demand elsewhere. why worry? in this ideal world where markets operate efficiently, without distorting policy interventions, imbalances can resolve themselves in a smooth and orderly manner. but we don't live in an ideal world. domestic labour markets in europe and asia are not very flexible, and reallocation of labour resources is difficult. domestic fiscal and social policies often stifle investment and encourage excessive savings in some parts of the world and overstimulate consumption in others. and there are still persistent impediments to the free flow of goods and services across borders. meanwhile, some domestic banking sectors and capital markets continue to operate under rigid and inefficient regulations. and some important economies, particularly in asia, are maintaining undervalued exchange rates through exchange market interventions and capital controls. in the process, they are accumulating excessive reserves. because of these issues — inflexible labour markets, inappropriate fiscal policies, barriers to open trade, and dysfunctional capital markets — market - equilibrating mechanisms are not being allowed to work as they should. and so there are risks that these current account imbalances will persist until they are resolved in a disorderly way. what are the risks? let me spend a few minutes outlining these risks. the first risk is that private and public savings in the united states will rise and that spending will decline without a compensating increase in demand in the rest of the world. if that drop in u. s. demand is not matched by higher demand in other countries, the global economy could slide into a phase of very slow growth, perhaps punctuated by periods of outright recession. a second risk is that investors could dramatically reduce their exposure to the united states, which could cause major disruption in world financial markets. instability in the financial sector could spill over into trade in goods and services, leading to an even more dramatic decline in demand and output. a third risk is that these events might also prompt governments to adopt wrongheaded protectionist measures, which would exacerbate the damage to the global economy. economic theory and history tell us that external indebtedness cannot keep growing indefinitely as a share of a country's gdp - even for a country like the united states with its reserve - currency status. there is no compelling reason to believe that historical and fundamental economic and financial constraints do not apply to the world economy today. there is no reason to believe that this time is different.

investors substituted the judgments of credit - rating agencies and others for their own due diligence. this opened the door to abuses in the creation of increasingly complex and opaque structured products with embedded leverage, and in the origination of loans intended for redistribution. these problems were compounded by a distinct disregard for economic fundamentals, which led many borrowers and lenders to discount the risk of a correction in house prices long after activity in the u. s. housing market had peaked. when the problems finally surfaced, the sudden realization that exposure to defaults was both widespread and difficult to locate led to extreme risk aversion and to a broad loss of confidence that impeded credit expansion and weighed heavily on economic activity. canada's financial system has fared relatively well throughout this global crisis, thanks to prudent practices and the important steps that we have already taken in canada to make our system more resilient to shocks. to be sure, our markets have been strained as a result of the global financial crisis but, for the most part, they have remained open. importantly, banks have continued to extend credit, albeit on tightened terms. still, the system has not performed as well as it should have. bank funding costs have come under pressure, and bond issuance has virtually ceased. further, our economy is now in recession as a result of the weakness in global economic activity engendered by the financial crisis. risk management : lessons from the current crisis the current global situation has clearly demonstrated the importance of sound risk management. so, let me turn to lessons that we can draw from the crisis to develop more robust risk - management processes in the future. as i noted earlier, a key contributing factor to the global financial crisis was the very high leverage embedded in structured products and actively pursued by some financial institutions – primarily those outside canada. in their search for higher returns, institutions took on more and more risk, while paying less and less attention to the consequences. risk - management models ( such as estimates of value at risk ) that were based on a short history of data and a presumption of continuous liquidity did not prepare them for crisis conditions. reliance on these models led to a myopic focus within institutions that ignored the risk of a significant disruption to the financial system if everyone reacted to a large shock in the same way. consequently, when significant problems emerged, and correlations between asset - price movements moved towards unity, institutions were often ill - prepared to cope, because they