The government of Australia would get reports like this before they hit the news! These are VERY risky times and times that the RIGHT calls WILL be made or else Australia's economy will suffer.
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Dangers of complacency worry BIS
By Gillian Tett and Chris Giles in London
Published: June 27 2005 20:25 | Last updated: June 27 2005 20:25
The vast market for debt insurance could “conceivably disappear”, creating widespread market disruption, if investors suddenly became far more risk-averse or there was a sharp rise in corporate defaults, the Bank for International Settlements said on Monday.
While this alarming scenario did not seem imminent, the BIS warned investors not to draw too much comfort from the fact that the credit derivatives market survived last month’s downgrade of General Motors and Ford relatively well.
“[This market reaction in May] may not be a true reflection of how these markets would function under stress,” the BIS warned, pointing out that the GM and Ford downgrades had been widely predicted, whereas a bigger market disruption due to a macro-economic dislocation could cause far more damage.
The BIS annual report shows an organisation seeking to counter a false sense of security after a period of economic gain unseen for nearly 30 years. A sense of complacency has been matched by an unwillingness among policymakers to resolve tensions in international financial markets.
As the world’s oldest international financial organisation, the BIS has a justified reputation for conservatism and concern about impending problems. But the list of potential vulnerabilities and the language the authors deployed in the report’s concluding chapter highlight the BIS’s mounting concerns about global financial fragility.
The BIS said a further decline of the US dollar was almost inevitable and warned that this could be rapid and disorderly.
The comments mark an unusually clear sign of the rising unease felt by international regulators about potential risks posed by the recent explosion in credit derivatives. The BIS stressed that this extraordinary expansion had brought benefits to the global financial system, most notably by permitting risk to be spread between numerous investors.
This could conceivably make the financial system more resilient in cases of a market shock. However, what has raised concern at the BIS is a sharp increase in the complexity of credit derivative products being traded in the past couple of years.
This is making it hard for regulators to predict how markets might react in the event of a macro-economic or corporate shock. It may also mean that investors do not fully understand what they are purchasing in areas such as collateralised debt obligations (CDOs) – or pools of debt-linked securities.
The covenants on many CDO contracts can be difficult to comprehend and deal complexity has posed many modelling challenges . . . progress still needs to be made in understanding the nature of portfolio loss distributions, the profile of CDO tranches and their sensitivity to credit risk correlations,” the report said.
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