subprime crisis has led to calls for an international overseer charged with keeping a complete account of the financial flows and pipelines that transfer contagion across borders in order to provide an early warning system to identify emerging crises. in a speech two weeks ago, british prime minister gordon brown proposed a new role for the imf : “ … its role should be to prevent crises and not simply manage or resolve them as in the past. and in a wider role the imf, working with the global financial stability forum, should be at the heart of what we need – an early warning system involving regulators and supervisors in all countries for financial turbulence affecting the global economy. ” 4 financial times january 26, 2008. speech at the chamber of commence in delhi, 21 january 2008. obviously, there are pipelines that are not on our present maps. also, our knowledge of what flows through the known ones is scarce. but would it help us if we knew? would we be able to predict a looming crisis and thus prevent it? i do not have the answer to this, but i think it is fair to raise the question. we must expect turmoil in financial markets to occur from time to time. there will always be stupidity and greed, fear and euphoria ( and some scoundrels ). accidents will happen. authorities should strive to establish regulatory frameworks that give the right incentives for prudent behaviour. it is important to avoid overregulation that severely restricts markets and stifles innovation. we must of course make sure that obvious shortcomings in existing regulations are corrected. one such loophole was the possibility for banks to provide shortterm guarantees without having to set aside regulatory capital. the new capital adequacy framework, basel ii, rectifies this situation. it is also important to encourage market discipline and counterparty surveillance, crucial elements to the well functioning of financial markets. basel ii is enhanced through the so - called pillar iii, which requires banks to publish information on key parameters of their business profile, risk exposure and risk management. the recent episodes have also reminded us of the importance of vigilance and competence in supervision. in general, the markets themselves are the best regulators as long as economic agents follow the advice of sir john gieve, deputy governor of the bank of england : “ financial markets … can only work well if investors and firms expect to live or die by their own decisions and do not come to rely on a safety

banks : restoring market function and confidence, ” remarks at the panel session “ monetary policy boundaries : alternative instruments and policy coordination ” at the money and banking conference sponsored by the central bank of argentina on sept. 1, 2009, available online at http : / / www. boj. or. jp / en / type / press / koen07 / ko0909a. pdf. if a decision maker ’ s confidence is “ contaminated ” or eroded in the sense that he / she thinks, though with a small probability ( say ε ), that he / she is ignorant about the situation he / she faces, his / her rational behavior can be described as “ maximin ” optimization. in the maximin optimization, he / she is particularly sensitive to the worst - case scenario. see, nishimura, k. g., and h. ozaki ( 2006 ), “ an axiomatic approach to εcontamination, ” economic theory, vol. 27 ( 2 ), pp. 333 - 340. also, the fed expanded swap lines with other central banks to enable other central banks to provide further dollar liquidity. a significantly longer duration of liquidity - provision operations helped to substantially reduce financial institutions ’ fear over procuring longer - term liquidity. the expansion of counterparties and collateral eligibility secured them new no - risk funding sources, that is, central banks, to partly alleviate a lingering fear of counterparty risks in money markets. i think no additional words are needed about their put - option characteristics of the asset purchase programs. looking ahead : no free umbrella against plain old rain clearly, central banks ’ provision of catastrophe insurance measures has worked quite well, together with various governmental measures of similar characteristics. 4 immediate dangers have subsided, though we are still facing a possibly bumpy adjustment process after the collapse of the “ credit bubble ”. in order to look ahead, the following two points should be kept in mind. first, these catastrophe - insurance measures are in fact “ free ” insurance. beneficiaries of these measures do not pay fair, or, in many cases, any premium for these hedges. rather, central banks and governments implemented these measures against the “ unusual and exigent ” circumstances of contagious confidence erosion. thus, the measures were to be temporary. a permanent provision of such free put - like options obviously distorts the market mechanism and prompts undesirable risk taking or “ moral hazard. ” to