is also clear that distorted market mechanisms are unlikely to be the only culprit. but even in the case of household indebtedness, i would argue that cognitive or behavioural biases as well as other forms of psychological influence ( e. g. emotions ) are equally important as a potential explanation – even if less recognised. these biases imply that individual decision - making may deviate from the principles of rational choice on which the welfare theorems are based ( and on which our understanding of the performance of the market system is founded ). if the basic assumptions about rational behaviour do not hold, the decentralised decisions of individuals can – plausibly – lead to sub - optimal market outcomes. indebtedness of banks, sovereigns and households let us now turn to the factors explaining the excessive indebtedness of banks, sovereigns and households. in the case of excessive leverage in the banking sector we can make a conventional and probably little disputed diagnosis. it is widely accepted that one main cause of over - leverage in banking is the existence of distorted incentives, originating from faulty, or defective, system design and regulation. the move from basel ii to basel iii is an explicit acknowledgement that capital and liquidity requirements ahead of the crisis were too lax. this was particularly the case for too - big - to - fail institutions. the implicit state guarantee for these institutions is a major source of incentive distortions. it is in complete contradiction with the functioning of a free market system and the hypotheses of our welfare theorems. limited liability and the prevalence of bonus systems provide other significant distortions affecting individual decision - making. at various levels of financial institutions, decision - makers face asymmetric incentives. to give you an example, remuneration levels were high when risk taking paid - off, but there were no negative consequences – except possible job losses – when risks materialised. it is not surprising that excessive risk - taking was the consequence. domestic credit to private sector refers to financial resources provided to the private sector, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment. worldbank, world development indicators, http : / / data. worldbank. org / indicator / fs. ast. prvt. gd. zs / countries / 1w? display = graph. bis central bankers ’ speeches this problem of socially excessive risk - taking is

than 15 years, these numbers have increased dramatically. current estimates suggest that approximately 7500 hedge funds manage assets totaling close to usd 1000bn ( graph 1 ). 3 remarkably, according to the csfb / tremont hedge fund index, there have been only a few quarters with net outflows since 1994. 4 these figures demonstrate that the hedge fund industry has matured at an extraordinary rate and today constitutes a non - negligible component of the global asset management industry. 5 a more detailed study on hedge funds will be published in the forthcoming quarterly bulletin of the swiss national bank ( march 2005 ). alfred winslow jones is credited for the creation of the first hedge fund in 1949. his strategy consisted in combining long positions in undervalued stocks and short positions in overvalued stocks, in an attempt to minimise the influence of overall stock market moves. to magnify his portfolio ’ s return, jones added leverage. according to hedge fund research inc., 7436 funds managed usd 973bn of assets at the end of 2004. other sources may come up with different figures. the csfb / tremont hedge fund index is the largest asset - weighted hedge fund index. the csfb / tremont index is broadly diversified, encompassing around 400 funds across ten style - based sectors, and representative of the entire hedge fund industry. assets included within the csfb / tremont hedge fund index amounted to usd 615bn in september 2004. performance is calculated net of fees. not included in these figures are significant pools of capital held in privately managed accounts run by hedge fund managers as well as capital managed by the proprietary desks of global investment banks. though typically not formally structured around hedge fund vehicles, these assets closely mirror the investment activities of hedge funds. until the second half of the nineties, the hedge fund industry capital base was largely one of high net worth fortunes. part of the acceleration of inflows throughout the second half of the nineties can be attributed to pension funds, endowments and other institutional investors who have begun to allocate small percentages of their asset base to hedge funds. more recently, funds of funds have become an important source of new inflows to the industry. the largest share of the industry ’ s total client base continues to be private wealthy individuals either as direct investors or through funds of funds. industry flows data suggest, however, that assets from institutional investors have recently grown more rapidly than the overall industry asset base. a major