Has the search for efficiency made the financial world

Money does not perform. People do.

Istanbul, 13 March 2008

William R White

Head, Monetary and Economic Department

Bank for International Settlements, Basel

Has the search for efficiency made the financial world less safe?

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OverviewThe search for efficiencyAs good as it gets?Could financial imbalances lead to “headwinds”?Current financial turbulenceConclusion

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The search for efficiency

In the real economyIn financial marketsIn the conduct of monetary policy

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Efficiency in the real economy

Deregulation in industrial economiesProductivity and ITTransition economies and globalisationA disinflationary bias?

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Efficiency in financial markets

Deregulation and technologyRisk decomposition and risk managementNew products and new playersCheaper and better services

55

subtitleEfficiency in financial markets

66

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Efficiency in the conduct of monetary policy

More focus on near-term price stabilityMore reliance on market processesMore attention to communication

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As good as it gets?

Lower and less volatile inflationHigher and less volatile growthMore resilience to shocks

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Could financial imbalances lead to “headwinds”?

1, 2, 3, …?Efficiencies on the real side keep inflation downMore efficient central banks conclude all is wellMore efficient financial markets overreach and imbalances build up

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Could financial imbalances lead to “headwinds”?

Credit growthAsset pricesSectoral imbalancesHeadwinds in history

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Credit growth

Low real interest rates and the Wicksellian natural rateRapid credit growth globallyThe particular case of China

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subtitleAsset prices: bond rates and corporate spreads

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subtitleAsset prices: sovereign spreads

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subtitleAsset prices: equity

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subtitleAsset prices: real estate

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subtitleAsset prices: implied volatility

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Sectoral imbalances

Over extended consumer and household balance sheetsLarge external imbalances

2020

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Headwinds in history

Net private savingsCredit cycles and financial stress“Boom-bust” cycles in historical perspective

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Boom-bust cycles in historical perspective

Why history still mattersHistorical examplesAnd all without inflation

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Current financial turbulence: subprime as “catalyst”

Implications of the securitisation revolution for participantsImplications for the financial system as a wholeImplications for the broader economy

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Implications for participants; households

Easier and cheaper access to mortgage creditMore options, especially variable ratesIntertemporal smoothing BUTChoice requires more judgementMore exposure to market swings

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Implications for participants; originators and banks

Greater risk diversificationNormally more sources of liquidity BUTLess need for “due diligence”

Difficulties in valuing complex productsFailure to price liquidity adequately

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subtitleImplications for participants; originators and banks

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Implications for the financial system as a whole

Risk transferred to those who can manage it ORTo the most gullible and the most greedy?Everyone becomes suspectAnd the demand for liquidity soars

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subtitleImplications for the financial system as a whole

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subtitleImplications for the financial system as a whole

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Implications for the broader economy

Will current turmoil result in credit rationing?How vulnerable is the global economy?Is the global housing sector of particular concern?And what about the dollar?

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Conclusion

Current financial turbulence has deep rootsThe boy who cried wolf!How a “better” financial system can still be improvedImplications for monetary and regulatory policy

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