The biggest driver of the bubble was too much money flowing into the economic center from the 'developing' world. High profits had already combined with saturated markets so that US companies had no place to invest in new production so they were buying back their own stock as a last resort the EU was in a similar situation. When there was a huge influx of profits from the developing world that mass of capital created a tidal force for the financial industry to make places for that money to go, they made derivatives. And those derivatives produced the incentive to write worse and worse mortgages on property valued at a higher and higher level at the US and to a greater degree the UK.
Part of the solution is to re-direct all of that financial force back into the market which created it and where the opportunities for greater growth are much better, albeit with higher risk.
It was fear, or in financialese, 'risk-aversion' that caused the money to leave the places where development is needed and go to places where it was not in the first place.
Investment in the developing world has much higher potential returns.
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http://delong.typepad.com/sdj/2011/02/g ... ility.html
Global Imbalances: Links to Economic and Financial Stability
Ben Bernanke:
FRB: Speech--Bernanke, Global Imbalances: Links to Economic and Financial Stability--February 18, 2011: [T]he United States--the recipient of the largest capital inflows in the world--has also faced challenges coping with capital inflows. Notably, the failures of the U.S. financial system in allocating strong flows of capital, both domestic and foreign, helped precipitate the recent financial crisis and global recession. Why was the United States, a mature economy, the recipient of net capital inflows that rose to as much as 6 percent of its gross domestic product prior to the financial crisis?... [C]apital flows from emerging markets to advanced economies will tend to be directed to the safest and most liquid assets, of which... there is a relative shortage in emerging markets.... ome emerging Asian economies and Middle Eastern oil exporters did indeed evince a strong preference for very safe and liquid U.S. assets in the middle of the past decade, especially Treasury and agency securities.... European investors [also] placed a high value on safety and liquidity in their U.S. investments....
The preferences of foreign investors for highly rated U.S. assets, together with similar preferences by many domestic investors, had a number of implications, including for the relative yields on such assets. Importantly, though, the preference by so many investors for perceived safety created strong incentives for U.S. financial engineers to develop investment products that "transformed" risky loans into highly rated securities. Remarkably, even though a large share of new U.S. mortgages during the housing boom were of weak credit quality, financial engineering resulted in the overwhelming share of private-label mortgage-related securities being rated AAA. The underlying contradiction was, of course, ultimately exposed, at great cost to financial stability and the global economy....
Our collective challenge is to reshape the international monetary system.... [C]ountries with excessive and unsustainable trade surpluses will need to allow their exchange rates to better reflect market fundamentals and increase their efforts to substitute domestic demand for exports.... [C]ountries with large, persistent trade deficits must find ways to increase national saving, including putting fiscal policies on a more sustainable trajectory...
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