not regarded as being worth overcoming. for we thought we knew something about the financial markets which has now turned out to be false. we believed the financial markets would generally perform their task efficiently and smoothly. and if financial markets do what they are supposed to, at least most of the time, there is no need to model them specifically. however, it was the financial crisis, if not beforehand, which showed that the financial markets sometimes do not do what they are supposed to be doing – and on a large scale. let me briefly give an example of a problem in the financial markets which, i believe, played a central role in the crisis : banks ’ systemic importance, the “ too - big - to - fail ” problem. it is a core tenet of market economies that firms can fail. joseph schumpeter called this “ creative destruction ” ; allan meltzer put an even finer point on it : “ capitalism without failure is like religion without sin. it doesn ’ t work. ” not taken into account with regard to banks were the side effects of failure. and one thing came to light in the crisis : these side effects can be so severe that failure is no longer the basis of a healthy market but, in a worst case scenario, the downfall of the market. in order to prevent such a downfall, central government has to intervene and rescue banks. by creating flawed incentives, this implicit government guarantee ultimately exacerbates the underlying problem – a problem that the markets believe has still not yet been solved, as studies by the imf and other institutions show. are these really new insights? no, this is certainly not news. it is precisely here in germany where the premises of the ordo - liberal school of thought are cited in this context. walter eucken is quoted again and again with respect to the “ too - big - to - fail ” problem. more than 60 years ago, he came up with a short and snappy solution to the problem : “ whoever reaps the benefits must also bear the liability. ” incentives are appropriate only where the banks ’ shareholders and creditors are liable. and only where the banks ’ shareholders and creditors are liable will taxpayers not be asked to foot the bill. the knowledge that regulatory policy came up with a fundamental answer to the “ too - big - to - fail ” problem decades ago is not the end of the road, however. although the principles of ordnungspolitik are pointing in the right direction,

##ies which have provided credit risk protection. if these counterparties were found not to be in a position to sustain the losses, credit risk “ insurance ” might not be available when claims are ultimately made. on the other hand, if the functioning of the credit risk transfer market were impaired, for instance if financial market volatility rose unexpectedly, this could have an adverse impact as banks might not then be able to lay - off their credit risk in the way they have become accustomed which could, in turn, induce greater caution in their lending to lower quality borrowers in particular. iii. 3 euro area corporate and household sectors turning to developments in the euro area corporate sector, over the past six months there have been mounting signs that an adverse turn in the credit cycle seems increasingly likely, driven by factors such as rising leverage ratios, a further tightening of monetary conditions and expectations of a future slowdown in the pace of profit growth. a favourable economic environment together with the persistently low cost of issuing corporate sector debt and greater investor appetite for lower quality credit have created conditions that have been conducive to a surge in global merger and acquisition ( m & a ) activity [ see chart on the left of slide 8 ], and in particular of leveraged buy - outs ( lbos ). such transactions have become an important source of growth in leveraged loans. 1 [ see chart on the right of slide 8 ] the rapid growth in the value of lbo transactions has taken european leveraged loan issuance beyond levels last seen at the height of the telecom boom of the late 1990s. at the same time, the average degree of leverage in these loans – measured by debt - to - ebitda ratios2 – has increased substantially. as a result, the credit quality of different market organizations and lenders define leveraged loans in different ways ; however there are two broad ways to classify loans as leveraged or nonleveraged. the first is based on credit ratings, and the second is based on a loan ’ s initial interest rate spread over libor. the extent to which a credit is leveraged reflects, other things being equal, the leverage ratios of a borrower with higher ratios resulting in higher spreads or lower credit ratings. ebitda stands foe earnings before interest, taxes, depreciation, and amortization. issuing companies has deteriorated. it cannot be excluded that certain features of the leveraged loan markets, such as debtor - friendly re - payment structures and an increasing