees in advance creates, but retain the ability to mount a rescue in a crisis.
Unfortunately, much of central banking is going backward on this. Moral hazard is increasing, even for banks. In the 2023 bank bailout, the Fed accepted less-than-full collateral, recognizing Treasury bonds at face value rather than their (much lower) market value.
The emergency rescue facility then became a funding facility that even healthy banks chose to tap—in effect easing monetary policy by the back door and prompting the Fed to tighten the terms before it ended. Something similar could be under way with Japan’s plans to use an emergency Fed loan facility to raise cash to prop up the yen without having to sell its hoard of Treasurys.
I don’t know how to break the cycle of crises needing rescues that lead to more leverage and new crises. And I’m concerned we’re firmly into the added-leverage phase of the latest cycle.
At least central bankers are still thinking about it, even if they don’t, so far, have good answers.
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Strong family financial planning can help reduce taxes and support younger generations. From intrafamily loans and asset gifts to inheritance disclaimers, strategic cooperation can create meaningful financial benefits—when families have the trust and structure to make it work.
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Happy is the family whose members—parents, grandparents and grown children—trust each other enough to cooperate on shared goals, especially financial ones. When that is truly the case, Uncle Sam’s tax rules can help as well.
This matters especially now that mortgage rates are above 7%, and many families are looking for ways to help younger members. If the elders have resources and are confident younger ones can cooperate, a family loan could make homeownership possible while providing the elders with a useful income stream.
Other strategies can actually lower taxes, such as when funding 529 plans or Roth IRAs, or when someone inherits a traditional IRA with required withdrawals larger than they will need.
Here are three strategies useful for functional families.
It is perfectly legal for families to lend money to a relative for a down payment or even a private mortgage.
But it is important not to cut corners, says Ryan McKeown, a CPA with Modern Wealth Enhancement in Minnesota. If the loan is for a down payment, be honest with the mortgage provider and have a formal agreement. The lender owes tax on the interest payments received.
If the loan is for a private mortgage, both sides should have legal representation with a formal written agreement, including payment terms. The lender owes tax on the interest, and the borrower often can deduct it if he or she itemizes.
To avoid IRS trouble, the interest rate shouldn’t be lower than the agency’s Applicable Federal Rate at the time of the loan. Currently that is about 5% for loans longer than nine years; about 4.5% for loans three to nine years; and about 4% for loans three years or less. Currently, traditional mortgage rates are generally above 7%.
In addition, the lender could use the $19,000 annual gift-tax exemption (described below) to forgive some or all of the interest or principal annually. If both lenders and borrowers are married, that is up to $76,000 a year. There is no tax for the borrower on such forgiveness, because it is from a gift.
If you’re going this route, McKeown advises against having a fixed plan to forgive the debt. Instead, do it in one-off letters specifying the amount—and keep careful records. Otherwise the IRS might try to treat the loan as a taxable gift.
Powerful tax-saving moves for families often use gift-tax provisions. Under current law, anyone can give anyone else up to $19,000 of assets annually, free of gift tax. That means a married couple with three grandchildren could give them a total of $114,000 in 2026.
The gifts can be cash or other assets, like stock. For noncash gifts, the cost basis—which is the starting point for measuring taxable gain after a sale—“carries over” to the recipient. So if someone buys $1,000 of stock and gives it away when it is worth $5,000, the recipient’s cost basis is $1,000. If the recipient later sells the shares for $8,000, the taxable gain is $7,000.
Here’s an example showing how gifts could save a family taxes. Grandma is a widow of modest means, while her child and spouse have prospered. The couple has two children, and they want to contribute $5,000 to a 529 college-savings plan for each—but they need to sell stock to do it. Their tax rate on the sale would be 18.8%, and they would need to sell about $11,000 of stock.
However, Grandma’s federal tax rate on the stock sale is 0%. If the couple gives $10,000 of shares to Grandma, she could sell them, pay no tax, and fund the grandchildren’s 529 plans. This saves about $1,000 of tax.
These moves are legal, and they could be used in other ways, such as to help a young person fund a Roth IRA.
But trust among family members is essential: Under the law, givers can’t put conditions on a gift. Grandma could use her stock proceeds to take a cruise, but she makes 529 contributions instead.
Mark Sellner, a retired tax attorney and CPA living in Sarasota, Fla., uses this strategy. His children sell stock he gives them and fund 529 plans for his grandchildren.
The family’s tax savings aren’t huge, but he likes other benefits. The sales by his children don’t boost his adjusted gross income, which in turn could raise his Medicare Irmaa premiums or his 3.8% surtax on net investment income.
Sellner doesn’t worry about his children using the funds for another purpose.
“There can’t be any strings attached to gifts. Of course, it is up to us to decide whether to make them in the future,” he says.
Two caveats: The “kiddie tax” applies to most children under age 24, and it is levied at the parents’ rate on investment income above $2,700 in 2026. Consider this before making gifts to a young person.
Investors who give away stock also forgo the step-up, an important provision that exempts assets held at death from capital-gains tax.
Sellner knows he’s losing a step-up, but says, “The children could use a little more now. Why should they wait 20 years to get it?”
A disclaimer is a highly useful strategy in which one heir renounces an inheritance in favor of another heir. Assuming family members cooperate, this can save taxes.
Here’s one example. Dad died and had a large traditional IRA that he left to Mom. She has enough assets and income to cover her expenses, and she lives in a state with a stiff estate tax. The inherited IRA would put her estate over the threshold.
Also surviving are three young-adult children. If Mom disclaims all or part of Dad’s IRA within nine months of his death, that amount could go directly to the children. They will have 10 years to empty the account, and the family as a whole will likely save estate and income taxes.
Disclaimers have many key details, especially regarding beneficiary documents. Although heirs have great freedom in choosing what assets to disclaim, the rules about who gets disclaimed property are rigid. It is best if the original owner names tiers of heirs so that if one disclaims, the next recipient is clear.
