Greenspan never understood the distortions in credit allocation the risk weighted capital requirements for banks caused
Fed chairman Alan Greenspan in January 2004 said: “There are several developments, however, that I find worrisome…The first is that yield spreads continue to fall. As yield spreads fall, we are in effect getting an incremental increase in risk-taking that is adding strength to the economic expansion. And when we get down to the rate levels at which everybody is reaching for yield, at some point the process stops and untoward things happen. The trouble is, we don’t know what will happen except that at these low rate levels there is a clear potential for huge declines in the prices of debt obligations such as Baa-rated or junk bonds.”
This is clear evidence Greenspan did not understand much of the distortions produced by the risk weighted capital requirements for banks.
The reality was that as “yield spreads continue to fall” banks reached out for those yields with which they could most leverage their equity with; not “Baa-rated or junk bonds” but AAA rated securities.
Bonds perceived ex ante as junk never ever signify a danger to the bank systems
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