Monitor the leverage cycle

John Geanakoplos is someone you don't hear much about in the mainstream media.  He is an economist, James Tobin Professor of Economics, at Yale and also a partner in a firm that trades primarily in mortgage securities.  He has a different idea about the financial crisis than most economists in the public eye.  Geanakoplos thinks the fundamental problem is leverage.

In his words: 

There are times when leverage is so high that people and institutions can buy many assets with very little money down and times when leverage is so low that buyers must have all or nearly all of the money in hand to purchase those very same assets. When leverage is loose, asset prices go up because buyers can get easy credit and spend more. Similarly, when leverage is highly constrained, that is, when credit is very difficult to obtain, prices plummet. This is what happened in real estate and what happened in the financial markets.

The collateral rate is the value of collateral that must be pledged to guarantee one dollar of loan. Today, many businesses and ordinary people are willing to agree to pay bank interest rates, but they cannot get loans because they do not have the collateral to put down to convince the banks their loan will be safe.

Geanakoplos believes that the Fed should monitor the leverage cycle as much as it monitors interest rates.  Yet, there really is no meaningful monitoring of the leverage cycle.  He makes a strong case that there should be and proposes how it could be monitored.

A very interesting thesis.