Second, financial institutions and other market participants need access to high quality information in terms of the financial condition of their counterparties. Balance sheet information including capital and liquidity positions and counterparty exposures would enable financial market participants to more accurately assess the condition of those with which they do business. Increased transparency would reduce the level of uncertainty, which contributes to risk aversion and financial crises. Greater transparency in terms of off balance-sheet activities such as OTC derivatives exposures might also be helpful for the same reasons. Greater transparency is often unpopular because it may reduce market power and reveal business strategies and, thereby, limit profits. But the private loss of profit opportunities must be balanced against the public good of greater financial stability. Such steps reinforce the work underway to make the major financial intermediaries and financial market infrastructures more resistant to shocks when they inevitably occur. This includes appropriate capital and liquidity requirements and appropriate risk management practices for banks and financial market infrastructures. Finally, when institutions do get into difficulty we need a credible way of enabling these institutions to recover or, if recovery is not possible, to be resolved in an orderly manner so that failure of any one institution doesn’t threaten to bring down the rest of the financial system. So how are we doing relative to the agenda that I have laid out? In my opinion, we have made a good start, but there is a long ways to go.

For example, the U.S. housing boom was unsustainable because it was not possible to indefinitely keep relaxing credit underwriting standards to qualify new buyers to stoke demand. It was also unsustainable because the rise in prices often led to a supply response that limited the prospect of further price increases. 2  BIS central bankers’ speeches  Another class of threats to financial stability emerge from sudden reversals of market sentiment regarding economic policy and institutional arrangements. This is a complex issue which I will not explore in detail today, other than to note that here too, early profits all too often feed pro-cyclical behavior, undermining market discipline. This in turn facilitates the accumulation of both private and public imbalances that are painfully difficult to unwind when financing suddenly stops. When sudden reversals occur, large costs are imposed on the real economy and the financial system, costs that are not fully internalized by the market participants that may have benefited from the boom. The often significant negative externalities associated with financial market instability suggest that regulation and prudential standards should be aimed both at limiting the frequency and extent of booms and at building a more resilient financial system, so there is less damage when the busts inevitably occur. The goal here is not to use regulation to prevent or even limit innovation, whether real or financial. Many innovations have generated significant benefits for the macro-economy. For example, the Internet, which lay at the heart of the tech bubble, generated myriad benefits.