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Measuring up

OFR uses new tools to monitor stability of financial system

A heat map and daily market snapshots to help monitor financial stresses are now available from the Treasury Department's Office of Financial Research.

OFR officials launched the Financial System Vulnerabilities Monitor and Financial Stress index in late October to add to their kit of quantitative monitoring tools that help identify where further study might be needed.

The FSVM heat map, with 58 indicators of potential vulnerabilities, will be released quarterly. Its six categories of indicators reflect the key risks that have contributed to financial instability in the past: macroeconomic, market, credit, solvency and leverage, funding and liquidity, and contagion. The FSI, constructed from 33 financial market indicators, is a daily market-based snapshot of stress in global financial markets.

"The logic for two monitoring tools is simple," said OFR Director Richard Berner in a recent blog. "Just as monitoring health requires tracking both blood pressure and body temperature, monitoring financial stability requires tracking both vulnerabilities and stress."

OFR officials define vulnerabilities as factors that can originate, amplify or transmit disruptions in the financial system, such as Lehman Brothers and other broker-dealers relying on unstable funding that led to a run on those institutions. Stress is a disruption in the normal functioning of the financial system, and can be minor such as brief price volatility, or major.

Each should be measured separately, said Mr. Berner, who noted that in the years leading up to the U.S. financial crisis, the FSVM showed many vulnerability indicators flashing orange or red, while the FSI shows low levels of stress. If these new tools had been around then, they could have signaled warnings of potential financial instability because of excesses in U.S. housing valuations, household leverage, financial firm leverage, and easy financial conditions and confidence that allowed vulnerabilities to grow as borrowers, investors and financial intermediaries took more risks, he said.

The tools are available on the Office of Financial Research website.