Both of these aspects were important during the near-collapse of LTCM, a large hedge fund, in September 1998. The purpose of this Box is to provide an overview and assessment of various proposals that have been made to enhance the transparency of hedge fund activities, and to shed some light on some potential market-based solutions to the portfolio problem. In early May 2006, a month-long correction in the financial markets took place. Most equity and commodity markets experienced price falls, and emerging countries’ assets and currencies were adversely affected by significant outflows. At the same time, highly liquid and secure G7 government bond markets experienced strong inflows due to safe-haven buying. The sudden change in investors’ positions can be broadly traced to three underlying factors: the immediately preceding sharp rise in most equity indices and commodities; an unexpected reappraisal of risks, particularly in emerging markets and concerns about the US economic outlook. Whereas the net impact on prices was in the end limited, these events could signal risks of volatility surges in the period to come, at least for some asset markets. From a financial system stability perspective, among a broad set of economic and political indicators to be taken into account when assessing a country’s vulnerability to a currency crisis, it is crucial to assess the evolution of the external imbalances of countries. By late 2006, with the major exception of the US, collectively the central and eastern European countries (CEEC) were the only region in the world recording sizeable and persistent current account deficits. By contrast, Asian and Latin American countries recorded either moderate deficit or surplus positions. Although the CEEC are economically relatively small, financial distress in these countries could entail more widespread financial stability risks. For instance, the Asian crisis in 1997-1998 demonstrated that financial distress in one country can affect a much larger economic area if investors simultaneously withdraw their funds from countries with similar characteristics. From a euro area perspective, the CEEC are particularly relevant given their geographic proximity and the participation of some of these countries in the Exchange Rate Mechanism (ERM) II. In recent years, US house prices have risen rapidly: by the end of 2005, aggregate nominal and real house prices were about 70% and 53% respectively above their early-2000 levels. These large overall changes at the national level, however, mask considerable heterogeneity in house price dynamics across cities, states and regions during this period. To a large extent, these differences can be attributed to the importance of local conditions in determining housing market conditions. For instance, from 2000 onwards property price inflation in areas with lower elasticity of land supply – such as coastal areas – was more pronounced than in other regions of the country. Reflecting this heterogeneity, the distribution of house price changes across 387 US metropolitan statistical areas has been wider since 2000 than it was during the 1990s, and considerably more positively skewed. This geographical heterogeneity in house price changes can be contrasted with generally declining income dispersion across states over recent decades, prompting the question whether house prices, especially in some regions of the US, have become decoupled from their underlying fundamental determinants. While there is much debate as to the degree to which house prices are on aggregate misaligned with the underlying fundamentals for the US as a whole – in particular given the possibility of structural changes affecting house price relationships with the fundamentals or historical norms – it would appear that house prices may well be overvalued in some US cities. If so, this would mean that some local markets could be vulnerable to house price correction. In this regard, this Box analyses a key issue for financial stability, namely the extent to which any prospective local housing market correction would spill over to other areas of the country. The single largest vulnerability to a disorderly correction of global current account configurations arising from EMEs continues to stem from a number of downside risks to the Chinese economy. Though still notable, the risks in this context since the completion of the June 2006 FSR appear to be on an incipient downward trend in spite of the upturn in domestic economic activity over the same period. Five developments underlie this assessment. For the purposes of financial system stability assessment, it is important to identify and monitor the activities of banking groups whose size and nature of business is such that their failure and inability to operate would most likely have adverse implications for financial intermediation, the smooth functioning of financial markets or other financial institutions operating within the system. A simple and common approach for identifying such institutions – often grouped under the heading large and complex banking groups (LCBGs) – is to rank them by the size of their balance sheets. However, asset size alone may fail to shed much light on the importance and complexities of the interconnections that a banking group may have within a financial system, especially given the growing importance of banks’ off-balance sheet activities. Knowledge about such interconnections is important because it can help in mapping how, or if, strains in a large banking group could spread to other institutions or markets.