July 25, 2007 / 12:02 AM / 12 years ago

Moody's says turbulence doesn't pose systemic risk

LONDON, July 25 (Reuters) - Moody’s Investors Service said on Wednesday that recent market turbulence did not pose a systemic risk, as banks’ and securities firms’ ability to withstand shocks was high, but it did raise concerns over other underlying issues.

“The shock-absorption capacity of the ‘core’ of the financial system is very high,” the ratings agency said in a report.

It said it was unlikely the system would see problems similar to that caused by the collapse of hedge fund Long-Term Capital Management in 1998 in the wake of the Russian debt crisis.

However, “the combination of a significant wave of financial innovation with a relaxation of risk management (and) underwriting standards has proved to be a dangerous cocktail,” the agency said.

Global credit markets have seen huge volatility and turmoil in recent weeks after two Bear Stearns hedge funds racked up huge losses due to bad bets on subprime mortgage debt and fears built over the huge pipeline of “junk” bonds and loans to be raised to finance a glut of leveraged buyouts.

Moody’s said high liquidity in the world economy and the robustness of banks and securities firms reduced the risk of a generalised “seizing up” in financial markets.

“Naturally, this does not mean that some localised market ‘seize-ups’ cannot happen — especially for highly customised and complex financial products,” the agency said.

However, overall, the re-pricing of assets is “salutary”, Moody’s said.

“It instils a more realistic perception of risk. It will restore a steadier balance between lenders and borrowers, and within lending firms, between risk managers and front offices,” the agency said.

But underling problems with the market, specifically the degree of leverage in the system as a whole and the interplay between buy-and-hold and mark-to-market investors, are unlikely to disappear, the agency said.

Moody’s acknowledged that ratings agencies too had been blamed for some of the problems. It said there was “confusion about ratings” in areas such as structured finance.

Some critics have argued that the ratings agencies have taken too long to act on securities linked to subprime mortgages, with market prices on them having dropped well in advance of the recent ratings actions.

But Moody’s said ratings were not based on prices. “Ratings are not and cannot be predictors of market prices. Ratings are based on the financial metrics of the borrower or the borrowing structure, not on the conditions of the market at the hypothetical time the security may be traded,” it said.

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