Policy lessons from the recent financial market turmoil

Speech by Mr Hervé Hannoun, Deputy General Manager of the BIS at the XLV Meeting of Central Bank Governors of the American Continent Ottawa, 8-9 May 2008.

Abstract

The key features of the recent financial market turmoil can be summarised as excessive and hidden leverage, excessive complexity, and imprudent financial alchemy. Though the turmoil was not entirely surprising - the repricing of credit risk had indeed been envisaged by many observers before it occurred - what did come as a surprise was the securitisation crisis and its spillover to the money markets. This resulted from the three main ingredients that in the years 2000-07 had led to global credit excesses: first, accommodative monetary policies; second, large global imbalances and forex reserve accumulation; and third, rapid financial innovation.

In general, observers are divided into two groups when assessing the underlying causes of the current financial turmoil. The first type of explanation observers come up with is the general macrofinancial explanation: the turmoil is seen as the long-run consequence of the easy global money and credit conditions that prevailed, particularly from early 2002. The second type of explanation is the idiosyncratic or microfinancial explanation: the turmoil is the result of shortcomings in specific types of financial products and entities that have come into being in recent years.

What should policymakers have done to avoid the recent global financial turmoil? And what should be done, looking forward, to avoid the repetition of the serious financial excesses that we have seen? There are three schools of thought on the crucial question of "what is preventable", and the lessons from the current turmoil can help us analyse the respective merits of these different approaches. A key lesson, at least for the central banking community, is to consider developing a macrofinancial stability framework in supervisory and monetary policymaking, as an alternative to the "serial bubbles" that we have experienced over the past 10 years.