david longworth : credit markets, financial stability and monetary policy remarks by mr david longworth, deputy governor of the bank of canada, to the global investment conference, lake louise, alberta, 10 april 2008. * * * good afternoon, ladies and gentlemen. it's good to be here in my home province of alberta to discuss with you some interesting topics at a very interesting time. i remember back in january thinking that the previous five months had been the busiest of my career at the bank of canada. however, i believe i can now say that the past eight months have definitely been the most active – and most interesting – in my bank of canada career. today, i'd like to discuss some of the crucial issues that we have been dealing with during this period. i'll begin with a brief overview of some key events that have led to the turbulence that continues to upset financial markets and that greatly contributed to the remarkably wide credit spreads that we now witness. i'll discuss some of the ongoing analysis of these credit spreads that we are conducting at the bank of canada. i will then turn to the policy issues around financial stability that the turbulence has highlighted and describe some of the work that we are doing to promote financial stability throughout this period of uncertainty. finally, i'll describe how we take financial market developments into account as we conduct monetary policy and the important role that this policy plays in promoting economic and financial stability for canadians. how did this happen? what were some of the root causes of the current market turbulence? we know that for a number of years, desired world savings exceeded desired world investment. as a result, long - term real interest rates decreased around the world. this led investors to search for yield, and they became willing to take on risk at lower premiums than they had demanded in the past. part of this search for yield led to rapid growth in the demand for, and development of, more complex structured financial products, such as collateralized debt obligations ( cdos ) backed by asset - backed securities or by other cdos, and asset - backed commercial paper ( abcp ) backed by cdos, some of which ( after 2000 ) were based on u. s. subprime mortgages. 1 these complex instruments were rated by credit - rating agencies using the same scale that they had used in the past for plain - vanilla corporate debt. some sellers of these complex financial instruments emphasized that these products were highly rated – many were aaa – but placed

of market uncertainty relates to the degree of de - leveraging of hedge funds, proprietary desks, and other highly leveraged institutions. with some prime brokers facing capital constraints and with the volatility of asset prices having risen, certain institutions – including hedge funds – are seeing their lines of credit cut and their margin requirements raised. this typically forces them to sell assets, which has exacerbated the illiquidity in markets, making it extremely difficult for market participants to price these assets or, at times, to find a market for them. one might assume that this situation could create an excellent buying opportunity for sizable, unleveraged institutional investors, the so - called " real money funds. " yet most have remained largely on the sidelines. they may be held back by the continued uncertainty, perhaps waiting to see if the market has further to fall, thus creating even better buying opportunities. again, the increased provision of information by financial institutions on their losses and exposures should be very helpful in easing uncertainties. financial stability policies now, let me turn to issues regarding financial stability policies that have arisen out of this period of turbulence. i will touch briefly on three issues : first, polices related to transparency and information ; second, policies regarding the regulation of financial institutions ; and third, central bank financial stability policies. 5 we know that markets work best when relevant information is available to all. one result of the recent turmoil is that concerns have been raised regarding the transparency of complex financial instruments and the role of the information supplied by credit - rating agencies. in canada, issues regarding the transparency of instruments have been most pronounced with respect to abcp – particularly the non - bank - sponsored abcp covered by the montreal accord. there has already been some movement towards greater transparency in the banksponsored segments of this market. 6 but greater transparency of financial instruments isn't a more detailed discussion of these and other issues can be found in m. carney, " addressing financial turbulence " ( speech to the toronto board of trade, toronto, on, 13 march 2008 ). for example, we have seen the adoption of global - style liquidity facilities ; institutions seeking more than one credit rating ; and the bank of canada announcing it will accept abcp securities that meet certain criteria, including transparency criteria. the latter point is discussed later in this speech. enough – investors also need to know how to interpret the information. although credit - rating agencies have helped with interpretation in