spirals in asset prices and created " excessive " losses, with no relation to real underlying economic reality. such liquidity spirals may have occurred at some critical moments 7. however, it now seems that the disproportion between banking losses, on the one hand, and movements in underlying asset prices, on the other, can ( almost ) fully be accounted for by the extraordinary degree of leverage which accumulated in the financial system over the last decade. procylicality was at work, but on a much longer time horizon, and during the upward phase of the credit cycle. the following stylized facts describe what happened 8 : • overall leverage grew strongly during the last decade • there was an upward break in the trend growth around 2003 / 2004 • " inside " leverage ( between financial institutions ) grew faster than " outside " leverage ( in the real economy ) • the growth in leverage was closely associated with a dramatic increase in maturity transformation • risk measurement methodologies played a role in minimizing the impact of leverage in financial and risk reporting • accounting methodologies also played a central role. instant recognition of profits led to a disconnection in time between measuring the return on an asset and recognizing the risk ; this created a powerful incentive to take risk and strongly amplified the credit cycle. at times, cds indices appeared mispriced with implied probabilities of default clearly inconsistent with any plausible state of the global economy. see cgfs, april 2009. policy options addressing procyclicality clearly involves many policy actions. those should be part of an integrated framework of macro prudential supervision. i will briefly deal with the general approach, then discuss the instruments available to mitigate procyclicality. general approach as in many matters of public policy, there is a choice between rules and discretion in dealing with procyclicality. the rule based approach can be built on " automatic stabilizers " which would constrain institutions in their behaviour, regardless of their own individual situations. examples would include contra cyclical capital requirement, for instance, as well as dynamic provisioning. alternatively, discretionary action could consist in " top down " interventions from macro prudential authorities. they would step in and impose ( or relax ) constraints whenever they come to the conclusion that dangerous imbalances are building up ( or unwinding ). we probably cannot dispense of this second approach. the difficulty to date cycles makes it dangerous to rely purely on automatic mechanisms,

be able to both meet those requirements and distribute profits. conversely, capital dries up during downturns, when it is most necessary 9. there is clearly an asymmetry with strong equity outflows in boom times and no inflows in bad times. it is not clear that introducing counter cyclical capital requirements will suffice to counteract this very powerful dynamic, especially in bad times. it may be necessary to look at other tools in order to address procyclicality and pre - empt the build up of imbalances. those tools have to act more directly on individual and collective incentives. this is where accounting may matter most. economically, it will always remain difficult, when looking at revenues drawn from a financial investment, to distinguish excess return from additional risk taking. but financial reporting may be conceived in such a way that this distinction is prudently introduced. there is no reasonable or practical alternative to fair value accounting for tradable securities. this does not mean, however, that any single valuation gain or loss should instantly be recognized as a profit ( or loss ) and financially treated as such. there is a possibility to delink valuation from income / profit recognition. some disconnection between the valuation process – which should remain anchored on market prices – and income and profit recognition will have to be introduced, if only to account for risks which are there but have not yet materialized. dynamic provisioning is one technique for doing so, when risks are closely related to the economic cycle. valuation reserves may also be used when complexity or illiquidity creates additional risk linked to valuation. provided those adjustments are rule based and made in a fully transparent process, they would not reduce the quantity or quality of information available to investors as to the real health of financial institutions. another avenue for research would be for the regulatory system to " force " the pricing of risk in all its dimensions. there is a clear analogy with tax theory : internalizing the risk eliminates market failures. this approach would be best implemented to liquidity risk linked to maturity transformation. quantitative liquidity ratios are currently considered in a number of juridictions to be imposed on financial institutions. however, they may not protect the system against an aggregate liquidity shock, when, by definition, the demand for liquidity becomes infinite and any buffer proves insufficient. pricing liquidity ex ante in the system would reduce the probability of such a shock and create incentives against relying too much on maturity transformation.