Stability in the elemental sense I have described was profoundly threatened last autumn – when the universal crisis of confidence triggered by Lehmans’ failure tore the fabric of international commerce. That stability has been sustained owes everything to governments stepping in, effectively being prepared to borrow from the future in order to prop up the banking system now. In that sense, we are, of course, “beyond Financial Stability”, insofar as, ordinarily, we would regard instability as a state of affairs that requires such support. The Turner Report rehearses the analysis of how we got to that point. It rightly places weight on the baleful effects of persistent and cumulative global current and capital account imbalances. I dearly wish that the international authorities had taken on board the lessons from the 1990s EME crises about the vital importance of monitoring, and where necessary managing, national balance sheets – for large countries as well as EMEs. It is striking, however, that other analysts, including recently from the IMF, are starting to play down the part played by the international monetary system. I do not go along with that. There can  BIS Review 39/2009  1  surely be no disputing that macroeconomic imbalances have mattered greatly to the crisis, as they contributed to the build up of debt and, through the compression of risk-free rates and risk premia, the appreciation of asset prices. But in acknowledging that, we do not have to claim that of themselves such imbalances lead inevitably to financial instability.
Further, supervisors should be vigilant in ensuring that banks’ so-called “treasury” or “liquidity” portfolios are not concentrated in funding instruments, such as FRNs, issued by other banks. That turns out to have been all too prevalent. And they were not liquid when the music stopped. Years ago, regulators decided to deduct banks’ holdings of each other’s capital-instruments, to avoid the system as a whole generating illusory capital. The same principle could perhaps apply in liquidity regulation. The authorities also need to be clear about what level of stress, and/or what proportion of short-term liabilities, the stock liquidity buffer must cover. That must be a judgment for the authorities; and it must, as the Turner Report makes clear, be more demanding than in the past. But just as important, we must not imagine that the kind of modelling that can be applied to, say, credit risk and, perhaps, to some types of market risk can sensibly be carried across to liquidity risk. Liquidity goes wrong when there is, in the jargon, strategic interaction: I run (or sell) because I think you will etc. Liquidity buffers need to sustain confidence; if successful, the buffer is never needed. A time series of data showing low use of a liquidity buffer is not compelling evidence that a requirement was too high. Our successors must remember that in 10-20 years time. Of course, no liquidity buffer can be proof against all circumstances. Which is why central banks are in the business of providing liquidity insurance to the system.