Are foreigners to blame for the global recession?

US Economic Crisis

Since the global financial crisis hit, one of the easiest things for financial analysts, market experts and industry spectators to do was to point the finger. The generic term "greedy bankers" was used to throw a blanket over those involved in the US financial sector as the collapse of Fannie and Freddie sent the rest of the world tumbling.

However new research by economist Ricardo Caballero has found that 'foreigners' may have been the driving force behind one of the worst recessions in living memory.

Time magazine reports that Caballero, the head of MIT's economics department, has deflected part of the blame away from careless American bankers and regulators, instead choosing to accuse countries like China, Saudi Arabia and Canada for pumping way too much cash into the American system.

"There is no doubt that the pressure on the US financial system [that led to the financial crisis] came from abroad," says Caballero, adding that foreign investors created a "demand for assets that was difficult for the US financial sector to produce. All they wanted were safe assets, and [their ensuing purchases] made the US unsafe."

The system is broken

Many analysts and experts look to the real estate sector and its "sub-prime mortgages" for causing the first domino to fall, encouraging very high risk mortgage applications. Most of the Banking system has repeatedly been accused of ignoring its responsibility to monitor the credit worthiness of mortgage applicants. These worthless debt instruments were then passed on to Wall Street, separating them up into billions-of-dollars worth of of highly questionable securities - Collateralized Debt Obligations.

The Bush administration has also shouldered a large chunk of the blame for its slack regulation of the banking system because, in theory, under the US system of checks and balances, if the cognizant federal agencies continued to screw up, then Congressional oversight should have kicked in to fix any problems.

But this has long been broken.

"Safe haven" for foreign investors

All of this has contributed to making the US a "safe haven" for foreign investors who bought the bonds of mortgage guarantors Fannie Mae and Freddie Mac, in turn serving to fuel the housing bubble.

Ohio State University professor René Stulz, explains, "Investors looking for safe investments in the U.S. created a demand for new products that caused our financial system to work differently from how it had worked in the past and to become more fragile in ways that were not well understood at the time."

The world had an insatiable appetite for safe debt instruments, a demand that the US felt compelled to provide lots of nice triple-A-rated securitized bonds, that when the real estate bubble finally, and spectacularly popped, mass panic ensued, and the US was left holding the bag for much of the risk.

What Caballero is saying is that US lawmakers and bankers are simply two in a whole load of contributing factors, and that fixing the US financial system in order to prevent a similar crisis happening again is only part of the answer.

Fixing the supply side of US economics

Foreign investors, he says, need to change their behavior as well. Specifically, Caballero believes the US needs to encourage foreign governments to hold a range of US investments, instead of just funneling all of their money into Treasuries or mortgage bonds.

It is quite true that attending to the supply side of American economics is the only real way to make the US financial system more resilient to shocks.

As Caballero himself puts it, "There is a crack in the US financial system, but it's important to ask where the water that caused the crack came from."

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