International Capital Flows and the Return to Safe Assets in the United States, 2003-2007

By Ben S. Bernanke, Carol C. Bertaut, L. DeMarco, Steven B. Kamin. 2010

265 citations recorded by the source corpus.

A broad array of domestic institutional factors –including problems with the originate-to-distribute model for mortgage loans, deteriorating lending standards, deficiencies in risk management, conflicting incentives for the government-sponsored enterprises (GSEs), and shortcomings of supervision and regulation– were the primary sources of the US housing boom and bust and the associated financial crisis. In addition, the extended rise in US house prices was likely also supported by long-term interest rates (including mortgage rates) that were surprisingly low, given the level of short-term rates and other macro fundamentals –a development that Greenspan (2005) dubbed a “conundrum.” The “global saving glut” (GSG) hypothesis (Bernanke, 2005 and 2007) argues that increased capital inflows to the United States from countries in which desired saving greatly exceeded desired investment –including Asian emerging markets and commodity exporters– were an important reason that US longer-term interest rates during this period were lower than expected. This essay investigates further the effects of capital inflows to the United States on US longer-term interest rates; however, we look beyond the overall size of the inflows emphasised by the GSG hypothesis to examine the implications for US yields of the portfolio preferences of foreign creditors. We present evidence that, in the spirit of Caballero and Krishnamurthy (2009), foreign investors during this period tended to prefer US assets perceived to be safe. In particular, foreign investors –especially the GSG countries–acquired a substantial share of the new issues of US Treasuries, Agency debt, and Agency-sponsored mortgage-backed securities. The downward pressure on yields exerted by inflows from the GSG countries was reinforced by the portfolio preferences of other foreign investors. We focus particularly on the case of Europe: although Europe did not run a large current account surplus as did the GSG countries, we show that it leveraged up its international balance sheet, issuing external liabilities to finance substantial purchases of apparently safe US “private label” mortgage-backed securities and other fixed-income products. The strong demand for apparently safe assets by both domestic and foreign investors not only served to reduce yields on these assets but also provided additional incentives for the US financial services industry to develop structured investment products that “transformed” risky loans into highly-rated securities. Our findings do not challenge the view that domestic factors, including those listed above, were the primary sources of the housing boom and bust in the United States. However, examining how changes in the pattern of international capital flows affected yields on US assets helps provide a deeper understanding of the origins and dynamics of the crisis.

Subfields: Finance

View Paper: https://www.semanticscholar.org/paper/0f92bb0615f4c689e98069a1f12e3fd3c852c14f

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Citations in the corpus

Cecchetti , Mohanty and Zampolli The real effects of debt The real effects of debt (2011, unknown): “22 This is also known as the global saving glut hypothesis (Bernanke (2005), Bernanke et al (2011)).”
The Safety Trap (2017, background): “First and most closely related is the literature that identifies the shortage of safe assets as key macroeconomic fact (see e.g. Caballero 2006 and 2010, Caballero and Krishnamurthy 2009, Bernanke et al 2011, Barclay’s 2012).”
Financial Intermediation, International Risk Sharing, and Reserve Currencies (2017, unknown): “30 Bernanke et al. (2011) showed that these heightened holdings were largely related to European financial institutions buying agency debt while funding themselves in the U.”
The Financial Crisis and the Geography of Wealth Transfers (2011, unknown): “According to Bernanke et al. (2011), saving glut economies such as China and Emerging Asia have concentrated their portfolio holdings into government bonds, pushing downwards their yields and inducing more advanced economies, in particular the Euro Area to invest in higher yielding securities, such ”
The Hyperglobalization of Trade and Its Future (2013, background): “But that excess liquidity was a factor and that Chinese mercantilist policies created excess liquidity are plausible deeper causes of the Lehman crisis (see Bernanke et al. 2011).”
Global Safe Assets (2012, background): “Here, we define outside liquidity from the point of view of the financial sector, so that it may also include safe claims on firms and households (what Bernanke et al. (2011) calls “private label safe assets”).”
Financial Globalisation and the Crisis (2012, unknown): “As documented by Acharya and Schnabl (2010) and Bernanke et al. (2011), European banks were major purchasers of asset-backed securities.”
The Volatility of Capital Flows in Emerging Markets: Measures and Determinants (2017, background): “However, there is a strand of the literature arguing that long-run interest rates may be at least as important for capital flows as short-run rates, if investors prefer to diversify assets with short maturities and assets of different maturity are imperfect substitutes (see Bernanke et al. (2011)).”
The History and Economics of Safe Assets (2016, unknown): “” This has been referred to as the global savings glut and is the subject of a large body of literature (see, for example, Caballero 2006; Bernanke 2005, 2007; Caballero & Krishnamurthy 2009; Gourinchas et al. 2014; Bernanke et al. 2011; Bertaut et al. 2011; Gourinchas & Jeanne 2012).”