Foreigners Guilty of causing US finance crisis...

Did Foreigners Cause America's Financial Crisis?

By Stephen Gandel Friday, Jan. 15, 2010

Blame China, Saudi Arabia and, yes, Canada.

Much of the fault of the financial crisis has been heaped on Wall Streeters, unscrupulous mortgage lenders and weak regulators. But in a new research paper, economist Ricardo Caballero says there is another major group of contributors to America's monetary mess who are not getting the blame they deserve: foreigners.

"There is no doubt that the pressure on the U.S. financial system [that led to the financial crisis] came from abroad," says Caballero, who is the head of MIT's economics department. "Foreign investors created a demand for assets that was difficult for the U.S. financial sector to produce. All they wanted were safe assets, and [their ensuing purchases] made the U.S. unsafe."

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China, contending with a huge trade surplus with the U.S., bought more and more Treasury bonds, pushing down yields and making Treasuries less attractive to other foreign investors. As a result, the rising demand for higher yielding U.S. debt opened the door for Wall Street investment bankers to spin out new classes of fixed-income securities, most notably collateralized debt obligations or CDOs. Much of the money raised by those investments was funneled in the mortgage market. That gave lenders the ability to make more loans, allowing more people to buy houses and push up real estate prices. Many of those loans, it turns out, were made to people who couldn't afford to pay. What happened next . real estate bust, foreclosures and Wall Street mayhem . is well known.

How to prevent a similar crisis from happening again is the question that Caballero thinks we are getting wrong. He believes reforming the U.S. financial system is only part of the answer. Foreign investors, he says, need to change their behavior as well.

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