Instead, the main causes of the crisis originated in the financial sector and stemmed from a widespread underappreciation and underpricing of risk. Failures of risk-management systems, incentive problems in securitization and compensation structures, and regulatory shortcomings and gaps led to a vulnerable, overleveraged financial system with inadequate capital and liquidity buffers. These problems were amplified by the eagerness of U.S. households to take on huge amounts of mortgage debt and of lenders to advance them the credit, justified by overly optimistic expectations for house price appreciation as the real estate boom progressed.
But these financial sector problems were enabled, if not encouraged, by developments in the global economy. The capital outflows associated with the persistent current account surpluses were large even in net terms and, combined with relatively restrained business capital spending in many advanced economies (including the United States), put downward pressure on real interest rates globally.4
From a purely theoretical perspective, there is no compelling reason to believe that low real interest rates, by themselves, pose a particular risk to global economic and financial stability, as real interest rates should be driven by underlying forces to balance the global demand for saving and investment. Capital inflows from abroad can be beneficial if they are invested prudently. But in an environment in which the financial sector is prone to excess and the supervisory structure does not respond sufficiently, the interaction of low interest rates and financial vulnerabilities can clearly be dangerous. Notably, the generally stable macroeconomic environment that prevailed before the crisis may have exacerbated this problem, as it contributed to overly sanguine perceptions of risk.
Rather than financing productive business investment, capital inflows too often facilitated spending on housing and consumer goods. This circumstance was particularly true in the United States, where an innovative and entrepreneurial financial system aggressively competed for the opportunity to channel this capital to customers, in part by devising new and complex mortgage products. The resulting availability of funds and reduced interest rates boosted asset prices, particularly in the housing sector, and market participants assumed housing prices would continue to rise.