t t mboweni : what is happening in financial markets? address by mr t t mboweni, governor of the south african reserve bank, at the cape town club, cape town, 5 october 2007. * * * honoured guests, ladies and gentlemen 1. introduction thank you for providing me with the opportunity to address you this evening on the recent turmoil experienced in global financial markets which began in july this year. at the time of our last monetary policy committee meeting in august, the turbulence on the international financial markets had intensified and it was unclear how developments would unfold. as we prepare for the mpc meeting next week, the dust appears to have settled. in fact, if one looks at the conditions in the financial and commodity markets today and compares them to the conditions prevailing in mid - july, one would not think there had ever been any disruptions. my remarks to you this evening will focus on the developments in the international and domestic financial markets, potential implications for global growth and the policy implications. 2. the build - up to the turbulence for the past few years now, global financial markets have prospered and seen innovation and integration on an unprecedented scale, leading to more prominent roles being played by investors such as hedge funds, and new derivative instruments and structured products. this boom in financial markets was a result of low interest rates in developed markets, and the financial system being flooded with liquidity. investors, in an attempt to earn higher returns, invested in riskier assets. as more and more investors jumped on the bandwagon, and demand for riskier assets increased, the excess yield these assets offered diminished. however, this strategy remained beneficial given that the global economy was characterised by low and falling inflation and robust economic growth. this demand for excess yield gave rise to, amongst other things, the boom in the us sub - prime market. the economic and financial environment has almost been a utopia situation in certain respects, displaying a remarkable resilience, even during recent periods of correction. however, this resilience only served to increase the level of complacency about the nature of the risks involved. the central banking community had consistently expressed concern about the level of pricing observed in markets, which did not seem to adequately reflect the level of risk being taken. now, the sub - prime “ bust ” has led to a tightening of both liquidity and credit conditions, creating turmoil in financial markets. i am reminded of a comment by warren buffet : “ it ’

us even further. dampened business sentiment and falls in the equity market, combined with the weaker housing market and deterioration in consumer sentiment could mean a more intense negative impact on wealth. the most recent evidence by way of economic data releases seems to suggest that the problems in the housing market may be deeper than initially assumed and harbour real risks for consumption and growth. the recent policy actions from the fomc very much seem to acknowledge this change in prospects. as the imf has noted, most of the world will likely emerge relatively unscathed from this crisis. the recent shifts away from the us as being the key driver of global growth, together with the better balance achieved during the last two years represents significant support for the global economy. however, the ramifications of any sharp slowdown in the us always remain and should not be underestimated. as for emerging markets, lower external debt, better reserves levels, more prudent fiscal management, leading to much more improved fundamentals, have undoubtedly already delivered dividends. whilst the global economy is deemed to be robust enough to shake off us weakness, contagion effects means that the sub - prime problems can contaminate other countries. as noted, emerging markets are better prepared for, but certainly not immune to global financial market risks. a reduction in global risk appetite would curb net capital inflows into emerging markets, placing downward pressure on emerging market currencies and in turn exacerbate inflationary pressures. 7. policy implications the recent events and actions by central banks around the world have raised an interesting debate on “ moral hazard ”. it raises the question of whether central bank support of the markets does not amount to a bail - out of careless investors, thereby paving the way for more careless behaviour in future. in a recent speech by federal reserve bank chairman, ben bernanke, he noted that well - functioning financial markets are essential for a prosperous economy. central banks need to ensure the functioning of financial markets, but in a very difficult balancing act, also need to guard against recreating conditions of careless lending that preceded the market turmoil. in this context it is important to point out that central banks can ill - afford to take any chances with systemic risks. in the process of addressing problems “ for the greater good ” there could be some by - product of unintentionally providing help to those who do not quite deserve it. this was the dilemma faced by the bank of england when it eventually had to