This point was already raised almost ten years ago by Miller et al. (2001), who argued that eliminating  3  4  See, for example, Acharya and Naqvi (2010). BIS central bankers’ speeches  downside risk of asset prices feeds the bubble, so more bubbles were not only the result of irrational exuberance but was also “exaggerated by the faith in the stabilizing powers of Mr. Greenspan.” Regarding the second question, on the instruments for financial stability, this is what has been termed macroprudential tools, as opposed to the microprudential regulation, which targets the health of specific financial institutions. One of the first tools used for financial stability was the dynamic provisions to housing loans implemented in Spain in 2000. It is still too early to have a full evaluation of this instrument, since it did not avoid a housing bubble, many small institutions dedicated to housing finance, the “cajas”, went bust during the crisis, but the overall Spanish financial system fared well through it all. On the time dimension, the idea of macroprudential tools is to avoid the buildup of financial vulnerabilities in the upturn of the business cycle, and to have a cushion for the downturn. Financial systems tend to be procyclical, and hence some break system should be implemented to avoid excessive risk-taking. This has been underlying the new rules in Basel III, especially in the definition of the countercyclical buffer of new capital requirements.
This resulted in rising allocation to the bonds of countries with increasing debt. The risk linked to this strategy became clear in the wake of the financial crisis. A reallocation of government debt on the basis of GDP weights will reduce this risk. Moreover, we have started investing in government debt issued by emerging countries. The consequence of this is a reduction in the Fund’s European holdings. Increased demand for the safest government bonds may be regarded as an adjustment to the climate of high spreads and volatility that we have witnessed in recent years. In a market environment characterised by general uncertainty, market expectations might cause a slight increase in risk premiums to mount rapidly, unless the underlying cause of the increased risk premiums is dealt with by the relevant authorities. To sum up: a downweighting of Europe, the introduction of GDP weights as the basis for asset allocation, and increased risk premiums of certain bonds have all contributed to our present positions. During the past year, the Fund has reduced its exposure to some European government bonds, most notably Italian and Spanish bonds. Slide 15: Risk has many facets Credit risk is not the only risk attracting attention in portfolio management. It is our view that unequal treatment of investors during the restructuring of Greek government debt in March this year, contributed to increase European risk premiums.