quite correctly see as unfair that aig was saved from bankruptcy because of the dangers to the system that its failure would have posed, even as many other companies, including nonfinancial and smaller financial firms, have not received the same treatment. allowing aig to at least partly avoid the discipline of the marketplace also sets a bad precedent. for these reasons, it is essential that we make changes to the financial rules of the game to prevent a similar episode from occurring in the future. first, we must ensure that all types of financial institutions, especially large and interconnected ones like aig, receive strong and effective government oversight. aig's regulatory oversight was limited, which allowed it to take dangerous risks largely out of sight of federal regulators. second, the aig experience demonstrates that federal regulators urgently need a new set of procedures for dealing with a complex, systemically important financial institution on the brink of failure. such rules already exists for banks : if a bank approaches insolvency, the fdic is empowered to intervene as needed to protect depositors, sell the bank's assets, and take any necessary steps to prevent broader consequences to the financial system. however, for an insurance conglomerate like aig, or for a large financial holding company that owns many subsidiary companies, these rules do not apply. among other things, a good system for resolving nonbank financial institutions would allow federal regulators to unwind a failing company in ways that minimize disruptions in financial markets. an effective regime would also provide the authorities greater latitude to negotiate with creditors and to modify contracts entered into by the company, including contracts that set bonuses and other compensation for management. more generally, we need significant reforms to financial regulation and financial practices that will reduce the risk of future financial crises like the one we are currently experiencing. the federal reserve strongly supports such reform efforts. conclusion the current crisis has been one of the most difficult financial and economic episodes in modern history. recently we have seen tentative signs that the sharp decline in economic activity may be slowing, for example, in data on home sales, homebuilding, and consumer spending, including sales of new motor vehicles. a leveling out of economic activity is the first step toward recovery. to be sure, we will not have a sustainable recovery without a stabilization of our financial system and credit markets. we are making progress on that front as well, and the federal reserve is committed to working to restore financial stability as a necessary step toward full economic recovery. i am fundamentally

a foundation for risk - management practices that will strengthen the value of the banking franchise. the new framework should improve supervisors'ability to understand and monitor the risk taking and capital adequacy of large complex banks, thereby allowing regulators to address emerging problems more proactively. the new framework should also enable supervisors to have much more informed and timely conversations with bankers about their risk profiles, based on the new information flows generated. our hope is that conversations around this common analytical framework will create a common language for risk management. in the united states, we intend to use the framework to determine whether bankers are indeed able to monitor their own risk - taking and capital positions, placing the onus on bankers to show that they are able to measure, understand, and effectively manage their consolidated risks. we expect improved risk management not only through institutions'efforts to calculate minimum regulatory capital in pillar 1, but also through their development of credible internal capital adequacy processes as required by pillar 2. each institution must correct for pillar 1 assumptions that may not apply to that particular bank, for example if the " well diversified " assumption is not met because of geographic or sectoral concentrations. in essence, the bank should determine whether capital levels are appropriate in light of any deviations from pillar 1 assumptions. we also hope that the added transparency contained in pillar 3 of basel ii will generate improved market discipline for these large organizations. market discipline is not possible if counterparties and rating agencies do not have good information about banks'risk positions and the techniques used to manage those positions. indeed, market participants play a useful role by requiring banks to hold more capital than implied by minimum regulatory capital requirements, or sometimes their own economic capital models, and by demanding additional disclosures about how risks are being managed. from the outset of our participation in the development of basel ii, the u. s. agencies have clearly and consistently stated that the final adoption of the new capital rules in the united states would occur only after ( 1 ) we had reviewed all public comments and incorporated any needed adjustments to address legitimate concerns and ( 2 ) we were satisfied that basel ii was consistent with safe and sound banking in this country. throughout this process we have stressed that, if we become concerned about the level of overall capital in the banking system or the capital results for individual portfolios, we will seek to modify the framework, including possibly recalibrating the regulatory capital formulas that translate an individual bank's risk parameters into required capital. the agencies '