Arnold Kling  

The Bernank on What Caused the Bubble

Seven Myths about Free Markets... The Expert-Hubris Industries...

Ben S. Bernanke, Carol Bertaut, Laurie Pounder DeMarco, and Steven Kamin write,

Europe did not run a current account surplus as did the GSG countries [Global Savings Glut countries, such as China], and thus was not a net exporter of saving to the rest of the world. But Europe leveraged up its international balance sheet significantly, issuing, among other instruments, considerable sovereign debt and bank debt, and using the proceeds to buy substantial amounts of highly rated U.S. MBS and other fixed-income products. In fact, the strong preference of the GSG countries for Treasuries and Agencies appears to have pushed Europeans and other advanced-economy investors, including U.S. investors, into apparently safe "private-label" MBS.

much of the investment in U.S. MBS around the world came from the expanding off-balance-sheet vehicles of large global banks, and many of those banks were located in Europe (Arteta, Carey, Correa, and Kotter, 2009). A final possibility, advanced by Acharya and Schnabl (2010) among others, is that the regulatory capital charges levied on banks that set up off-balance-sheet conduits to invest in U.S. MBS were inadequate, which also served to encourage investments in these assets.

Read the whole thing. I would argue--and nothing in the paper contradicts this--that the Basel capital accords created a worldwide monoculture in banking (they intentionally created a worldwide monoculture in bank regulation). The reduced capital requirements for AAA_rated securities created a regulatory hole through which the European and American banks drove the proverbial truck. It was not that the GSG countries dumped cheap money into the U.S. housing market. The problem was a financial sector that grew like a tumor in the U.S. and Europe, thanks to regulatory capital arbitrage that was, if anything, encouraged by the world's top banking regulators.

Going forward, the plan is to strengthen the Basel Accords so that this does not happen again. What could go wrong?

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COMMENTS (8 to date)

I found Dr Bernanke's conclusions regarding the need for expanded "macroprudential oversight" disturbing -- more at:

Thank you for the opportunity to comment...

Lorenzo from Oz writes:

So, how did Canada and Australia miss out?

K Smith writes:

Leave it to the Bernank to blame others for the consequences of Fed shenanigans. Methinks the pot is calling the kettle black. Oh, the humanity!

blinded1 writes:

Bernanke has to find some scapegoat to blame, because he knows, everyone knows that he himself is the No. 1 factor of the bubble.

Frank writes:

Do capital regulations apply to off-balance-sheet vehicles or investments?

Steve Roth writes:

"financial sector that grew like a tumor in the U.S."

If you want less of something, tax it.

Let the market sort it out from there.

It's not (just) that banks are too big to fail. The financial sector is too big too fail.

And it's X times larger than is necessary to lubricate a productive real economy.

fundamentalist writes:

Yes, the financial sector grew like a tumor, but lack of regulation wasn't the problem. As Keynes noted after WWI, capital inflows require trade deficits. Chinese cannot buy US assets with yuan. They must have dollars. They get those dollars by selling us goods.

Greenspan and Bernanke flooded China with cheap dollars through imports. Those dollars came home via capital flows into securities and fueled several bubbles over the years. The MBS market was just one.

It's impossible for the financial sector to grow as it did without the Fed flooding the world with new credit. The buck stops with Bernanke, no matter how much he tries to blame others. The fact that he can get away with such blame shifting advertises the poor state of monetary theory in mainstream econ.

clarence swinney writes:

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