Bank of England Warns of Potential "System-wide Stress"
The latest Bank of England Financial Stability Report, issued on April 26, warns that "ever riskier lending practices," including everything from derivatives, to the bundling and resale of loans, and issuing of "sub-prime" loans in every sector, has "potentially increased the vulnerability of the [global financial] system as a whole...to an abrupt change in conditions." The report points to "recent developments in the U.S. sub-prime mortgage market" as a mild taste of what could happen, should "more significant" markets, such as corporate credit, be hit by similar drops in liquidity.
As John Gieve, the bank's Deputy Governor for Financial Stability, put it in the press statement announcing the release of the report: "Risk-taking is increasing, including through higher leverage, lower margin requirements and relaxation of covenants. The rapid growth in credit risk transfer markets is also making more participants dependent on continuous market liquidity and could amplify the impact of shocks like a sharp reversal in credit spreads from their current low levels." Sharp language, for a banker.
Across the Atlantic, U.S. Treasury Under Secretary for Domestic Finance, Robert Steel, told a Manhattan Institute forum taking place on the same day, that the Bush administration believes that government regulation of speculative hedge funds would increase "moral hazard." Steel gave the twisted argument that government regulation would "communicate a sense of confidence in the actual product, which, by definition, is more risky, illiquid and has more flexibility than the average person should embrace," and it might encourage the average person to put their money into hedge funds.
Steel, who like Treasury Sec. Henry Paulson was a top executive at Goldman Sachs before moving over to Treasury, didn't mention that in the past few years, pension funds, university endowments, and the like, have been moving "the average person's" money for them into these "risky and illiquid" speculative funds, which the Bank of England now admits can blow out at any time.
