Former U.S. Secretary of the Treasury Timothy F. Geithner and Professor Andrew Metrick survey the causes, events, policy responses, and aftermath of the recent global financial crisis.
Lecture: The Global Savings Glut Hypothesis
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The Global Financial Crisis
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Safe Assets and the Global Savings Glut
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Andrew MetrickMichael H. Jordan Professor of Finance and Management
Yale School of Management
Timothy GeithnerLecturer in Management, Yale SOM, Former U.S. Secretary of the Treasury
Yale School of Management
[MUSIC]
All right. So, we know what safe assets are.
But, why all of the sudden would the demand for safe assets, or
the supply of safe assets change.
That is actually something that happened at a very large scale over the four,
five years that preceded the global financial crisis.
And it's an extremely important part of the story.
And we're gonna look at some data on this today, try to get a sense of that.
Starts with just an observation, and
it doesn't have to do with safe assets directly.
And that observation is, between 2003 and 2007, short-term
interest rates in the United States increased by four percentage points.
But longer term tenure interest rates hardly moved.
This is very unusual.
Let's see this in a picture.
The left side of the picture shows two lines.
The line that starts high goes low, and
comes back high again is the federal funds rate.
That is a short term interest rate.
That is effectively controlled by the Federal Reserve,
central bank of the United States.
The blue line that's a little more jagged, and
doesn't have as large moves over the long term, is the ten year treasury rate.
This is a longer term borrowing by the government.
Now, the longer term borrowing by the government is, of course, all promised and
guaranteed by the government, so it's very safe.
But, the federal funds rate at almost all times in our history,
the financial crisis will be an exception, is also viewed as a very, very safe rate.
This is borrowing between banks.
But the rate is managed by the Federal Reserve.
The gap between these two rates is a term spread.
It's the amount that you would need to pay extra, to borrow over ten years
instead of federal funds, which would be borrowing a very short term.
Perhaps overnight.
So, what do we see here?
At the beginning of the 21st century,
these two rates are quite similar, and in fact, that's relatively unusual
that these rates are so similar, and there's even a short period of time,
where the short term rate is actually higher than the long term rate.
Now, sometimes when short term rates are particularly high,
you will see them be a little bit higher than long term rates,
because people are expecting the short term rates to fall in the future.
And of course, a 10 year rate, is really nothing more than trying to combine
the short term rates over the next 10 years, in some way.
So, if we expect rates to fall a lot.
We could end up with these rates close to each other, or
even the short term rate higher.
In the early part of the 21st century, where we had a relatively mild recession,
the federal reserve was lowering interest rates.
And it falls to it's minimum around 2003.
Now, during this time long term rates, didn't move very much, and
it didn't move very much in part because
these changes down were largely expected at some point to be reversed.
But they weren't expected to be reversed immediately, and
they weren't expected to be reversed nearly as sharply.
The expectation of the Federal Reserve was, when they started to raise interest
rates, which they did following 2003, that this would move the long term rates back
up near the levels they were at the beginning of the 21st century.
So, if you look in 2000, that rate is close to six percent.
By 2003, the long term rate is down near 3%.
Despite increasing the short term rates, the Federal funds target rate
over the subsequent four years, long term rates only moved up about 1.5%.
Not sufficient, to bring them all the way back near the levels they were,
before the Federal Reserve started dropping rates.
This was a bit of a puzzle, so
let's have that kind of in mind which is that, long term rates
did not move as much as we might have expected from raising the short term rate.
Why this matters for creating some kind of a boom,
is related to the credit rates that are then in the economy.
On the right hand graph, we see three lines,
one of which is a derivative of the other two.
The blue line in the middle is the same as what we have have on the left hand graph.
The blue line in the middle is the 10 year treasury rate.
The black line that is above it is the 30-year fixed mortgage rate.
And you can see that these two lines, blue and black move together very closely.
Then, that is illustrated by the red line at the bottom,
which has nothing more than the spread between the two of them.
So historically, if you were going for a 30-year mortgage, You would pay between
one and a half and two percentage points more than the ten year government rate.
And that was true over this entire time period.
So therefore, when long rates don't move up.
When the ten year treasury bond does not move up as much as expected,
mortgage rates stay low.
And when mortgage rates stay low, that has a very boomy effect on the housing market.
In an influential speech, before he was Chairman of the Federal Reserve, but while
he was a member of the Federal Reserve Board, a Governor of the Federal Reserve,
Ben Bernanke proposed that one cause of what he called this conundrum.
Was a global savings glut from emerging market and
commodity rich countries that had large current account surpluses.
That is, the rest of the world
really liked buying safe government assets in the United States.
And thus, the demand for those assets was very, very high, and
even though there was a pumping of liquidity into the economy for
some time by the US government, in an attempt to raise interest rates
later to pull out and discourage the credit conditions from getting overheated.
There was still an enormous, enormous demand for
these assets, long term government bond assets from other countries,
that kept effectively the price of those assets high.
And when the price of a bond is high, the return on the bond,
the rate on the bond is low.
And essentially, it was this global savings glut Proposed Bernanke,
that was keeping the link from between short term and
long term interest rates from being as strong as it had been historically.
Next, we'll look at some data on this.
[MUSIC]
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