default are important for addressing the risks inherent in a market where the value of derivatives substantially exceeded the value of the underlying instruments. we are encouraged by the progress made to date, and will continue to encourage further improvements. second, we believe that the major dealers, as well as the large commercial and investment banks, should take a cold, hard look at financing conditions and margin practice, particularly with respect to hedge fund counterparties and in otc derivatives. the reports issued by the counterparty risk management policy groups i and ii both make the important observation that the financial system is likely to be more resilient under conditions of stress when counterparties set initial margins at levels that are likely to be sustainable in less benign conditions. when margin levels are set more conservatively, firms are likely to have more flexibility in responding to stress and are less likely to take action that might amplify the market shock and exacerbate the reduction in liquidity. when competitive pressure drives margins down, markets may be less resilient. third, we believe the major financial institutions need to continue to improve their capacity to measure their exposure to risk in a less benign market and economic environment. the discipline of stress testing and scenario analysis that is designed to measure tail risk is at the frontier of this challenge. senior management and boards of directors need to understand the limitations and uncertainty that pervade the tools we use to assess these risks, to try to better understand the potential scale of losses the firm may face, and to carefully examine how well risk exposures reflect the overall risk appetite of the firm, and the size of the capital and liquidity cushion maintained in relation to those exposures. let me conclude by reiterating the fundamental view that the wave of innovation underway in credit derivatives offers substantial benefits to both the efficiency and stability of our financial system. the extent of these benefits will depend, in part, on the degree to which market participants can keep up with the pace of change in the market through continued investment in both risk management and in the processing infrastructure. we have been through a period of relatively favorable financial conditions, and the prospect for future stability will depend in part on the degree of care and conservatism market participants bring today to judgments about opportunity and risk management. thank you.

challenge is substantially more difficult in markets where there have been dramatic changes in the instruments involved, in the nature of the participants and in the structure of the markets. we tend to look more closely at things we can measure than those we cannot. we are drawn to approaches that offer the comfort of precision and tend to look past the wide band of uncertainty that surrounds those estimates. measuring these broader risks is harder today because the classic array of historical stress events drawn from the past 25 years of financial crises are probably even less valuable than they were as an illustration of how market dynamics might unfold today in response to similar changes in asset prices and credit losses. those past crises would likely cause less damage today, if they were to recur, because of the many changes in the structure of our financial system - namely, the greater dispersion of credit and market risk, the improvements in risk management, the size of the capital cushions, and the improvements in many parts of the payment and settlement infrastructure. but most crises come from the unanticipated. assessing a firm ’ s exposure to risk in the tail of the distribution requires, among other things, an evaluation of the impact of the failure of a major counterparty and the impact that failure might have on other counterparties and on market prices. it requires, for the largest institutions, an understanding of the constraints the firm may face in its ability to adjust positions or hedge against further losses without amplifying the shock. and it requires anticipating potentially adverse effects on market liquidity, as other market participants react to actual and anticipated losses. in the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank - centered financial systems. and the increase in the diversity of nonbank financial institutions that hold risk may also serve as a stabilizing force in credit markets. but the greater relative importance of nonbank financial institutions also means that distress among these institutions has the potential to have a substantial impact on market behavior and liquidity. understanding these relationships is an important part of the risk management challenge for banks, even in a world where derivatives have helped spread risk more broadly. the innovations that have taken place in the credit derivatives market were driven to a significant degree by the losses experienced in past crises, but most of the growth in this market has occurred in relatively favorable overall economic and financial conditions. this wave of innovation in credit markets has occurred in an environment in which : • the price of