as you all know, share prices quickly recovered, and implied volatility reverted to near - record low levels. what lessons can be drawn from such an episode? perhaps because of more complete markets, shocks to liquidity are less likely to become self - fulfilling and less likely to impose more lasting damage. that hypothesis seems particularly credible when the shock is based neither on rapidly changing economic fundamentals nor a genuine breakdown in market infrastructure. in the recent episode, opportunistic capital apparently viewed large movements in asset prices as trading opportunities. or, perhaps, striking as it was, we have not yet witnessed a scenario that subjects the latest product innovations and behavior of market participants to a sufficiently stringent stress test. some highly - leveraged private pools of capital may be unable to ride out bouts of very high turbulence if they are compelled to sell assets to meet margin calls or withdrawals, and by so doing, amplify the initial shocks. the losses would be sharper and correlations would be higher for assets in which markets quickly become shallow. in theory, to the extent that more complete markets yield deeper, more robust asset markets and better - diversified positions, the dynamics of the disturbance should be more manageable. but, the question of actual experience versus theory remains. of course, a reduction in liquidity rooted in economic fundamentals would likely be more protracted and beget far more serious consequences. in a period of sustained and diminished liquidity, it is indeed plausible that financial intermediaries could revert to their traditional roles, thereby likely worsening the efficiency and completeness of markets. in such a case, those who pine for the good old days and purported good old roles of commercial and investment banks might not enjoy the economic environment that accompanies their return. even so, over the long - term, i remain a watchful optimist : reductions in liquidity are unlikely to turn back the clock on financial innovation. the knowledge of how to bundle, distribute, and price risk cannot be erased from our collective memories. nor can this knowledge be walled off from the rest of the world by one country or financial center. the culture of capitalism remains on the march. firstmover advantages are growing, even while the half - life of financial innovation is shrinking. the growth of competing financial centers around the globe is testament to the enduring power of financial innovation and the dynamism of financial intermediaries. in my judgment, while the completeness of markets will remain an

kevin m warsh : financial intermediation and complete markets remarks by mr kevin m warsh, member of the board of governors of the us federal reserve system, at the european economics and financial centre, london, 5 june 2007. * * * thank you for the opportunity to speak today about financial intermediation and developments in the capital markets. new financial instruments and changing models of financial intermediation are having a profound impact on global financial markets. london, home to one of the world ’ s fastest growing and much admired financial centers, represents a most appropriate venue to discuss these changes. 1 during the past few decades – particularly the last few years – we have witnessed an escalating supply of new financial instruments scarcely able to match surging demand. through the technique of unbundling risks – dividing them by category and tranche – financial instruments proliferated to enable risks to be borne by those most willing to accept them. and with the benefit of ample liquidity, which i described in previous remarks as broadly equal to confidence, financial products quickly found deep markets, ensuring robust trading. 2 indeed, liquidity - fueled innovation has made markets substantially more “ complete ” – that is, more risks are more readily priced and traded without significant diminution in value than in prior periods. 3 the concept of “ complete markets ” is, in my view, a useful, aspirational, and theoretical construct, even though perfectly complete markets, in which every agent is able to costlessly trade claims on every state of the world, represents an unachievable goal. after all, the fundamental departures from the complete markets paradigm – transactions costs and asymmetric information – will never vanish. nevertheless, in these heady times, one wonders whether some market participants may treat recent developments as a testament to an all - but - assured path to complete markets. in my remarks today, i will discuss how liquidity and financial innovation are making markets more complete – or more precisely, less incomplete – than in earlier periods. 4 i will also describe how the acceleration toward complete markets conflated the roles among financial intermediaries. finally, i will consider the possible consequences should this trend toward complete markets be slowed or upended by some form of negative liquidity shock. financial intermediation : remembering the “ good old days ” broadly speaking, intermediaries facilitate the transfer of capital and risk between borrowers and savers. the case for financial intermediation rests on two premises