Trichet pins blame for market turmoil
Thursday, May 15 15:01:57
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(BizWorld)
European Central Bank President Jean-Claude Trichet said a lack of transparency is one of the main causes of the financial market turmoil of the past nine months.
‘The present turbulences have, once more, demonstrated that opacity regarding the stance of markets, financial instruments or financial institutions is a recipe for catastrophe,’ he said in a speech.
‘In the prelude to an episode of uncertainty and turbulence, absence of transparency inevitably triggers contagion and negative herd behaviour - we saw this at the heart of the Asian crisis, we very much also see it at the heart of the present episode,’ he said.
Trichet said the absence of pertinent, credible and reliable information drives market participants to assume the worst possible hypothesis on the position of financial institutions and instruments and to act accordingly.
He said it is essential to increase transparency as an insurance policy against irrational herd behaviour and unjustified contagion in times of stress.
Trichet said market participants last summer received a rude awakening from a false sense of security engendered by the upward spiralling of asset prices, further leveraging, increasing product complexity and shrinking transparency.
He said a constellation of three broad factors already individually known to market participants and policymakers explained the sharpness and speed of the contagion from the U.S. subprime mortgage market to unrelated market segments.
‘These factors are an abundance of liquidity that underpinned a build up of leverage in the financial system, an increasingly interwoven and complex financial system the growth of which was fed by financial innovation, and some financial agents’ incentives that were aligned against prudent practices,’ he said.
He said the abundance of liquidity led to an increasingly aggressive ‘hunt for yield’ which was reflected in a surge in demand for highly complex financial products. And as in previous such episodes, there was a sudden recognition and recoil from underlying credits whose quality had actually been worsening for years.
This was compounded by greatly increased linkages within the financial system compared with a decade ago, and by incentives to generate fees and short-term apparent profits, he said.
‘The ‘shadow banking system’ that rapidly emerged as an (outgrowth) of the formal banking sector unlike its better understood and regulated sibling rested on a poorly understood system of credence – provided by rating agencies – and the false perception that the only way for asset prices was upward,’ he said.
Trichet said the turbulence of the past year represents the first ‘real magnitude’ stress test for today’s global financial system.
‘In retrospect, the shock to the global financial system following the burst of the internet bubble was, all things considered, relatively modest,’ he said.
Couldn’t help jumping the gun a year.