The Rt Hon Sir Edward George: Global economic recovery - where to from here? Speech by The Rt Hon Sir Edward George, Governor of the Bank of England, at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London, Mansion House, 26 June 2002. *  *  *  My Lord Mayor, Mr Chancellor, my Lords, Aldermen, Mr Recorder, Sheriffs, Ladies and Gentlemen. On this great annual occasion last year I spoke about the problems that confronted us in keeping the UK economy on course in the face of the cold winds blowing from abroad. I drew attention to the risk that in seeking to avoid being sucked down into the Charybdis of adverse external influences, by lowering interest rates in this country, we could find ourselves thrown onto the Scylla of excessive domestic exuberance. In the event, the cruel terrorist attacks on New York and Washington on September 11th - had a damaging short term impact on economic conditions everywhere. We were drawn irresistibly towards Charybdis despite the resilience of domestic consumer demand, which we sought to sustain by steering towards Scylla, with further reductions in interest rates. The economy as a whole became becalmed over the winter. That of course, was disappointing after 37 successive quarters of relatively steady growth. But the economy as a whole still managed to grow in the year to the first quarter - by 1% on the present data which was somewhat faster than in a number of other G7 countries.
This increase in yields did not solely reflect an increase in credit risk; it also reflected a genuine loss of confidence and an accompanying increase in risk aversion. Yield spreads on even the very safest ABS obligations soared hundreds of basis points. This can be seen in the fact that AAA-rated student loan tranches, with underlying loans 97% guaranteed by the federal government, climbed to yield levels as much as 400 basis points over LIBOR. With the spike in yields, the economic incentives to issue evaporated – issuance was just too costly and there was no active market. After averaging around $ billion per quarter of new originations in 2007 and the first three quarters of 2008, consumer ABS issuance plunged to only $ billion during the fourth quarter of 2008. Issuance of commercial mortgage backed securities ground to a complete halt and this market currently remains closed. So why did the ABS market collapse? There are many reasons. One factor was that in some areas, the risk management incentives of banks and other issuers of ABS were misaligned with those of the end investors in these securities. This misalignment manifested itself in the overall deterioration in lending standards that took place across the economy beginning during the middle part of this decade. Some originators did not do an adequate job of due diligence because the underlying loans were swiftly moved off their balance sheets through the securitization process.