Saturday, July 16, 2011

We're Missing A Mechanism

. Saturday, July 16, 2011

Felix Salmon:

The big-picture thing to remember when looking at this chart is something which I’ve said many times before — that it wasn’t an excess of greed and speculation which led to the financial crisis, but rather an excess of overcaution, with an attendant surge in demand for triple-A-rated bonds. On a micro level, triple-A securities are safer than any other securities. But on a macro level, they’re much more dangerous, precisely because they’re considered risk-free. They breed complacency and regulatory arbitrage, and they are a key ingredient in the cause of all big crises, which is leverage.

Much more at the link including the mentioned chart. Brad DeLong has made similar points in the past, and Tyler Cowen links to related discussion of how demand for AAA assets shifted to sovereign debt when it became clear that much AAA-rated ABS wasn't in fact AAA. Now of course there is a lot of trouble with sovereigns.

What we don't have a clear sense of is the mechanisms driving all of this. Is it a global movement towards safety beginning in the 1990s? Is it regulatory response, since both high-quality securities and OECD sovereign debt are privileged in the Basel accords?

From an IPE perspective, there appears to be insufficient supply of risk-free assets, which the US Treasury used to be able to provide. Unfortunately, the debt ceiling political theater has reduced that capability, which could have an adverse effect on the global economy and financial, not just the US economy and financial system. I'm very nervous about the state of the world right now.


Anonymous said...

I don't study IPE, but somewhere along the road I read something that pinned the high demand for riskless assets on two factors: the baby boomers' massive retirement savings and the oil-producing states' massive rents. Is that not correct?

Kindred Winecoff said...

Anon, global imbalances more generally might be an explanation, but we still need a mechanism linking the two.

We're Missing A Mechanism
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