central bankers ’ speeches another class of threats to financial stability emerge from sudden reversals of market sentiment regarding economic policy and institutional arrangements. this is a complex issue which i will not explore in detail today, other than to note that here too, early profits all too often feed pro - cyclical behavior, undermining market discipline. this in turn facilitates the accumulation of both private and public imbalances that are painfully difficult to unwind when financing suddenly stops. when sudden reversals occur, large costs are imposed on the real economy and the financial system, costs that are not fully internalized by the market participants that may have benefited from the boom. the often significant negative externalities associated with financial market instability suggest that regulation and prudential standards should be aimed both at limiting the frequency and extent of booms and at building a more resilient financial system, so there is less damage when the busts inevitably occur. the goal here is not to use regulation to prevent or even limit innovation, whether real or financial. many innovations have generated significant benefits for the macro - economy. for example, the internet, which lay at the heart of the tech bubble, generated myriad benefits. similarly, innovations in the financial realm have enabled businesses to limit risk and specialize in their core competencies, and households to smooth consumption. this in turn has enabled the economy to be more productive. instead, a critical objective of prudential oversight and regulation should be to enhance the system so that financial transactions of all forms reflect an assessment of risk and return by both the borrower and the lender that is as accurate as possible, recognizing that we live in an inherently uncertain world. this means that our reform efforts should be aimed at strengthening the quality of information and the system of incentives governing risk - taking by both institutions and individuals. and on those occasions when regulators judge that a systematic understatement and mispricing of risk may be occurring, we need to find better and more effective ways to actively lean against those dynamics. this includes using the bully pulpit to point out why a particular boom is likely to prove unsustainable. it also means ensuring that markets are structured so that investors with differing perspectives on the value of an asset are able to actively participate. booms tend to go further when the ability to “ go short ” is limited or emerges only late in the game. second, regulation needs to be oriented to establishing standards that will be appropriate throughout the cycle – for both the boom period

system. ” in the u. s., some of this responsibility undoubtedly falls to the financial stability oversight council, bis central bankers ’ speeches which was created by the dodd - frank act. but this is a relatively new institutional arrangement and how well it will be able to perform its mission in practice remains to be determined. similarly, on an international basis, the financial stability board has undertaken an initiative to evaluate risks within the shadow banking system, but this effort is also still in a fledging stage. finally, turning to the last issue about how to deal with institutions that run into difficulty, there has been progress. in the united states, the dodd - frank act ( dfa ) gave the fdic the authority to resolve certain large systemically important financial firms, on the recommendation of the federal reserve and the fdic, and after the treasury secretary makes certain determinations in consultation with the president. among other things, dfa enables the fdic to establish a bridge institution in which critical activities could be moved so that the failure of a major institution will not unduly disrupt the provision of key financial services. dfa also authorizes the federal reserve to require that such institutions develop recovery and resolution plans – plans that must be acceptable to the federal reserve and the fdic. the need to produce such plans will likely create some incentive for rationalizing complex corporate structures and, presumably, make resolution easier to implement. but a major challenge remains in implementing resolution effectively on a cross - border basis. the legal rules and regulatory regimes differ across legal jurisdictions. so, when a multinational banking organization becomes insolvent, each subsidiary and affiliate must be resolved in multiple bankruptcy proceedings, with the prospect of inconsistent treatment and larger than necessary losses in aggregate. although the financial stability board has taken up this issue, the legal impediments to progress here are significant despite the best efforts and intentions of regulators. the difficulty in implementing an efficient cross - border resolution is one of the reasons why the largest globally active firms are being asked to hold additional capital. in conclusion, let me emphasize the importance of the mission – to reform and better regulate the global financial system so it can perform its key financial intermediation function of funneling savings from investors to borrowers even under adverse circumstances. clearly, the financial system we had in 2008 was woefully inadequate relative to this mission. both the official sector and the private sector have responsibilities with respect to the work that remains ahead. it falls on us as regulators to