Crisis Counsel

Chief risk officer, Bank of America

There's no question that the risk of a slowdown has increased due to the hit to business confidence and the wider credit spreads. Also, consumers' reduced ability to get credit could impact spending. There will continue to be pain in both the subprime mortgage and the leveraged loan markets. In the leveraged loan market, unlike the subprime market, the credit fundamentals haven't changed. But there's an oversupply of new issues--$237 billion worth of leveraged loans in the pipeline. They will have to work through the system before we have equilibrium.

We knew these corrections would come. The surprise is the degree of volatility and the effect on liquidity, especially short-term liquidity. The very substantial changes in the financial markets over the past five years have presented new challenges. We have new players: foreign investors, hedge funds, and private equity firms. And we have new products--more complex products than in the past. The changes do distribute risk more broadly, but they've contributed to the uncertainty. Getting a handle on where the risk is isn't as easy as it used to be when banks made loans that defaulted when they were bad. These more complex products are less transparent, so it's difficult to determine the value. And the hedge funds are less transparent. The uncertainty creates a higher level of risk aversion. That, in turn, creates liquidity risk. People want to sit on the sidelines until they think they have it all figured out.

Where does it go from here? The longer there's risk aversion, the greater the impact on the markets. The oversupply of leveraged loans will take a few months to go through the system. The subprime issues will continue to be problematic through 2008. But these are healthy corrections for the long term. We don't see broad signs of weakness in the economy, and that's what matters most. Global economic growth is expected to remain strong. The U.S. economy continues to be sound. One of the most important indicators is low unemployment, at 4.6%. We're seeing steady gains in personal income. There's a continued acceleration in exports. And corporate balance sheets are strong.