Third, there was in the LTCM crisis the combination of non-transparency and surprise. Fourth, and crucially, many market participants learned that modern hedging strategies and models do not necessarily work as they were intended. Hedging market risk has many positive advantages but it can be complex and comes with its own inherent risks. The Role of the Public Sector. Let me be clear, it is the private sector, not the public sector, that is in the best position to provide effective supervision.
Market discipline is the first line of defense in maintaining the integrity of our financial system.
The public sector, for its part, has three fundamental roles. First, it needs to create an environment in which market discipline can work effectively. Counterparties and creditors have more knowledge of their counterparts, more skill in evaluating risk and greater incentives than any public regulator will ever have. The best approach to regulation is therefore to maximize the quality of counterparty discipline and to ensure that public activities do not crowd out the supervision provided by counterparties, creditors and investors. Second the public sector must promote the maximum degree of transparency, because transparency is the necessary corollary to counterparty discipline.