Tuesday, June 19, 2007

Credit Market Doomsday #3

First the BBC, then the Wall Street Journal, and now with Bloomberg the central bankers are meeting soon to discuss issues concerning the low risk premiums.

With hedge funds and private equity firms pumping record sums of money around the world economy, central bankers fret that investors are taking on too much risk. As a result, the bankers are increasingly turning to the Basel, Switzerland-based BIS (Bank of International Settlements), the oldest international financial institution, for research and advice, and to coordinate damage-control plans.

The ``central banks' central bank'' now performs many of the functions of a monetary authority, churning out research on everything from derivatives to inflation-targeting. It also holds about 6 percent of central banks' currency reserves on their behalf.

``Funds are flowing across the world with unbelievable speed, and central bankers feel they are in uncharted territory,'' Meyer said. ``Central bankers want to talk to each other about this, and the BIS is the best vehicle.''

While market blowouts such as the Asian crisis of 1997 are always hard to spot in advance, policy makers say, the increasing popularity and complexity of the derivatives used by investors to hedge their bets are making the task even tougher.

Fed Bank of New York President Timothy Geithner argues that the danger that new crises will be harder to manage should be the ``principal preoccupation'' of central bankers.

The agenda for this year's annual meeting may already have been set by a report published last month. The Financial Stability Forum, which is based at the BIS and brings together regulators and central bankers, argued that hedge funds should ``enhance sound practice'' methods for improving risk management and preventing potential shocks to the international financial system.

Investors' perception of risk is near historic lows. The gap between the yield demanded by investors to hold high-yield, high- risk U.S. corporate debt and government bonds fell to the lowest ever on June 5. European companies have borrowed a record $284.7 billion in loans and bonds rated below investment grade since the start of the year.

Growing concern about the extent of investors' risk-taking comes as a global cash glut swamps the ability of central bankers to set policy. . . .

``The problem is that you will inevitably end up fighting the last war,''

This is commonly the problem with a financial crisis.

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