Low interest rates, for example, can contribute to the build-up of  4  On this, see the discussion in Robert Shiller (2000), Irrational Exuberance, Princeton University Press. 5  This has been convincingly argued by Christina Romer (1990), “The Great Crash and the Onset of the Great Depression”, Quarterly Journal of Economics, 105(August), 597–624  6  As quoted in John Lewis Gaddis (2005), The Cold War: A New History, Penguin Press. BIS Review 158/2010  3  financial imbalances via the so-called “risktaking” channel. 7 Simply put, very low interest rates may create incentives for banks to take on more risks. Recent research has provided empirical evidence compatible with such a notion. It has been documented, 8 for example, how market based measures of bank’s risks as perceived by financial market participants tend to react positively to changes in interest rates, so that a lower interest rate leads investor to perceive banks as less risky. By the same token, several papers 9 have shown that credit standards are correlated with the level of interest rates: lower interest rates, in particular, imply lower credit standards including to customers who are perceived as representing a higher credit risk. On the theoretical side, research done at the Banque de France 10 has shown that, when the regulatory environment is not transparent, a decrease in the level of real interest rate increases banks’ risk-taking behavior, in parts because it may facilitate the under-pricing of risks typical when asset prices rise.
They have also been the focus of testimony before a number of committees in Congress, including Secretary Geithner and Thomas Baxter’s January 27,  4  BIS Review 73/2010  2010 testimony before the House Oversight and Government Reform Committees. A summary of the salient facts, however, follows. As part of the November 2008 restructuring, Treasury invested $ billion in newly issued Senior Preferred Stock of AIG under its TARP authority. 2 In connection with that investment, the Federal Reserve modified the terms of the Fed Facility to be more sustainable: The maturity of the Fed Facility was extended to five years (due 2013), the maximum amount available was reduced from $ billion to $ billion, and the interest rate and commitment fees were reduced. The Fed Facility remained secured by substantially all of AIG’s assets, and the company continued to be required to apply proceeds of asset sales to permanently repay any outstanding balances under the facility. At the same time, the Board approved the establishment of an additional lending facility that would provide a permanent solution to the AIG securities lending program’s losses and liquidity drains, thus eliminating the need for the Securities Borrowing Facility. Under the new facility, the New York Fed extended approximately $ billion in secured, non-recourse credit to a special purpose limited liability company, Maiden Lane II, in which AIG would hold a $ billion first-loss position. Maiden Lane II then purchased, at market prices, RMBS with a par value of $ billion from certain AIG domestic insurance company subsidiaries.