3 Questions: Ricardo Caballero on the search for safe investments
What caused the financial crisis of 2008? MIT economist Ricardo Caballero has posited that a key structural factor was a massive global imbalance between the demand for safe investments, especially bonds, and the supply of safe places to put new capital. Because this “insatiable demand for safe debt instruments,” as Caballero has called it, was not wholly absorbed by the traditional safe haven of U.S. Treasury notes, it helped spur the growth of the mortgage-backed bond market. But these bonds, backed by subprime loans, turned out to be unsafe despite their AAA ratings, exploding en masse. Financial markets are still feeling the aftereffects. As a solution to this imbalance, Caballero — an expert on global capital markets, financial panics and risk who is among the 100 most-cited economists worldwide — has proposed the idea of government-issued investment insurance meant to help spur financial activity. Without such policies, he has warned,...