Stormy – interesting; also bizarre – I found the Rogoff paper somewhat underwhelming. The idea of a historical correlation between asset prices and banking problems is not explosive. The how is more interesting.

The stupidity of some western corporations has put them at the “disposal” of wiser people than they. They richly deserve this fate.

At the risk of being foolish, uninformed and certainly untechnical, I see the connection in this way:

Four things initially stimulated the housing bubble:

1. Lower interest rates
2. “Innovative” packaging with little regulatory oversight
3. Lower taxation of the wealthy.
4. Enormous profits within the multinationals and the financial community as they moved to and invested in developing countries. Some of those profits went to repurchase stock—but in the top tiers, salaries escalated rapidly. A great deal of that money went into bigger houses, plush mansions, etc.

In real estate, everything is location. If a McMansion goes up near you, then your property value rises. A great deal of money was being made—and spent. These purchases were like stones thrown into a pond. Property values escalated. With low interest rates, those who shouldn’t have sold and resold. (I, for example, was able to sell my home at twice the value it had a year earlier. I lived, at the time, on the Eastern Shore. People from Washington were moving in, flush with cash. Bidding wars ensued…and this was at the very beginning of the bubble!) Smartly enough, I took the money and moved to rural Canada.

Official inflows greatly exacerbated the bubble, fueling it indirectly.

Official inflows of cash from developing countries—purchase of Treasuries, etc.—allowed the U.S. to avoid meeting its debt obligations. Instead of using taxes to pay our way, we used credit, credit in the form of those Treasury purchases. If we had kept taxes higher, then the bubble would not have been as dangerous. Taxes take money from the taxpayer so that the government can pay its bills. With less money in circulation, the bubble would have been more subdued. (In one way, you could say that China financed the Iraq war.)

GDP of course rose. But GDP is only a number, hiding, sometimes, a lot of rather nasty surprises.

I tend to be a bit bizarre, I suspect, in the way I put stuff together.

anonymous — do we know for a fact that China/ the oil states didn’t buy this stuff. the answer is no. China and the oil states don’t disclose enough to be able to tell, and the us data has enough gaps that it doesn’t rule out much of anything. especially with respect to CDOs — a CDO might be legally based in the caribbean or europe, so the us data provides no information on who buys its various tranches.

that said, I am fairly confident that China’s exposure is in the tens of billions (mostly with the banks) not the hundreds of billions. the fact that so much of china’s holdings are known to be in treasuries and agencies sets a limit on their exposure to the more toxic stuff.

as for the gulf, all the evidence is anecdotal, since next to zero gulf flows appear in the us data and the UK and the swiss have not opted to provide detailed data on flows in and out of their respective economies. the absence of better data out of the uk — given all the talk in the UK about transparency — ought to be a scandal. (and yes, i understand fully why there is a data hole; i am naive, but not that naive … )

but the anecdotes suggest that the gulf likes property (of the big office building kind), that the gulf likes equity and private equity, and the gulf likes fairly safe and secure treasuries. conversely, the gulf supposedly hasn’t been a big player in the more exotic bits of the debt market.

if someone has good evidence to contrary, i am all ears. i am uncomfortable with the absence of hard date to back my inferences about GCC demand.

We know that Russia has been a big buyer of agencies, and the safe agencies — there isn’t much space left over for more risky assets, and the bank of russia’s guidelines don’t really allow it to be too aggressive. some other oil central banks seemingly still have large deposits — not securities of any kind.

again — if someone has data or anecdotes to the contrary, do talk!

In a big (ok, very big) picture kind of way, sure on the equations part, a rise in savings and investment in Asia “had to be” balanced by a decline in savings and investment in USA, UK, Australia etc,but that equation works as a backward check test, not as a cause effect flow. You cannot force people to increase consumption or deplete savings. Japan in the late 90s and early 2000s is a prime example. For lack of a better word, it is greed that causes such phenomena.

The same for investment, risk preferences and the chase for higher returns are never enforced, they are a product of human greed. Not going to go further on this ‘cos don’t want to repeat my blog post. Just to conclude, one has free will, face the consequences of your choices when you have the freedom to make those choices.

Asia has a painful memory of the 1997 crisis, it seems that many western analysts overlook this, thus it prefers building a safe portfolio on its reserves. Thus that might explains why “safe” T-Bonds/Bills/Agencies were bought despite the “unappealing” yields.

Since 1990s, we have seen an awful lot of “new” financial engineered products being “invented” and sold as “safe” investment vehicles to those traditionally long “safe” T-Bons/Bills/Agencies funds (especially in the West). I cannot argue against the fact that Asian/Oil Exporters might have bought some, but the ratio is relatively small in comparison to the West. (Not tryin to start a East/West divide here)

And now, I believe we are seeing an unwinding of such risk appetites in the East/West. East selling their “safe” T-bonds/bills/agencies and buying the “riskier” assets from the West. And those holders of now “toxic” structured/engineered products reverting back to “safe” traditionals.

Perhaps someone can come up with a quantitative study to show a clearer picture?

No doubt this mechanism is mostly correct. But we do know that it was not only US investors who bought the toxic MBS/CDO securities. Do we actually know for a fact that China and the oil states didn’t buy this stuff? It may be true that they “mostly” bought treasuries and agencies, but even a small fraction of a $1.2T portfolio is tens of billions…