by Calculated Risk on 9/12/2007 09:37:00 PM

Here is a letter today from Mervyn King, Governor of the Bank of England including, a paper titled: Turmoil in Financial Markets: What can Central Banks do?.

Here is the conclusion:

The path ahead is uncertain. There are strong private incentives to market players to recognise early and transparently their exposures to off-balance sheet entities and to accelerate the re-pricing of asset-backed securities. Policy actions must be supportive of this process. Injections of liquidity in normal money market operations against high quality collateral are unlikely by themselves to bring down the LIBOR spreads that reflect a need for banks collectively to finance the expansion of their balance sheets. To do that, general injections of liquidity against a wider range of collateral would be necessary. But unless they were made available at an appropriate penalty rate, they would encourage in future the very risk-taking that has led us to where we are. All central banks are aware that there are circumstances in which action might be necessary to prevent a major shock to the system as a whole. Balancing these considerations will pose considerable challenges, and in present circumstances judging that balance is something we do almost daily.

The key objectives remain, first, the continuous pursuit of the inflation target to maintain economic stability and, second, ensuring that the financial system continues to function effectively, including the proper pricing of risk. If risk continues to be under-priced, the next period of turmoil will be on an even bigger scale. The current turmoil, which has at its heart the earlier under-pricing of risk, has disturbed the unusual serenity of recent years, but, managed properly, it should not threaten our long-run economic stability.
emphasis added