the potential for unintended market reactions by communicating their goals and economic outlook as clearly as possible to inform market expectations and thereby avoid possible misperceptions about the future path for policy. the record shows that on occasion monetary policy has been used to counter financial instability. these incidents arise when financial instability is so great that the financial markets themselves seem to become incapable of intermediating effectively and, partially as a result of these market weaknesses, the economic outlook has been revised down sharply and the downside risks to that outlook have become quite large. naturally, at those moments, asset prices as well as market functioning become a focus for policymakers. however, this does not mean that policymakers have particular targets for those asset prices - - that they seek to place a floor under such prices, as some have inferred. rather, in those situations asset prices are evaluated in the context of all the factors bearing on the economic outlook, just as when markets are orderly, though financial market conditions in all their aspects play a particularly prominent role in such an evaluation when markets are stressed. bank supervision the concentration in banking structures that i referred to earlier, coupled with the growing scope of permissible bank activities paralleling the evolving nature of the world ’ s financial markets, has had some profound effects on bank supervision. for one thing, supervisors worldwide have increasingly shifted the emphasis of their concern toward large banks ’ internal risk - management policies and systems and relatively away from individual bank positions and transactions. much of this shift in emphasis has reflected changes in banks ’ own internal policies, as increases in the scale and scope of operations have required different control and management systems to maximize risk - adjusted profits. in addition, the change has reflected the need to alter supervisory strategy to address the reality that earlier techniques are inadequate for large, complex entities, especially given supervisors ’ limited resources. the same motivations have induced u. s. and other supervisors to emphasize transparency and disclosure by the largest banks in order to exploit the potential market discipline as a supervisory supplement. market discipline, in turn, requires not only disclosure, but also the expectation that bank counterparties face a risk of loss. government guarantees in the name of stability may actually pose a greater risk of bank difficulties by reducing market discipline, or, alternatively, could require more intrusive supervision, reducing the innovative market dynamics i mentioned earlier. if you see in these developments the seeds of basel ii - in their requirements for better risk - management systems and greater disclosure - you understand the

, if exposures change over time and one party comes to represent a credit risk to the other, the party posing the credit risk will post collateral to cover some ( or all ) of the exposure. these programs offer market participants a powerful tool for helping control credit risk, but they also embody substantial documentation and operational challenges. alternative procedures could lead to risk reduction in many areas of the settlement of otc derivatives. collateral programs themselves could be strengthened to provide even greater benefits. need to address backlogs. most dealers acknowledge that the failure to confirm trades heightens the risk that the transaction will be unenforceable. because unconfirmed trades create the potential that errors in trade records and management information systems will go undetected, they also create the possibility that both market and credit risk will be measured incorrectly. quantitative measures of market risk and credit risk are only as good as the transaction data on which they are based. most firms active in the markets recognize the need to address the backlogs in confirmations. the crmpg report, for example, directed several recommendations toward firms ’ need to improve market practices in this area, and it set a target of confirming trades within five days of the trade date. the problem of backlogs can be attacked from two directions. first, individual firms can strengthen their policies with regard to confirmations. they could monitor backlogs more carefully and devote resources to reducing those backlogs. they could enhance internal systems for capturing trade data and generating confirmations. management can place a priority on reducing the backlog and assign clear responsibility for such reduction. second, backlogs can be reduced by standardizing and electronically matching confirmations or by developing electronic trading systems that create a match at the time of the trade. these latter methods for reducing backlogs clearly must be pursued collectively. a system for electronically matching confirmations will be helpful only if substantial portions of a firm ’ s counterparties use the same system. similarly, electronic trading systems require a critical mass of participants. need to strengthen collateral management practices. the volatile market conditions that surrounded the ltcm episode provided a test of many firms ’ risk management systems and particularly their collateral programs. during the episode, collateral successfully mitigated credit risk, as designed. however, events also highlighted weaknesses in current policies and programs. these weaknesses have been examined in some depth in studies both by banking supervisors and by isda. it is important to address them because improperly managed collateral programs may give