What factors lead to overheating episodes in credit markets ?

The recent speech by Jeremy Stein a Federal Reserve Governor brought on board just last year,received a lot of  http://wp.me/pc3rd-1gkattention for its suggestion that monetary tools might be used in addressing credit market-overheating. That is an interesting argument, but I don’t want to deal with that today. Rather, I want to look at Stein’s comments on collateral transformation:

Collateral transformation is best explained with an example.

Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral must Continue reading “What factors lead to overheating episodes in credit markets ?”