Products such as CDOs, CDOs of ABS and CDO squared have been prominent in recent months in the business news, especially because of their adverse impact on the results of the biggest international financial institutions. Some of these products used the bonds resulting from a specific securitisation, packaging them and combining them with other financial instruments in order to re-securitise them. Other products, to offer another example, were made up of securitisations of relatively heterogeneous asset portfolios, in which the degree of concentration was high. Evaluating these products required the use of sophisticated models based on numerous assumptions and on information not directly observable in the markets. Also, owing to their recent development, the models had not been tested in a highly adverse scenario. In addition, the sophistication of these products meant that the calculation of the parameters needed for the valuation models was more complex, making it increasingly difficult to value the level of risk incurred. Events have highlighted the fact that the valuation models have not worked well, meaning that many banks have miscalculated the level of risk assumed and that stress tests have not worked properly. Beyond these quantitative considerations, the use of these complex products also indicates significant shortcomings in the more qualitative facet of risk management. Quite simply, numerous banks and investors took positions in products that they did not properly understand. And today it is quite clear to see that they have perhaps committed the most basic error contrary to sound risk management, i.e.

If fiscal policy is systematically too expansionary during booms and when petroleum revenues are higher than expected, Norway will in periods experience pressures in the economy and rising price and cost inflation. This will often give rise to situations where the krone depreciates, thereby undermining the credibility of our monetary policy. There is a price to be paid for this. Market participants will lose confidence in the krone and demand a higher interest rate for maintaining krone positions rather than switching to other currencies. The result is a permanently higher interest rate level in Norway compared with other countries. Intricate relationships Earlier, monetary policy was based on extensive use of interventions – in other words, purchases and sales of foreign exchange in order to defend the krone exchange rate. Denmark has used this instrument with positive results. There are probably many reasons for this in addition to its stable terms of trade. For instance, fiscal policy in Denmark has on numerous occasions made a substantial contribution to exchange rate stability. Over time our experience of large-scale and persistent interventions has been mixed. When the central bank intervenes heavily to defend the krone, market participants may easily move into a game situation and perceive central bank intervention as an interesting opportunity to make a profit. Market operators know that a situation in which the krone is being propped up only because Norges Bank is buying kroner cannot continue. It is then tempting to take reverse positions in the foreign exchange market in relation to the central bank.