A large portion of securities investment from China went to U.S. Treasuries and agency debt markets (Chart 7),3 contributing to the decline not only in interest rates but also in their volatility (Chart 8). The sustained volatility decline after 2004 was remarkable, and likely contributed to the perception of declining risk, thereby encouraging the risk taking that turned out to be excessive after all.
However, this so-called “savings glut” argument cannot explain why risk taking accelerated exactly in 2004, since the savings glut emerged well before 2004. What happened exactly in 2004? This question leads us squarely to the regulatory changes in the United States in 2004.