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BlackRock's Peter Fisher on "Savings Glut" Hypothesis, Bank Supervision, CDS

The following is from the chapter by Peter R. Fisher, "The Market View: Incentives Matter," in the 2009 book, "The Road Ahead for the Fed."  Fisher is a Managing Director of BlackRock, Inc., and co-head of its Fixed Income Portfolio Management Group.  The whole chapter is worth reading.

"What went wrong to cause the excessive growth of leverage
and credit that led to this particular systemic failure of housing
finance and banking?


Monetary policy was too easy in the United States and in other
countries. The savings glut hypothesis begs the question of
where the glut of (Asian and especially Chinese) savings came
from. It came from a persistent “glut” of (Western and especially
American) consumption in excess of income that could
have been curtailed but, instead, grew when monetary policy
remained too easy for too long. We over-stimulated housing
and banking—the most interest-rate sensitive sectors of our
economy—even as some other countries did the same thing...

Disciplined credit underwriting and crude capital rules will
produce a sounder banking system than sophisticated, riskbased
(and even counter-cyclical) capital rules applied to
credit written with shoddy underwriting. The failure of bank
management and bank supervisors to apply equal or greater resources
to the enforcement of credit standards, as were applied
to the design and implementation of capital rules, created a
lopsided regulatory process that is inherently unstable. In the
absence of greater underwriting discipline, higher capital requirements
will make our banking system less efficient but will
not make it more stable.

GSEs unbounded. The panoply of federal incentives for
housing played an important role in the extended rise of house
prices that became a bubble. But particular attention should be
paid to the change in the balance sheets of Fannie Mae and
Freddie Mac that was permitted after 1993, when the Treasury
Department terminated its “traffic cop” role in regulating their
debt issuance. The subsequent rapid growth of their balance
sheets fueled the housing boom of the 1990s and stimulated
the growth of the securitization markets. More importantly,
it created an expectation of ever-rising GSE earnings that fate-
fully led them in this decade, egged on by Congress, to chase
wider margins by moving down in credit quality.

Credit default swaps and the mispricing of risk. Credit default
swaps, which began as a form of credit insurance against the
risk of default, mutated from their origins into a form of offtrack
betting on credit which became a source of instability by
accentuating and prolonging the credit cycle.