kevin m warsh : remarks on covered bond framework speech by mr kevin m warsh, member of the board of governors of the us federal reserve system, at the us department of the treasury press conference on covered bond framework, washington dc, 28 july 2008. * * * on behalf of the federal reserve, i am pleased to join secretary paulson and my fellow bank supervisors today. financial markets continue to show the ill effects of turmoil triggered by mortgage losses. the real economy is underperforming in terms of growth and job creation, a result in part of financial strains. and financial institutions themselves are affected by the generalized pullback in liquidity and deteriorating credit quality. nearly one year after the onset of financial market distress, many financial institutions have retreated from certain business lines, limited their participation in markets for some financial products, delevered their balance sheets, and taken other actions aimed at balance sheet repair. these developments are both necessary and expected. but, the path to a new financial market architecture, however uneven and improvised, will not only be marked by the forces of retrenchment. the path should equally, in my view, be distinguished by the creative impulses that drive product and market innovation. it is perhaps too convenient to denigrate the attributes of dynamism and ingenuity, particularly late in economic cycles, when the forces of innovation can disappoint and weaken the real economy. policymakers and market participants alike should recognize that innovation - - in our product markets, labor markets, and yes, our financial markets - - is likely to prove a necessary net contributor to economic growth in the coming period. we should also be reminded that financial innovation need not be equated with product complexity. while some take comfort in the presumption that global economies have decoupled, i would note that our global financial markets are more integrated than ever. financial products successfully developed in a single geography often can be readily exported to another ; readily, that is, if the new product export befits investor preferences and policymakers remove barriers to their adoption. today's introduction of the treasury covered bond framework may be illustrative of the benefits of product innovation in globally connected financial markets. treasury's discussions with market participants suggest that a covered bond framework may attract investor interest and facilitate greater access to mortgage credit. high - quality assets might be financed if banks are allowed to manage pools of loans, substituting new loans into the pool as others become delin

evident for only a few weeks. most recently, the flexibility of our market - driven economy has allowed us, thus far, to weather reasonably well the steep rise in spot and futures prices for oil and natural gas that we have experienced over the past two years. the consequence has been a far more stable economy. * * * in perhaps what must be the greatest irony of economic policymaking, success at stabilization carries its own risks. monetary policy - - in fact, all economic policy - - to the extent that it is successful over a prolonged period, will reduce economic variability and, hence, perceived credit risk and interest rate term premiums. a decline in perceived risk is often self - reinforcing in that it encourages presumptions of prolonged stability and thus a willingness to reach over an ever - more - extended time period. but, because people are inherently risk averse, risk premiums cannot decline indefinitely. whatever the reason for narrowing credit spreads, and they differ from episode to episode, history cautions that extended periods of low concern about credit risk have invariably been followed by reversal, with an attendant fall in the prices of risky assets. such developments apparently reflect not only market dynamics but also the all - too - evident alternating and infectious bouts of human euphoria and distress and the instability they engender. 3 / 5 therefore, because it is difficult to suppress growing market exuberance when the economic environment is perceived as more stable, a highly flexible system needs to be in place to rebalance an economy in which psychology and asset prices could change rapidly. indeed, as i have pointed out in the past, policies to enhance economic flexibility need to be as integral a part of economic policy as are monetary and fiscal initiatives. relying on policymakers to perceive when speculative asset bubbles have developed and then to implement timely policies to address successfully these misalignments in asset prices is simply not realistic. as the federal open market committee ( fomc ) transcripts of the mid1990s duly note, we at the fed were uncomfortable with a stock market that appeared as early as 1996 to disconnect from its moorings. yet the significant monetary tightening of 1994 did not prevent what must by then have been the beginnings of the bubble of the 1990s. and equity prices continued to rise during the tightening of policy between mid - 1999 and may 2000. indeed, the equity market's ability to withstand periods of tightening arguably reinforced the bull market's momentum. the fomc knew