We examine optimal provision of riskless government bonds under asymmetric information and
safe asset scarcity. Paradoxically, corporations have incentives to issue junk debt precisely when
intrinsic demand for safe debt is high since uninformed investors then migrate to risky overheated
debt markets. Uninformed demand stimulates informed speculation which drives junk debt prices
closer to fundamentals, encouraging pooling at high leverage. Acting as borrower of Örst resort,
the government can issue safe bonds which siphon o§ uninformed demand for risky corporate
debt and reduce socially wasteful informed speculation. Thus, government bonds either eliminate
pooling at high leverage or improve risk sharing in such equilibria. The optimal quantity of
government bonds is increasing in intrinsic demand for safe assets and non-monotonic in marginal
Q.