Central bank emergency operations designed to keep financial markets functioning in times of stress may be unintentionally encouraging greater leverage and indirectly easing government borrowing costs, analysts say. Such facilities - created to prevent market dysfunction during crises - have evolved beyond lending to troubled banks and into a role as market makers of last resort.
These interventions can arrest the forced selling that would otherwise destabilise corporate and sovereign bond markets. At the same time, the mere expectation that central banks will step in appears to lower investors' perception of risk, which in turn makes debt-fuelled strategies more attractive.
Hedge funds are a central focus of concern. Estimates from the Federal Reserve Bank of Dallas put hedge funds' US Treasury holdings at $2.4 trillion at the end of 2025, up from about $600 billion a decade earlier. Some of these funds use extreme leverage - in some cases as much as 100 times - to try to extract returns from small price differences between government securities and related futures or swaps.
Officials caution that policy tools introduced to make the system less fragile can also create new vulnerabilities. Bank of England Chief Economist Huw Pill has warned that mechanisms intended to reduce financial vulnerability could produce unintended weaknesses. One element of that concern is the easing of financing conditions for leveraged trades: central bank assurances about liquidity in repo and government bond markets lower the financing hurdle for investors who depend on leverage to magnify returns.
When leveraged investors buy large volumes of government debt, their demand can push yields down, effectively lowering the government's cost of borrowing. That effect persists until a market shock forces a sharp repricing and triggers rapid unwinds of highly leveraged positions. In such episodes, central banks may feel compelled to intervene again to restore order, which can reinforce market expectations of future support and encourage another cycle of risk-taking.
History provides examples of these dynamics. The collapse of Treasury basis trades was one factor that prompted Federal Reserve action in 2020. More recently, the Bank of England's temporary gilt purchases during Britain's 2022 pension-fund crisis are cited as an alternative approach: that targeted intervention halted forced selling while allowing the central bank to continue with broader monetary tightening.
Designing emergency facilities that restore liquidity in a crisis without amounting to a permanent guarantee is a central policy challenge. Officials have also raised concerns that crisis-era programmes can blur the line between stabilising markets and providing cheap funding. In the United States, the Federal Reserve's 2023 bank rescue facility was later tapped by healthy institutions as a low-cost funding source, prompting policymakers to tighten the facility's terms before it expired.
The policy dilemma is therefore twofold: provide enough support to stop disorderly market moves when necessary, while avoiding the creation of incentives that encourage excessive leverage and build-up of systemic risk between crises.