Depression Economics in a Nutshell by Brad DeLong

Historically, we have had three types of excess demand for finance that have produced big downturns in economies.

In 2002 there was an excess demand for bonds and so logically there was less demand for currently produced goods and services. Brad doesn't say it, but that was in the aftermath of the Tech Bubble crash. He writes that in 2008 there wasn't excess demand for bonds because they are still cheap. They would be expensive if there was an increased demand.

Second is excess demand for liquid cash money.

It is possible to tell when there is monetarist downturn: since everybody is trying to build up their stocks of liquid cash money, everybody is selling their other financial assets and thus their prices--stocks, bonds, whatever--and all their prices are low. That is not the kind of downturn we have today: today the prices of some financial assets--the liabilities of credit-worthy governments, for example--are very high.

Third is an excess demand for safety after the housing bubble popped and the ensuing panic.

We conclude that the excess demand in financial markets right now on the part of investors is an excess demand for safety: for high quality AAA-rated assets for people that hold in their portfolios. Prices of risky financial assets are low--there is no excess demand for them. Prices of safe financial assets are high--there is an excess demand for them.

Thus businesses and households have cut back on their spending on currently-produced goods and services as they all have concluded: "We don’t have enough safe assets in our portfolios. We need to stop spending so much until we build up our holdings of safe assets to a higher level." And the fact that they cannot do so because there is a shortage of safe assets in the economy is what is keeping us wedged in this current situation of high unemployment and low capacity utilization.

Where did this excess demand for safe assets come from?

It came as a consequence of the deregulation of finance and of the securitization of mortgages, from the housing bubble and the crash, from the fact that then it turned out that investment banks that had created brand new derivative securities based on mortgages had not originated-and-distributed them but had, to a remarkable and astonishing degree, originated and kept them. They were supposed to sell off all the pieces o[f] real estate risk in small bundles to savers all over the world. They did not.