This context was critical to the decisions we made over the next several days. And I think it’s important to start with an explanation of the broad risks to the economy posed by the crisis now working through the financial system. The intensity of the crisis we now face in U.S. and global financial markets is a function of the size and character of the financial boom that preceded it. This was a period of rapid financial innovation – particularly in credit risk transfer instruments such as credit derivatives and securitized and structured products. There was considerable growth in leverage, greater reliance on ratings on structured credit products and a marked deterioration in underwriting standards. The innovation in financial products was accompanied by a dramatic increase in the amount of financial intermediation occurring outside the core banking system. The importance of securities broker-dealers, hedge funds, and mutual funds in the financial system rose steadily. Off-balance-sheet vehicles of various forms proliferated, and increased concentrations of longer-dated assets were held in funding vehicles with substantial liquidity risk. The deterioration in the U.S. housing market late in the summer of 2007 precipitated a sharp rise in uncertainty about the value of securitized or structured assets. Demand for these assets contracted dramatically and the securitization market for mortgages and other credit assets stopped working. This, in turn, increased funding pressures for a diverse mix of financial institutions. Uncertainty about the magnitude and the level of losses for financial institutions fueled concern about credit risk in exposure to those institutions.

As Secretary of the Treasury Henry M. Paulson, Jr., Federal Reserve Chairman Ben S. Bernanke and others have stated, we need a companion framework for facilitating the orderly unwinding of other types of regulated financial institutions where failure may pose risks to the stability of the financial system. The elements I just outlined need to be accompanied by a clearer structure of responsibility and authority over the payments system. Payment and settlement systems and central counterparties play a critical role in financial stability. Our current system is overseen by a patchwork of authorities, with responsibilities diffused across several agencies in a manner that leaves significant gaps. We need a more formal and integrated framework of oversight, one that establishes and enforces standards and continuously monitors the conditions in these markets. BIS Review 95/2008  3  And finally, as we adapt the U.S. framework, we have to work to bring about a consensus among the major economies on a complementary global framework. Given the level of financial integration globally, we cannot achieve a reasonable balance at home between efficiency and stability, without a complementary framework of supervision and regulation across the other major financial centers. To make it operational, the framework I just laid out will require a complicated set of choices. •  What level of conservatism should be built into future prudential regulations over capital and liquidity? •  Which types of institutions should be subject to these requirements?