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

Abstract

A broad array of domestic institutional factors-including problems with the originate-todistribute model for mortgage loans, deteriorating lending standards, deficiencies in risk management, conflicting incentives for the GSEs, and shortcomings of supervision and regulation-were the primary sources of the U.S. housing boom and bust and the associated financial crisis. In addition, the extended rise in U.S. 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 exporterswere an important reason that U.S. 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 U.S. longer-term interest rates; however, we look beyond the overall size of the inflows emphasized by the GSG hypothesis to examine the implications for U.S. 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 U.S. assets perceived to be safe. In particular, foreign investors-especially the GSG countries-acquired a substantial share of the new issues of U.S. 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 U.S. "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 U.S. 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 U.S. assets helps provide a deeper understanding of the origins and dynamics of the crisis.

Reverse Causality in Global and Intra‐European Imbalances

“…During the recovery after the global financial and economic crisis, the controversial dispute about global imbalances has been revived (Feldstein, 2008; Bernanke et al, 2011). The origins of the current account imbalances between East Asia and the USA have been attributed to an East Asian saving glut (Bernanke, 2005; Bernanke et al, 2011) combined with mercantilist trade strategies (Dooley et al, 2003; Bergsten, 2010). In contrast, Chinn and Ito (2008) pointed to a US saving deficiency and expansionary US fiscal policies.…”

Official Demand for U.S. Debt: Implications for U.S. Real Rates

“…On balance, nonetheless, he finds little role for foreign investors in reducing 10-year yields on U.S. Treasury bonds. See also Bernanke, Reinhart, and Sack (2004), Bernanke et al (2011), and Beltran et al (2013) on the link between foreign capital flows and Treasury yields. specific maturities, so-called "preferred-habitat" investors, play an important role for bond pricing.…”

The US Dollar's Continuing Hegemony as an International Currency: A Double‐matrix Analysis

“…While the US's respective shares of world GDP and of world trade in goods and services continue to be significant factors in the international use of the dollar as an international currency, it is foreign involvement in the US securities markets that now provides the more important explanation for this use. A steady trickle in the years before 2000, foreign capital flows into the US began to rise sharply from this time on, trade surpluses with the US being the principle source of the inflows from Asia and leverage in addition to surpluses being a major source of inflows from Europe (Bernanke et al., ) . Foreign investors are particularly prominent in the US treasuries market where they currently hold over 60 per cent of the total amount outstanding (45 per cent held by foreign official agents, 15 per cent held by foreign private agents) (Council on Foreign Relations, ).…”