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For immediate release: December 28, 2007

Decline in Risk Taking Healthy in Long Run but Poses Short-Run Challenges, According to Dallas Fed’s
Economic Letter

DALLAS—The abrupt transition from high to cautious levels of financial risk-taking will present a challenge to short- and medium-term economic growth, according to the December issue of the Federal Reserve Bank of Dallas’ Economic Letter.

However, an eventual return to more sustainable risk taking should be healthy for long-term economic growth, according to the authors—economics writer Danielle DiMartino, vice president and senior policy advisor John Duca, and executive vice president and research director Harvey Rosenblum.

In “From Complacency to Crisis: Financial Risk Taking in the Early 21st Century,” the authors trace the roots of the current credit crisis to earlier years in which investors—driven by creative financial products and a stable economy—were complacent about risk.

“The combination of improved macroeconomic performance and microeconomic financial innovation gave rise to low borrower defaults and low asset-price volatility, whetting the appetite for a new generation of securities that funneled more money to riskier firms and households,” they write.

This “overeager acceptance of risk taking” began correcting itself after mounting subprime mortgage defaults set off reverberations across the broader financial markets, according to the authors.

“Perhaps the 2007 credit crunch has taught investors they should not overlook the close links among default risk, interest rate risk and risk appetite—and they should not underestimate these risks when times are good,” they assert.

Investors also have learned the risk inherent in pricing products off thinly traded securities.

However, recent credit markets have become vulnerable to lower issuance volumes and limited trading of existing structured products.

“Should these conditions persist, the reduced availability of credit to nonprime firms and households could hurt overall economic growth,” according to the authors.


Media contact:
James Hoard
Phone: (214) 922-5307