Monday, June 25, 2007

BIS: Years of loose monetary policy has fueled a dangerous credit bubble

A report from the Telegraph. “The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy has fueled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.”

“Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and Southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived", said the bank.”

“In a thinly-veiled rebuke to the US Federal Reserve, the BIS said central banks were starting to doubt the wisdom of letting asset bubbles build up on the assumption that they could safely be cleaned up’ afterwards - which was more or less the strategy pursued by former Fed chief Alan Greenspan after the dotcom bust.”

“It said this approach had failed in the US in 1930 and in Japan in 1991 because excess debt and investment build up in the boom years had suffocating effects.”

The bank said it was far from clear whether the US would be able to shrug off the consequences of its latest imbalances, citing a current account deficit running at 6.5pc of GDP, a rise in US external liabilities by over $4 trillion from 2001 to 2005, and an unprecedented drop in the savings rate. ‘The dollar clearly remains vulnerable to a sudden loss of private sector confidence,’ it said.” read article >>

From Bloomberg: “Other risks facing banks include the potential for a ‘weakening in household spending,’ the report said. The possibility of a slump in real estate markets remains ‘a significant risk to financial stability,’ while the growth in securitization has spread ‘direct and indirect’ risk across the financial system, the BIS said.”

“‘Who now holds these risks, and can they manage them adequately?’ the report asked. ‘The honest answer is that we do not know.’”

“‘Hedge funds might be most exposed, since many have tended to specialize in purchases of the riskiest sorts of these instruments,’ the report said.”

“The BIS said it was unclear whether the collapse in U.S. subprime mortgages would spill over into other markets. Investors are increasingly concerned about how the decline will affect the values of collateralized debt obligations, securities that package other debt such as subprime loans, the bank said.”

“‘Exactly where in the CDO market the risks posed by subprime and Alt-A mortgages are concentrated is difficult to measure,’ the bank said...” read article >>

About BIS

The Bank for International Settlements (or BIS) is an international organization of central banks which exists to foster cooperation among central banks and other agencies in pursuit of monetary and financial stability. It carries out its work through subcommittees, the secretariats it hosts, and through its annual General Meeting of all members. The BIS also provides banking services, but only to central banks, or to international organizations like itself. Based in Basel, Switzerland, the BIS was established by the Hague agreement of 1930

BIS 77th Annual Report (24 June 2007)

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