preceded this crisis, but they may have amplified the dimension of the boom and they were important to how the crisis unfolded and to how policy has responded. in many respects, financial innovation over this period outpaced the system ’ s capacity to measure and limit risk, to manage the incentive problems in the securitization process and to provide for an appropriate degree of transparency through meaningful disclosure. once the performance of the underlying assets began to deteriorate, these weaknesses in the system magnified the uncertainty about the scale of potential losses and added to the intensity of pressures that accompanied the crisis. the growth in leverage and liquidity risk outside of banks made the system vulnerable to a sharp erosion in liquidity, but without the protections established to limit the risk of classic bank runs. the large share of financial assets held in institutions without direct access to the fed ’ s traditional lending facilities complicated the ability of our traditional policy instruments to contain the damage to the financial system and the economy. this crisis provides a stark illustration of how hard it is for a supervisory and regulatory framework designed principally around banks to contain the impact of financial shocks in a manner that mitigates the risks to the broader economy. elements of reform what broad principles and objectives should guide reform? i would like to outline some of the key elements of a stronger framework of regulation and oversight, and identify some of the harder questions we will need to answer to implement this framework. these questions are more fundamental than questions of the allocation of responsibility across supervisors, market regulators and central banks and thus must be resolved before turning to those questions. i focus here on the issues related to financial stability, and do not try to address the equally important areas of consumer and investor protection, market integrity or the role of the government - sponsored entities in housing. i believe the most important imperative is to build a financial system that is more robust to very bad outcomes and more resilient to shocks. this means ( 1 ) a system in which the major institutions are less vulnerable to shocks ; ( 2 ) a system that is less vulnerable to margin spirals and a generalized pull - back in liquidity and funding ; and ( 3 ) a system that is more able to withstand the effects of failure of a major financial institution. looking past the immediate crisis, a more resilient system must be built on stronger and better designed shock absorbers, both in the major institutions and in the infrastructure of the financial system. at the level of the financial institution, the key financial shock

timothy f geithner : systemic risk and financial markets testimony of mr timothy f geithner, president and chief executive officer of the federal reserve bank of new york, before the committee on financial services, us house of representatives, washington dc, 24 july 2008. * * * good morning, chairman frank, ranking member bachus and other members of the committee. thank you for giving me the opportunity to testify today. i very much welcome the opportunity to appear before you with chairman cox of the securities and exchange committee ( sec ). the federal reserve and the sec are working very closely together in navigating through the present challenges, and my colleagues at the fed and i very much appreciate his, and his colleagues ’, support and cooperation. the u. s. and global financial systems are going through a very challenging period of adjustment. the critical imperative today is to help facilitate that adjustment and to cushion its impact on the broader economy. the forces that made the system vulnerable to this crisis took a long time to build up, and the system will need some time to work through their aftermath. looking forward, the united states will have to undertake substantial reforms to the framework of policy, regulation and oversight of the financial system. there was a case for reform before this crisis. the regulatory framework in the united states was designed in a different time for a very different type of financial system than the one we have today. nonetheless, many observers believed that this framework, although messy and complex, worked reasonably well. it is harder to make that case today. the financial system plays a vital role in long - term economic growth by helping to efficiently allocate the resources of savers to those individuals and firms with ideas and the capacity to put those ideas into action. and the financial system plays a critical role in economic stability by affecting the capacity of the real economy to withstand shocks and the ability of macroeconomic policy to mitigate the impact of those shocks. the challenge is in achieving the right balance between efficiency and resilience, between innovation and stability. our financial system has many strengths, and we need to examine ways to build on those while making the system more resilient to future shocks. achieving this balance will involve a very complicated set of policy choices. until we get through this crisis, it will be hard to make definitive judgments about the appropriate scope and nature of the changes that will be necessary. any reform must offer the prospect of a substantial improvement in outcomes relative to potential costs. and those