##nb as prudential supervisor? these are the topics i would like to focus on today. let me start by giving an example of unethical behavior of bankers before the crisis. just some weeks ago, a former goldman sachs banker – fabrice tourre – was found guilty of fraud by a jury in new york city. mr tourre was held responsible for seriously misguiding his clients in the so - called “ abacus deal ”. abacus 2007 was the name of an investment in residential mortgagebacked securities, a product that yields income from mortgage payments by homeowners. the deal was as follows : while goldman sachs sold the product, while the intermediary company that arranged the deal, paulson & co., went “ short ” on the deal. that is, they bought other products that would bring in vast amounts of money if these mortgages were to default. to make sure that this setup would work, the mortgages selected for the abacus investment had a high chance of defaulting. of course, the clients to whom goldman sachs and paulson & co sold this product were kept in the dark about this. in other words, what tourre and paulson did was seeking to maximize their profits at the expense of their clients. it is therefore hardly surprising that this scheme, once it transpired, led to a significant loss of trust in the financial sector in general. bis central bankers ’ speeches this example illustrates how a bank can engage in unethical behaviour by deliberately misguiding its clients, and betting against them. let us now take a closer look at the banking business in general : where and why could things go wrong the way they did? a bank is an intermediary between people who have more money than they want to spend, and people who would like to borrow money. put briefly, a bank ’ s business is to earn money with money. in some cultures and traditions this is considered inherently immoral. in our society, we find this perfectly acceptable, and even consider it indispensable for our economy to function properly. the past few years have clearly shown, however, how things can go amiss. as the former chief economist of the imf, raghuram rajan, put it : “ because [ bankers ’ ] business typically offers few pillars to which they can anchor their morality, their primary compass becomes how much money they can make ” ( rajan 2010 : 126 ). the question, then, is

and the link made by markets of the cost of funding of banks with that of their respective sovereign. such negative effects may potentially be better mitigated in political federations given their stronger shock - absorbing institutions. for example, if a particular state in the u. s. were to experience a build - up in private sector liabilities that threatened its local banks, the responsibility for recapitalisation and deposit insurance would fall on the federal government – through institutions like the u. s. treasury and the federal deposit insurance corporation. this means that a u. s. state cannot be brought into financial difficulties by a mismatch between the size of its banking sector and that of its local economy, whereas a euro area country can – as we saw in ireland. on the real side of the current account, persistent trade imbalances within the euro area also reflect accumulated competitiveness losses in deficit countries. the problem may be masked while growth is driven by credit and consumption, as was the case in some euro area countries before 2008. but when there is a reversal in financial flows and foreigners are no longer willing to finance the further accumulation of external debt, accrued competitiveness losses come to the fore. this can result in particular regions suffering sustained low growth and unemployment. bis central bankers ’ speeches again, these negative effects may be more manageable with the shock - absorbing institutions of a political federation. a homogenous language and culture may facilitate labour mobility, providing one channel for adjustment – although recent evidence suggests this effect is not as significant in the u. s. as previously thought. at the same time, having a large federal budget creates a natural stabiliser as federal spending on “ big ticket ” items like social security, healthcare and defence redistributes incomes between rich and struggling regions. constructing a sui generis response it is clear that the way ahead for the euro area cannot involve trying to construct the institutions of a political federation overnight. this implies that the euro area needs a different approach to ensure the smooth functioning of monetary union that can compensate for some of these “ missing institutions ”. this approach has two main pillars. the first pillar is to strengthen fundamentally the governance procedures which prevent imbalances from arising. with fewer shock - absorbing institutions to mitigate crises when they arise, the euro area has learned that it must become more effective at preventing imbalances. this process has involved tightening the rules for fiscal policies and creating a much needed framework to monitor broader macroeconomic im