An interview with Ricardo Caballero conducted by The Region, a magazine published by the Federal Reserve Bank of Minneapolis. Caballero argues, convincingly in my view, that one of the causes of the recent financial crisis lies in the fact that the demand for AAA-rated assets is greater than the supply. In the years before the crisis of 2007/08 this demand was met by the creation of asset backed securities. In the years since the financial crisis the supply of asset backed securities has fallen considerably, but the demand for AAA-rated assets has not abated. Indeed, the demand for AAA-rated assets will only increase once all the new bank regulations that are currently being discussed come into force. What happens when demand is greater than supply? Prices go up. What happens when bond prices go up? Yields go down.
Update: I've added the chart below from a recent report by the Joint Forum of the BIS and the Basel Committee, Report on asset securitisation incentives which says it all.
