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The challenge ahead lies in preventing the system from feeding on itself through a spiralling process of leveraging, ECB President Jean-Claude Trichet said in
Three broad factors reinforced one another in a way that almost nobody could have foreseen, Trichet said outlining the factors underlying the recent financial market turbulences.
The driving force behind the substantial rise in financial leverage was a significant excess of savings over investment in the global economy which, in time, drove an increasingly aggressive “hunt for yield”, he explained. Furthermore, the evolution of the financial system seeded the fragility that later materialised in the unprecedented speed and reach of contagion during the unwinding of leverage. Finally, the emerging “shadow banking system” 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.
“Most remarkably ex-post, the “shadow banking sector” did not have to set aside capital against the risk of things going wrong, as eventually they did when euphoria turned into sobriety”, Trichet said.
He welcomed the international cooperation and the co-ordinated work at the EU level that aim at strengthening the supervisory and financial stability arrangements. “The present episode of turbulence is a global phenomenon”, he said, “and thus only a global response can be effective.”