the financial system mirror each other, such as npl problem usually reflects troubles with firms in the real economy. at the same time, it may also reflect problems in accounting practice, information disclosure, and corporate governance. one characteristic of the modern economy is that the financial system is a barometer for the entire economy : troubles in the real economy are often first broken out in the financial system. problems in the financial system, however, are not caused by the financial system alone. second, problems in developed countries, particularly in those emerged in mature market economies, are often relatively new as these economies are often places where financial innovation activities are concentrated. these problems are so new that market participants and regulators alike have a hard time predicting their course. naturally, it ’ s a big challenge to find solutions. in comparison, problems faced by the emerging markets or developing countries are more often a repeat of those already experienced by the developed economies. thus, the way for dealing with instability often can more probably be drawn from the international historical experience. rethinking financial instability or turbulences first, if an economic system or policies are flawed, sooner or later they will be forced to be corrected ; this is an objective law in the functioning of the market economy. the us subprime turbulence is a clear case. individuals without sufficient ability to repay and failing to meet loan standards were nonetheless given large amount of home loans. at some point, such hidden risks would have to surface. when an obvious bubble forms in an economy, bursting problems are bound to emerge with time. second, risks to the financial system brought by indirect financing are much higher than those tied to direct financing. so we say “ debt is more dangerous ”. institutional investors including pension funds, mutual funds, hedge funds, private equity funds, etc, presumably know and undertake relevant risks inherent in the investment. problems that arise are thus comparatively less painful to be absorbed. a recent estimate of the amount of the subprime mortgage securities is about us $ 200 billion. if these risks are truly spread among the institutional investors and other direct investors, it should not be so hard for an economy as large as the u. s. to absorb the losses ( all the more so given some of the burden will fall on europe, japan and even, to a much less extent, china ). so why, against most expectations, did this turbulence continue spreading? an understanding lies in the fact that while some of the investment risk was carried by direct investors, certain

to increase microeconomic flexibility. in other words, the adaptability of the micro entities to changes in prices as well as in market supply - demand should all be improved, thus avoiding the introduction of excess rigidity in pricing, supply, demand, and institutional design. sixth, to guard against and manage instability, developing countries must raise levels of confidence in their currencies, markets and central banks. key points here include maintaining the stability of currency value, adopting a flexible exchange rate policy, supporting confidence in currency convertibility, increasing the economy ’ s ability to deal with all kinds of shocks, and exercising regular assessment of the economy, so as to provide early warning about risks forming within the economy, and research and prepare contingency plans. imf ’ s annual surveillance mechanism – including the “ article iv consultation ” – functions as an effective tool for regular health check - up of the member economies. seventh, it ’ s truly an art to find the subtle balance needed for anti - crisis policy - making. it ’ s important to avoid creating too much moral hazard by bailing out institutions whose own operations lead to major mistakes. at the same time, it ’ s necessary to consider the impact on the real economy : if a crisis impact on the real economy and social confidence are severe, or it may result in a system - wide chain reaction, a prompt action would be required. of course, the reactions will vary under different circumstances. as the subprime mortgage crisis develops, we are carefully observing two recent policies. first, about 2 million american subprime home loan recipients face their problem to fully repay their mortgages. if foreclosure is enforced, it may lead to further declines of the housing prices. during the process, the government may wish to take steps to help poor people through their difficulties. but the fundamental issue is that people who didn ’ t meet loan conditions probably should not have bought such large houses. will the government ’ s provision of aid or subsidies lead to moral hazard? should the resulted loss be borne by the taxpayers? second, some us ( as well as a handful of european ) financial institutions employed sivs or other conduits to take on additional risk exposure. should these institutions be bailed out? several big us banks have recently created a “ super conduit ” worth us $ 75 billion, trying to help alleviate the crisis. but in so doing, how it is going to price the risk of related products? will this simply create