There is, of course, a circularity involved, since liquidity depends on valuation, fair value must be based on a market price, and the ability to price an asset itself depends on sufficient liquidity in the market. The difficulty to get out of this circularity in periods of stress is currently creating significant uncertainty. o  Hence a dependence of the whole market on the rating process. In a securitized world, investors heavily rely upon rating agencies to provide information about the risks attached to various instruments. These agencies have been strongly criticized recently. It is not my purpose to enter into any blame game. Suffice it to say that there has been a deep misunderstanding between investors and rating agencies as to the scope and true meaning of ratings. Most investors were not fully aware that rating did not encompass liquidity risk; nor did they realize that ratings for structured products were intrinsically more volatile than for more simple "plain vanilla" securities. The use of identical metrics for rating what are fundamentally different categories of assets certainly did not help and may have contributed to the confusion. o  Finally the turmoil has revealed the fragility of off-balance sheet structures and vehicles which underpinned securitization. Conduits, especially SIVs, were not built to absorb shocks. Their relationships with sponsor banks are sometimes very ambiguous.
Christian Noyer: Some thoughts on current financial turbulences Speech by Mr Christian Noyer, Governor of the Bank of France, at the Euro Fixed Income Forum, Paris, 4 December 2007. *  *  *  These are difficult times for policy makers. Financial turmoil has created macro economic uncertainties. Events are still unfolding. In those circumstances, I thought best to have a look at the dynamics driving recent turbulences; then describe potential consequences for the economy; finally make remarks on challenges for Central Banks and best ways to preserve and restore international financial stability. The dynamics of the crisis •  I will start with a paradox. By any measure, we are facing a huge shock in financial markets. Spreads in some segments of credit markets have widened with unprecedented speed and volatility. Even more significantly, interbank markets in large industrial countries have been severely disrupted, for the first time in fifty years, more disrupted in fact, and for a longer period, than after September 11, 2001. •  And yet, the losses themselves, while significant and spectacular for some institutions, would not seem to pose a major risk to the health of the financial system. Current median estimates put the direct cost of subprime defaults around 250 billions USD. This is a little less than one year of profits for the 40 major financial institutions in the world. Most notably, the turbulences occurred in a very favorable macro economic environment. Why is there such a disproportion between the cause and the effect?