Many bank assets are not marketable – or only became so a few years before the crisis. And where prices do exist, using their recent volatility and assuming price changes follow a normal distribution is unlikely to be reliable. Yet that is what most VAR models do (or at least did). We do have long runs of data on total incomes for economies – that is GDP. Since the value of bank assets – most of which are loans – ultimately depends upon the incomes of households and companies, variability in GDP is at least some guide to variability in their true value. Analysing changes in annual GDP for a large sample of countries over long periods reveals two characteristics: changes in annual GDP do not follow a normal distribution (they have much bigger chances of extreme movements) and the chances of big falls are much greater than the chances of big rises (there is clear downwards skew). The table below shows the proportion of occasions when annual GDP fell by various amounts in one year 3 . The sample is for around 40 (mainly developed) countries and in many cases goes back well over 100 years creating a total sample size of annual observations of around 4000. 3  For details see “What should equities and bonds be worth in a risky world”, by David Miles, Vladimir Pillonca and Melanie Baker, Morgan Stanley research paper, September 2005.
Indeed there are at least two situations where the use of capital controls and limits on gearing might not be a very effective means of maintaining financial stability, namely if either: 1.  the link between an institution’s leverage and its robustness to real (or imagined) risks to the value of its assets were very weak.....OR...  2.  there were great sensitivity of the overall cost of funding to changes in equity capital – so that requiring an institution to hold much more capital came at a very high price. If either of these things were true it would strengthen the case for using monetary policy directly to help preserve financial stability. But I think there is strong evidence that neither of these things are very likely. The only reason why a financial firm’s leverage (the ratio of assets to equity capital) would be irrelevant to robustness is if that equity were not truly loss-absorbing or if it was already so large relative to assets that the chances of losses being that great becomes virtually zero. But in fact bank equity capital that is truly loss absorbing has been 10% or less for most banks, and generally a great deal less. That is certainly not so high that chances of losses this big are of negligible probability. Value-at-Risk (VAR) models might have suggested otherwise. But those models have weaknesses that reflect the difficulty of accurately assessing risks. Assessing the probabilities of losses on bank assets is not easy.