timothy f geithner : credit markets innovations and their implications remarks by mr timothy f geithner, president and chief executive officer of the federal reserve bank of new york, at the 2007 credit markets symposium hosted by the federal reserve bank of richmond, charlotte, north carolina, 23 march 2007. * * * i am grateful to jeff lacker for including me in this conference, and my compliments to him and the richmond fed for bringing together an excellent group to discuss the implications of recent innovations in credit markets. the past few years have seen remarkable changes in credit markets, and this is a good time to take stock of what we know about those developments and their implications. the latest wave of credit market innovations has elicited some concerns about their implications for the stability of the financial system, concerns similar to those associated with earlier periods of rapid change in financial markets. will the most recent credit market innovations amplify credit cycles, contributing to " excessive " lending in times of relative stability, and then magnify the contraction in credit that follows? will they introduce greater volatility in financial markets? will they create greater risk of systemic financial crisis? these concerns have been heightened in some quarters by the problems currently being experienced in the subprime mortgage sector. it will take some time before the full implications are understood and the full impact can be assessed. as of now, though, there are few signs that the disruptions in this one sector of the credit markets will have a lasting impact on credit markets as a whole. indeed, economic theory and recent practical experience offer some reassurance against both these specific concerns and more general worries about the implications of credit market innovations for the performance of the financial system. the rapid growth in these new types of credit instruments is, of course, a sign of their value to market participants. for borrowers, credit market innovation offers the prospect of increased credit supply ; better pricing ; and a relaxation of financial constraints. for investors, new credit instruments bring the prospect of broader risk and return opportunities ; the ability to diversify portfolios ; and increased flexibility. and for lenders, innovations can help free up funding and capital for other uses ; they can help improve credit risk and asset / liability management ; and they can improve the return on capital and provide new and cheaper funding sources. by spreading risk more broadly, providing opportunities to manage and hedge risk, and making it possible to trade and price credit risk, credit market innovation should help make markets both more

accurately reflect climate - related risks to real estate, physical facilities, and companies that are subject to these risks through financing arrangements or supply chains. as we have seen in california and in florida, insurance companies can pull back from insuring properties see brunetti and others, “ climate change and financial stability, ” in note 11 ; see also sonia i. seneviratne, neville nicholls, david easterling, claire m. goodess, shinjiro kanae, james kossin, yali luo, jose marengo, kathleen mcinnes, mohammad rahimi, markus reichstein, asgeir sorteberg, carolina vera, and xuebin zhang ( 2012 ), “ changes in climate extremes and their impacts on the natural physical environment ” in matilde rusticucci and vladimir semenov, eds., managing the risks of extreme events and disasters to advance climate change adaptation ( cambridge university press, cambridge and new york ), pp. 109 – 230. see, for example, antonio grimaldi, kia javanmardian, dickon pinner, hamid samandari, and kurt strovink ( 2020 ), “ climate change and p & c insurance : the threat and opportunity, ” mckinsey insights, november 19, https : / / www. mckinsey. com / industries / financial - services / our - insights / climate - change - and - pand - c - insurance - the - threat - and - opportunity : “... insurers could play a role in matching risk transfer solutions to alternative capital from investors with more risk appetite. ” - 7and facilities in geographic areas subject to heightened flood or fire risk or seek to raise insurance rates on these properties and facilities to more accurately reflect risks. 14 although such changes may ultimately result in a more accurate assessment of actual risks, the abrupt changes to a wide range of contracts that embed systemic mispricing could initially amplify the shock. it is also increasingly apparent that the value and, in some cases, the usability of real estate in many areas will be directly affected by the increased risks of floods, wildfires, severe storms, and sea - level rise associated with climate change. the direct effects on homeowners and businesses are geographically concentrated and can have severe effects on safety and the usability of properties. as climate risks grow over time, the mortgages on these properties may become riskier, along with financial instruments involving these mortgage