Thanks kathy! that led me right to it...compare this with the speech tonight!! Nevermind, I wouldn't ask anyone to do that!!!
Well trust me, very similar in tone. remember...$hit happens! That's all he's saying.
Excerpts from that speech....
Modern quantitative approaches to risk measurement and risk management
take as their starting point historical experience with market price
fluctuations, which is statistically summarized in probability
distributions. We live in what is, for the most part, a stable economic
system, where market imbalances that produce unusual outcomes almost
always give rise to continuous and inevitable moves back toward
longer-run equilibrium. However, the violence of the responses to what
seemed to be relatively mild imbalances in Southeast Asia in 1997 and
throughout the global economy in August and September of 1998 has
illustrated yet again that the adjustments in asset markets can be
discontinuous, especially when investors hold highly leveraged positions
and when views about long-term equilibria are not firmly held.
Enough investors usually adopt strategies that take account of longer-run
tendencies to foster the propensity for convergence toward equilibrium.
But from time to time, this process has broken down as investors suffer
an abrupt collapse of comprehension of, and confidence in, future
economic events. It is almost as though, like a dam under mounting water
pressure, confidence appears normal until the moment it is breached.
Risk aversion in such an instance rises dramatically, and deliberate
trading strategies are replaced by rising fear-induced disengagement.
Yield spreads on relatively risky assets widen dramatically. In the more
extreme manifestation, the inability to differentiate among degrees of
risk drives trading strategies to ever-more-liquid instruments so
investors can immediately reverse decisions at minimum cost should that
be required. As a consequence, even among riskless assets, such as U.S.
Treasury securities, liquidity premiums rise sharply as investors seek
the heavily traded "on-the-run" issues--a behavior that was so evident
last fall.
History tells us that sharp reversals in confidence happen abruptly, most
often with little advance notice. These reversals can be self-reinforcing
processes that can compress sizable adjustments into a very short time
period. Panic market reactions are characterized by dramatic shifts in
behavior to minimize short-term losses. Claims on far-distant future
values are discounted to insignificance. What is so intriguing is that
this type of behavior has characterized human interaction with little
appreciable difference over the generations. Whether Dutch tulip bulbs or
Russian equities, the market price patterns remain much the same.
We can readily describe this process, but, to date, economists have been
unable to anticipate sharp reversals in confidence. Collapsing confidence
is generally described as a bursting bubble, an event incontrovertibly
evident only in retrospect. To anticipate a bubble about to burst
requires the forecast of a plunge in the prices of assets previously set
by the judgments of millions of investors, many of whom are highly
knowledgeable about the prospects for the specific companies that make up
our broad stock price indexes.
If episodic recurrences of ruptured confidence are integral to the way
our economy and our financial markets work now and in the future, it has
significant implications for risk management and, by implication,
macroeconomic modeling and monetary policy.
Probability distributions that are estimated largely, or exclusively,
over cycles excluding periods of panic will underestimate the probability
of extreme price movements because they fail to capture a secondary peak
at the extreme negative tail that reflects the probability of occurrence
of a panic. Furthermore, joint distributions estimated over periods
without panics will misestimate the degree of correlation between asset
returns during panics. Under these circumstances, fear and disengagement
by investors often result in simultaneous declines in the values of
private obligations, as investors no longer realistically differentiate
among degrees of risk and liquidity, and increases in the values of
riskless government securities. Consequently, the benefits of portfolio
diversification will tend to be overestimated when the rare panic periods
are not taken into account.
As we make progress, hopefully, toward understanding asset-pricing
mechanisms, we need also to upgrade our insights into the effect of
changing asset values on GDP--the so-called wealth effect.
Although many aspects of this issue deserve attention, let me cite a few
open questions of particular importance. Efforts to differentiate between
realized and unrealized gains, and the propensity to leverage both, may
afford a deeper understanding of the consequences of asset price change.
And differentiating between gains that arise from enhanced profitability
and those that reflect changes in discount factors may also be useful.
The former may be more likely to be sustained, given the tendencies of
discount factors to revert back to historic norms.
Moreover, it is evident that borrowings against capital gains on homes
influence consumer outlays beyond the effects of gains from financial
assets. Preliminary work at the Federal Reserve suggests that the
extraction of equity from housing has played an important role in recent
years. However, stock market values and capital gains on homes are
correlated and, hence, their separate effects are difficult to identify.
This is an area that clearly warrants further examination.
Finally, in the business sector, questions remain about the influence of
equity prices on investment spending. In particular, Do all equity price
movements--whether related to fundamentals or not--have the same effect
on investment spending?
In conclusion, the issues that I have touched on this morning are of
increasing importance for monetary policy. We no longer have the luxury
to look primarily to the flow of goods and services, as conventionally
estimated, when evaluating the macroeconomic environment in which
monetary policy must function. There are important--but extremely
difficult--questions surrounding the behavior of asset prices and the
implications of this behavior for the decisions of households and
businesses. Accordingly, we have little choice but to confront the
challenges posed by these questions if we are to understand better the
effect of changes in balance sheets on the economy and, hence,
indirectly, on monetary policy." |
