Risk accumulated in institutions that operated at the margin of the explicit safety net, such as mortgage affiliates of thrifts, structured investment vehicles and the GSEs. These changes within U.S. financial markets were complemented by a rise in global financial integration as technology and deregulation made it easier for savings to flow across international borders. As a consequence of this basic evolution of our financial system, a large share of financial assets ended up in institutions and vehicles with substantial leverage, and in many cases these assets were being funded with short-term obligations. And just as banks are vulnerable to a sudden withdrawal of deposits, these non-banks and funding vehicles are vulnerable to an erosion in market liquidity when confidence deteriorates and concerns about default risk increase. These changes in the structure of the financial system were probably not the only causes of the financial boom that preceded this crisis, but they may have amplified the dimension of the boom and they were important to how the crisis unfolded and to how policy has responded. In many respects, financial innovation over this period outpaced the system’s capacity to measure and limit risk, to manage the incentive problems in the securitization process and to provide for an appropriate degree of transparency through meaningful disclosure. Once the performance of the underlying assets began to deteriorate, these weaknesses in the system magnified the uncertainty about the scale of potential losses and added to the intensity of pressures that accompanied the crisis.
The debate about putting more activity through central counterparties is an example. Frankly, it could have taken place a decade ago, and it is a crying shame that it didn’t. The reason it didn’t was that no one came into work thinking that it was their job to think about that and that they had a responsibility for taking a system wide perspective and actually doing something. 2  See Tucker, P M W (2010), “Shadow Banking, Financing Markets and Financial Stability” at BGC Partners Seminar, London, January 2010. 4  BIS Review 145/2010  Institutions are now being created around the world – the Financial Stability Oversight Council in the US, the Systemic Risk Board in the EU, the Financial Policy Committee in the UK – which I earnestly hope will bring that kind of perspective to our work. And the final area is leaning against the credit cycle when it threatens stability. The zeitgeist embraced the seductive idea that either there wasn’t a bubble or if there was a bubble that there was nothing you could do about it. Which was dangerous nonsense, as events have proved. This is not about fine tuning the credit cycle. But we do need to be prepared to take the punchbowl away before the party gets completely out of control. That was the view 50 years ago. Forward to the past.