factors of relevance to the recent financial market developments, and should not be rushed into conclusions without a thorough and comprehensive analysis. possible impact on the european financial system what is the likely overall impact of the recent financial market developments on the european financial institutions? some institutions have experienced losses from their holdings of asset - backed securities, in particular as a result of both direct and indirect exposures to us sub - prime mortgage securities. moreover, a number of banks have faced liquidity pressures as credit lines to special - purpose investment vehicles had to be activated to meet commitments to provide liquidity support and as a result of increased uncertainty about counterparty risk. nevertheless, on the whole, exposures to the us sub - prime mortgage market manageable given the capital buffers. after several years of strong profit growth, including strong profitability in the first half of 2007, and with capital bases in excess of regulatory requirements, the shock - absorbing capacity of the euro area financial system – especially the core financial institutions – has been enhanced. although the profitability of some european financial institutions is likely to be adversely affected to varying degrees by the recent strains in financial markets, the euro area banking system on the whole should have no major problems in absorbing the impact of recent disturbances. looking forward, the most likely scenario is that financial market conditions will normalise progressively over a period of time – which could be protracted depending, among other factors, on the progress made in restoring confidence in the valuation of credit instruments and the creditworthiness of counterparties. however, it cannot be excluded that some lowprobability, but plausible and challenging, scenarios for financial stability could be triggered by adverse market disturbances or “ credit events ” which would further affect global market liquidity conditions. a potential further deterioration in credit quality could lead banks to tighten their lending standards and a less benign scenario could emerge involving a more significant re - pricing of risk and de - leveraging. concluding this assessment of some of the underlying causes and the likely consequences of the financial market turmoil, i want to stress the following : the recent market liquidity squeeze originated from a surge in default rates by a subset of borrowers with particularly weak credit histories and economic fundamentals. in other market segments and economic sectors, the fundamentals are broadly strong. in order to contain financial market volatility, it is crucial, at the current juncture, that unanticipated shocks and investor concerns do not lead to unwarranted contagion to markets and

rate even further ( see figure 3 ). over the past year, we have also lowered the forecast path for the repo rate. this has been necessary to meet the inflation target and support economic activity. but in our monetary policy we have also given some consideration to household debt and housing prices – and for good reason, in my opinion. let me explain this in more detail. … as there are considerable risks the financial crisis has made the risks linked to the housing market and high household debt crystal clear. the most well - known examples are the united states, ireland and spain. but denmark, too, has experienced problems in its housing market ( see figure 4 ). in sweden, house prices have risen substantially since the middle of the 1990s, even compared with the countries where prices have since plummeted ( see figure 4 ). as house purchases are to a great extent funded by borrowed money, it is hardly surprising that this has also entailed a large increase in household debt ( see figure 5 ). i think that it is important in this context to try to clarify the actual risks for sweden here. it is not very likely that a fall in house prices would lead to extensive loan losses from mortgages for banks and mortgage institutions. both the experiences from the 1990s and the analyses bis central bankers ’ speeches we have made ourselves point to this not being the case. 1 however, a fall in house prices can give rise to other effects, direct and indirect, on both the macro economy and financial stability. the most direct effects for the macro economy concern household consumption. experiences show that the countries hit by severe falls in house prices usually experience long periods of very weak consumption. this is because households then tend to increase their savings to restore their wealth. figure 6 shows developments in household consumption and real house prices in different countries. we can see that sweden has had a much stronger growth in consumption than the countries affected by severe falls in house prices. weaker consumption demand has direct effects on growth, and thus also on unemployment ( see figure 7 ). this in turn has indirect effects on financial stability in that the banks ’ loan losses in the corporate sector may increase as a result of the poorer economic activity. another aspect that can affect financial stability is that an increasingly large share of the banks ’ funding is through foreign investors ( see figure 8 ). confidence among foreign investors may be affected substantially by a fall in house prices. this could have direct effects on financial stability in that the banks have greater difficulty obtaining