market share, combined with unrealistic expectations about growth and performance prospects. but no matter how much risk exposures get sliced, diced and distributed among financial market participants, financial innovation cannot mask poor underwriting. at the same time, the additional complexity, opacity and leverage resulting from certain structured products and offbalance sheet vehicles further magnified the problem, as it has not been sufficiently clear where the ultimate risk lies. this brings me to my second point. risk management infrastructure and financial innovation indeed, the second fundamental shortcoming is the wide disparity between the rapid pace of financial innovation and the risk management infrastructure on which this innovation was built. when i spoke at last year ’ s garp conference, i noted that the linkages between the various segments of the credit markets and financial institutions had been fundamentally altered. this is mainly due to increased market - based credit intermediation, or the originateto - distribute model. historic or statistical measures of risk and exposure, such as value - at - risk, past loss experiences and name concentration in the traditional banking book have proved inadequate when assessing relationships in the originate - to - distribute model and how they may perform under stress. in fact, the use of these and other historic measures resulted in a massive understatement of stressed losses, which were far below the actual losses experienced to date. as i suggested at last year ’ s conference, the greater reliance on securitisation and other risk transfer mechanisms means that banks are more vulnerable to exposures building up or returning to the balance sheet when market liquidity seizes up. in addition, increased reliance on market liquidity means that problems in financial markets can adversely – and very quickly – affect banks ’ funding liquidity. however, for those institutions that stress test funding capabilities, many only assumed a firm - specific event. the problems arising from poor underwriting were compounded by failures to manage firmwide concentrations. many firms were unaware of their overall exposure to subprime mortgages and related structured products, such as cdos, whose repayment depend on such mortgages. these concentrations went far beyond traditional loan portfolio exposures and included cdos and mortgage - backed securities held in the trading book ; liquidity facilities extended to conduits ; reputational exposures to sponsored sivs ; and counterparty exposures to the monoline sector. in addition to failing to understand their firm - wide concentrations, many institutions could not readily nor easily aggregate their subprime exposure

forms of co - ordination, there is only one single policy, that is the exchange rate policy of the euro area as a whole. but different institutions are responsible for making it work. before discussing these different forms of policy co - ordination, however, i will provide an intellectual framework for the discussion by briefly outlining the limitations of economic policy - making as such. in other words, one cannot discuss how to play a symphony before knowing how to play the instruments. how to play an instrument? traditionally, economists distinguish between - at least - two instruments of economic policy - making : fiscal and monetary policy - making. as far as fiscal policy is concerned, three main functions can be distinguished. first, the allocation function or the provision of public goods. second, the redistribution function, or the adjustment of income and wealth to what society considers a ‘ fair ’ distribution. third, the stabilisation function, or the use of fiscal policies to stabilise the business cycle. when discussing policy co - ordination in the context of emu, the focus is on the latter function of fiscal policy, which does not imply that there is no role for the other functions. in the literature, the restrictions of the stabilisation function have come to the fore. as we have learnt from the experiences in the 1970s, fine - tuning has its difficulties, because of the time lag between the decision of measures and its effects, and - even more important - because of the lack of detailed information necessary for this kind of policy. apart from the fine - tuning problem, there is the potential problem of time inconsistency, since a government may be tempted to pursue an inconsistent policy for the sake of short - term gains, for example in the run - up to elections. under these circumstances, it is tempting to increase expenditure or reduce taxes. in other words, playing - 2the fiscal violin is not a piece of cake. indeed, it takes good musicians years to learn to master the vibrato of this instrument. pursuing monetary policy for the sake of short - term stabilisation is even more complicated than in the case of fiscal policies. although monetary policy - making is not so much hampered by the lack of detailed and recent information, the time lag problem is even severe than in the field of fiscal policies, especially because in monetary policies time lags may differ substantially from case to case. the time lag problem is linked with the fact that the transmission process of monetary policy in the real