Even central banks can't figure out market risks now

ECB Head Warns About
'Unstable' Markets

By Gillian Tett
Financial Times, London
Sunday, January 28, 2007

http://www.ft.com/cms/s/1a94c8be-af15-11db-a446-0000779e2340,_i_rssPage=...

DAVOS, Switzerland -- Conditions in global financial markets look potentially "unstable," suggesting investors need to prepare for a "repricing" of some assets, Jean-Claude Trichet, president of the European Central Bank, said over the weekend in Davos.

The recent explosion of structured financial products and derivatives had made it more difficult for regulators and investors to judge current risks in the financial system, Mr. Trichet said. "We are seeing elements in global financial markets which are not necessarily stable," Mr. Trichet said, pointing to the "low level of rates, spreads, and risk premiums" as factors that could trigger a repricing.

"There is now such creativity of new and very sophisticated financial instruments ... that we don't know fully where the risks are located." He added: "We are trying to understand what is going on but it is a big, big challenge."

Mr. Trichet's comments reflect a debate in policymaking circles about the implications of the growth in derivatives.

Many investment bankers and some regulators and economists argued at last week's World Economic Forum in Davos that the growth of the $450,000 billion (350,000 billion euros, £230,000 billion) derivatives sector had helped reduce market volatility and made the system more resilient to shocks by spreading credit risk. But other officials fear these instruments may be raising leverage and risk taking to dangerous levels and keeping the cost of borrowing artificially low, potentially increasing the chance of financial crises.

Senior policymakers admitted it had become hard to track the risks because the sector is opaque, much activity occurs in unregulated hedge funds, and products shift rapidly across markets and between the boundaries of national central banks.

Andrew Crockett, president of JPMorgan International, said: "These new instruments ought to make markets more complete. But there is a lack of transparency ... we don't know how much leverage there is in hedge funds, for example."

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