Timothy F Geithner: Liquidity risk and the global economy Remarks by Mr Timothy F Geithner, President and Chief Executive Officer of the Federal Reserve Bank of New York, at the Federal Reserve Bank of Atlanta's 2007 Financial Markets Conference – Credit Derivatives, Sea Island, Georgia, 15 May 2007. *  *  *  Thank you for giving me the chance to join you today. Although this is a conference primarily about credit derivatives, I am going to talk about some of the broader changes we are seeing in financial and credit markets, and their implications for policy. You are meeting during a period of remarkable change and exceptional conditions in financial markets. Financial markets over the past several years have been characterized by an unusual constellation of low forward interest rates, ample liquidity, low risk premia and low expectations of future volatility. In some markets, asset prices have risen substantially, and credit growth has expanded rapidly. In credit markets more generally, spreads have declined to levels that reflect very low expectations of near term losses and credit standards have weakened. It would not be accurate to say this is a world without volatility, for we have had a series of episodes of sharp declines in asset prices and increases in volatility. But these episodes have been contained and short lived, with markets recovering relatively quickly and with little appreciable effect on global economic activity. These conditions are global in nature, though they take somewhat different forms in different markets.
And the characteristic reluctance of savers to invest outside their home market may be diminishing. Alongside these longer terms trends, financial markets today also show the effects of other forces. The extraordinary growth in earnings of energy and commodity exporters, the substantial rise in wealth that has come with rapid growth in China, India, and other emerging markets, together with efforts by many of those governments to stem the appreciation of their currencies, has led to a rise in capital flows, official and private, into the United States and other major economies. These flows seem large enough to have had a material effect on global interest rates and asset prices. These changes in economic conditions reinforce each other. The long period of relative economic and financial stability has reinforced expectations of future stability, reducing implied volatility and risk premia, increasing comfort with higher leverage, and encouraging flows of capital into riskier assets. BIS Review 49/2007  1  The low level of real interest rates that has prevailed in much of the world through this expansion has contributed to relatively accommodative financial conditions. The high levels of reserve accumulation by governments with heavily managed exchange rate regimes put downward pressure on forward interest rates, potentially distorting asset prices. The increase in size of sovereign wealth funds, the shift in assets to hedge fund and private equity managers, and the possible reduction in home bias among private savers have increased the amount of mobile capital in search of higher returns.