Ken Rogoff has described a mystery.
As policymakers and investors continue to fret over the risks posed by today’s ultra-low global interest rates, academic economists continue to debate the underlying causes. By now, everyone accepts some version of US Federal Reserve Chairman Ben Bernanke’s statement in 2005 that a “global savings glut” is at the root of the problem. But economists disagree on why we have the glut, how long it will last, and, most fundamentally, on whether it is a good thing.
Brad DeLong suggests that this is
a catastrophic market failure in the inability of financial markets to properly mobilize the risk-bearing capacities of society as a whole
So who done it? My nominee is Basel. The Basel capital accords blessed certain assets as “low risk.” This fueled growth of Freddie and Fannie. Then, in 2000, private securities with AAA ratings were added to the list, fueling a boom there. We know how that turned out.
The financial crisis served to differentiate two types of investments–the ones that get bailed out and the ones that don’t. Investors naturally have a preference for the former. That means big banks can get cheap credit. And what does Basel tell them they can do with their cheap credit? Buy government bonds.
So what we have had over the past ten years is a massive exercise in credit allocation by the world’s bank regulators. They offer explicit and implicit guarantees to banks that invest in assets officially designated as low risk, and now they are shocked, shocked to find capital pouring into exactly those assets.
More so for foreign banks. The rating agencies were even worse, as was AIG, generating a lot of income without putting up any reserves against it. These are regulatory problems, but far more of non regulation than positive regulation. No positive regulation forces bad investments, but non regulation allows and supports them.
This is exactly the proposition of Jeffrey Friedman in “Engineering the Financial Crisis”, which though somewhat dry and technical, is well-written and quite thoughtful. It is refreshingly clear-minded and unbiased, and in my view presents a compelling argument.
Excellent point. Why the heck should banks make loans to small businesses when their loans aren’t guaranteed like governments or don’t have the implicit backing from the government of other banks plus Fannie and Freddie. In addition, these days banks that actually take some risk to make private sector loans risk running afoul of the regulators capital requirements or, more importantly, losing POLITICAL favor and the guarantees which come with it.
I still like the Great Stagnation as an explanation for low interest rates. New firms worth plowing some real capital into are few and far between.
To add to the story – what will the effective net tax rate be? The smartest investors will always be accounting for inflation and taxation, as well as risk, in their computations.
It may of course be a “civilizational” thing, but certainly a applicable to the developed economies of Western Civilization, that there has been inadequate (improper?) redeployments of surpluses (profits, etc.) for perhaps as long as the past 100 years.
More recently, in the past 30 or 40 years there have been increasing commitments of surpluses (including the surpluses yet to be produced) to consumption and consumptive activities – throughout Western Civilization.
It remains to be seen whether those pre-commitments of as yet unproduced surpluses will be (or can be) honored by those tasked to produce them. Current stagnation may be an indication that they will not be honored.
We live in an age of Managerial Capitalism with its many layers of management and intermediary managers. The predilections have been to accumulate surpluses and insulate them from risks in accordance with the motivations of managers in both business enterprise and politics.
You neglect the fact that regulatory judgements of what is low risk reflect crony capitalism, bribery, and interest group politics: Angelo Mozillo’s mortgages were deemed low risk by gaming the regulations, by bribing regulators, by bribing politicians, by bribing the executives of Fannie and Freddie, and because he was putting brown skinned people in middle class housing. Harvard deemed certain kinds of risk “racist”, because noticing that risk had disparate impact. Noticing what Angelo Mozillo was up to would be racist. To some extent, it still is.
> No positive regulation forces bad investments,
CRA
In the US, the 2005 crisis (which was hidden under the carpet and kicked down the road to 2007, so that everyone piously pretends it was the 2008 crisis) was not “derivatives”, but derivatives of dud mortgages, which is to say, the crisis was dud mortgages. And most of these dud mortgages, in California as near to 100% as makes no difference, were mortgages to colored people.
Government officials creating rules that push savings into government bonds or politically favored sectors. What a surprise: politicians want to spend more than they can tax.
The real surprise might be why people would consider this as an indication of a saving glut?
I’d say there is an investment deficit, by design (or unintended consequence of other designs). And certainly not because we are lacking in ideas or people to pursue those ideas.
Cycling savings into government sponsored consumption is hammering future prospects.