one of the few business - led recessions in the united states since the end of the second world war. most recessions since then have been brought on by sharp cutbacks in spending by households, with housing and consumer durables among the most sensitive sectors. the recent experience was clearly different. consumer spending and residential investment were both relatively well maintained throughout 2001, even as firms cut employment and stock market losses eroded household wealth. despite only modest increases in nominal wages and salaries, households'real disposable income was supported by tax cuts and lower inflation. in addition, low interest rates helped promote spending. as you know, consumers took advantage of falling mortgage rates to buy new homes, to refinance their existing mortgage debt, and to tap into their increasing home equity to pay off more expensive debt or to finance spending on other things. as a result, the contraction in real gdp during the first three quarters of 2001 turned out to be quite shallow despite the disruptive economic fallout from the horrific events of september 11. by early last summer, economic recovery appeared to be under way. real gdp increased at an annual rate of roughly 3 - 1 / 2 percent over the first three quarters of the year. businesses seemed to have brought their inventories into better alignment with sales, and employment began to rise again, though the gains were too small to make a dent in the unemployment rate. a particularly encouraging development, given the nature of the downturn, was that the contraction in business investment appeared to be slowing while household spending, still supported by low interest rates and gains in real disposable income, continued to trend up. although the government statistics were looking a bit better, signs appeared over the summer that the economy's resilience would be tested by several new shocks. as a banker who experienced several previous economic downturns, i know that whatever weaknesses exist in our economy become problematic at the low point of the economic cycle. at such times, we typically see loan losses and evidence of weak business models. what emerged in early 2002 was not what i had expected. the enron and worldcom scandals raised serious concerns about the adequacy of the corporate governance system and tended to cloud the outlook for business expansion. abroad, mounting tensions with iraq were beginning to take their toll on consumer and business confidence. the stock market moved down again, conditions eroded in corporate debt markets, and risk spreads widened. as we moved into the fall, industrial production faltered, and business investment

have the opportunity to enhance the stress tests by, for example, varying the scenario for stressing the trading books of the largest firms, so as to reflect changes in the composition of those books. as to regulatory measures of capital outside the customized context of stress testing, one approach is to revisit the calibration of two existing capital measures applicable to the largest firms. the first is the leverage ratio. u. s. regulatory practice has traditionally maintained a complementary relationship between the greater sensitivity of risk - based capital requirements and the check provided by the leverage ratio on too much leverage arising from low - risk - weighted assets. this relationship has obviously been changed by the substantial increase in the risk - based ratio resulting from the new minimum and conservation buffer requirements of basel iii. the existing u. s. leverage ratio does not take account of off - balance - sheet assets, which are significant for many of the largest firms. the new basel iii leverage ratio does include off - balance - sheet assets, but it may have been set too low. thus, the traditional complementarity of the capital ratios might be maintained by using section 165 to set a higher leverage ratio for the largest firms. the other capital measure that might be revisited is the risk - based capital surcharge mechanism. the amounts of the surcharges eventually agreed to in basel were at the lower end of the range needed to achieve the aim of reducing the probability of these firms ’ failures enough to offset fully the greater impact their failure would have on the financial system. at the time these surcharges were being negotiated, i favored a somewhat greater requirement for the largest, most interconnected firms. 8 here, after all, is where the potential for negative externalities is the greatest, while the marginal benefits accruing from scale and scope economies are hardest to discern. while it is clearly preferable at this point to implement what we have agreed, rather than to seek changes that could delay any additional capital requirement, it may be desirable for the basel committee to return to this calibration issue sooner rather than later. the area in which the most work is needed is in addressing the risks arising from the use of short - term wholesale funding by systemically important firms. the systemic risks associated with runs on wholesale funding would, almost by definition, be exacerbated if a very large user of that funding were to come under serious stress. there could also be greater negative externalities from a disruption of large, matched