Summing up by the Chairman

Directors noted that global fi nancial stability has endured a diffi cult period since the publication of the April 2007 Global Financial Stability Report (GFSR). Overall, fi nancial risks have risen and markets are continuing to experience bouts of turbulence. Directors agreed with staff that, while there has been some calming in certain respects, markets generally remain unsettled, and credit conditions may not normalize soon. Against this background, Directors welcomed the GFSR as providing a clear, well-focused, and timely analysis of the recent market turbulence. They broadly concurred with the report’s insights regarding the causes and consequences of the recent episode of turmoil, and felt that the report presents a balanced assessment of the primary areas of concern and the potential policy responses. Directors continued to view the staff’s use of the global fi nancial stability map as useful, allowing them to track the deterioration in risks and conditions more concretely. Directors noted that the threat to fi nancial stability has been most evident in the money markets that provide short-term fi nancing. At the heart of the diffi culties in these markets was a funding mismatch whereby medium-term, illiquid, hard-to-value assets, such as structured credit securities, had been fi nanced by shortterm money market securities—often assetbacked commercial paper. When these asset values were threatened by a rise in delinquencies and ratings declined, short-term funding for those holding these assets became more diffi cult to obtain. For some entities, especially some conduits and special investment vehicles, investors became uncomfortable holding the commercial paper that was supporting these illiquid, hard-to-value assets. For others, such as hedge funds, this forced a deleveraging process, once their prime brokers balked at providing additional funding and insisted that more collateral be posted at lower values. Directors noted that, in the recent situation of market turbulence, various central banks had moved quickly to provide liquidity—both in the overnight market, but also at longer maturities. Despite signifi cant injections of liquidity, market participants remain uncertain about their counterparties’ condition, and are thus reluctant to onlend. Directors agreed with staff that there are potentially a number of other reasons why funding markets had not functioned normally— including the possibility that large banks have experienced an increase in their balance sheets in the form of structured credit securities or loans associated with leveraged buyouts. In such circumstances, it remains to be seen how effective lower interest rates will be in stemming pressures in money markets, and how policymakers will balance medium-term infl ation objectives against nearer-term threats to fi nancial stability. Some Directors cautioned that care will be needed to avoid moral hazard, including by ensuring that central banks focus on addressing general disorderly markets, rather than taking on credit risk or favoring certain institutions. Directors commended the staff for its analysis of the various issues raised by the turbulence, including the implications of the potential losses, their distribution, and their wider impact on the fi nancial system of developments in U.S. The following remarks by the Acting Chair were made at the conclusion of the Executive Board’s discussion of the Global Financial Stability Report on September 14, 2007.