the implementation of basel ii. we should also work toward ensuring that clearing and settlement arrangements on which core institutions and other participants depend are safe and efficient. weaknesses in such systems can be a source of systemic contagion. conversely, when such arrangements are robust, the potential for contagion is significantly diminished. the benefits of such supervisory initiatives can extend beyond the core regulated institutions themselves because improvements in their counterparty - riskmanagement practices will strengthen market discipline on their unregulated counterparties. although the critical roles that these core institutions play in global markets require us to focus on them, we need to address the possibility that this approach could increase moral hazard by reinforcing perceptions that these institutions are too big to fail. this risk can be mitigated by the steps that i have mentioned earlier, including the promotion of enhanced risk - management practices and the implementation of capital requirements that are more risk sensitive, steps that greatly reduce the chances that government intervention will be needed. in all of this work, coordination and cooperation among regulators, domestically and internationally, are critical because the same firms are the core firms in each of the principal global financial centers. effective oversight of these firms generally can be conducted only by the home country supervisor, which alone has the authority over a firm's consolidated global operations. when supervisory coordination and cooperation exist, much good work can be accomplished relatively quickly. an excellent example is the work that the federal reserve bank of new york and other prudential supervisors have undertaken over the past year and a half to encourage and support market participants'progress in addressing what were serious weaknesses in the infrastructure of the credit derivatives markets. those supervisors are now systematically reviewing the core firms'management of counterparty exposures to hedge funds and other highly leveraged counterparties. both market participants and public authorities should understand that, despite our best efforts, crises are inevitable, and so we need to work on crisis management as well. here, too, cooperation among authorities here and abroad is critical. we must understand the market structures and vulnerabilities and the objectives and constraints under which authorities with different jurisdictions would be working in those circumstances. inevitably, uncertainty on the part of market participants and public authorities will be heightened in the event of market turmoil, and that uncertainty can feed on itself. both authorities and participants need to think through how they will handle such crises. for the authorities, that process includes considering how to resolve any failures of large institutions in ways that impose costs on shareholders and unins

##ured liability holders while preserving orderly markets. such a resolution will be necessary to limit the moral hazard of any interventions that we are forced to undertake. market participants need to consider how they would settle contracts and work with troubled borrowers in a distress situation. more planning will reduce the rise in uncertainty in a crisis and the likelihood that fear will lead to precipitous actions that are in no one's best interest. in sum, there are good reasons to think that financial innovation over the past few decades, including the emergence and growth of the credit derivatives markets, has made the financial system and the economy more resilient. but it would be foolish to think that these innovations have eliminated systemic risk. both market participants and public authorities need to think carefully about how systemic risks might crystallize in the new world that credit derivatives have helped create. they need to identify the implications for risk management and ensure that risk - management practices are adapting to target new sources of risk. and they need to think about how they would respond to crises that sooner or later will emerge in that new world.