The Bernank on What Caused the Bubble
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?