Friday, July 13, 2012

Global Savings Glut

There has been many attempts to try and explain the financial crisis. In my eyes there were no less than a dozen factors that contributed to housing bubble, housing collapse, and financial meltdown. A bubble is a lot like a forest fire that gets out of control. You need fuel (usually not one or two trees but a forest filled with overgrowth), you need the spark to ignite the fire (lightening). Finally, you need an accelerant (high winds).

In the case of the housing bubble the fuel was provided by decades of poor regulation and deregulation (alone each case is fine). For example, during the 90's we had a campaign to make everyone a homeowner (great idea, bad when we used subprime loans to do this). Toward the end of the decade we had Gramm-Leach-Bliley (more on this in later chapters) that removed the separation between commercial and investment banks (fine if commercial banks were stocked full of subprime mortgages desperately need buyers, enter investment banks).

The spark was a large amount of money flowing out of the stock market into the housing market. Domestic investors needed a home for their money after the collapse of the bubble.

Finally, you need the accelerator. Domestic money was not sufficient to sustain the low interest rates homeowners craved. If there were only a way to attract foreign money (enter China, OPEC, Europe, Banking centers). Here we have the global savings glut.  The inflow of cheap foreign capital prevented long-term interest rates from rising giving us the accelerant needed to sustain and prop up our housing bubble.

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