the start, a broad range of recent financial shocks do not seem to have adversely impacted the real economy. the international financial crisis that began in 1997 did not spillover to the nonfinancial sector in the united states. the equity price collapse and deterioration in credit in 2000 did not cause significant damage to the core institutions in the u. s. market. the relatively limited damage caused by operations failures of the 9 / 11 attacks reflected the strength of the capital position of major intermediaries, as well as the policy actions by the federal reserve to provide liquidity to the markets. more recently, the series of smaller financial shocks experienced since 2001, including the corporate bond defaults after 2001, the corporate accounting scandals in 2002, credit downgrades in the u. s. automobile industry in 2005, the failure of refco, the sharp declines in mid - 2006 in equity, commodity and emerging markets debt prices caused little contagion to other markets and limited strain on financial institutions. challenges the favorable balance between efficiency and resilience in the financial system we have observed recently does not of course guarantee we will achieve as favorable a balance in the future. the prospects for future stability will depend in part on how effective supervisors are in adapting policies in response to the ongoing evolution in markets. financial institutions face strong incentives to monitor and limit their risk profile and the risk - taking of their leveraged counterparties to some efficient level where benefits balance costs at the margin. this is good for the firm and also good from society ’ s perspective. private pools of capital have the capacity to use extensive leverage to amplify returns. this leverage can be acquired in a variety of ways : through repurchase agreements and reverse repos, through secured financing and securities lending and through derivatives and structured financial products. the ability of funds to take on risk and leverage is constrained by two external sources of discipline the returns required by their investors, and the terms on which their dealers / financers are willing to extend credit. in other words, the fund is constrained by the willingness of outsiders, collectively, to take exposure to the fund. the willingness of banks and investment banks to take on exposure to hedge funds is in turn influenced by the capital and supervisory framework that applies to those institutions and the discipline imposed on them by the market. the effectiveness of market discipline in constraining the risk - taking behavior of financial firms, however, may be compromised by the presence of market failures of the type mentioned above. while

in looking at risks in the financial system as a whole, not just those that have their origin in banks. and it means that we will have to continue to intensify our cooperation with other supervisory and regulatory authorities. the u. s. financial system is of course only as strong as our economy as a whole. overall, the fundamentals of the u. s. economy look quite strong. but the size of our fiscal deficit, and the risks posed by our large external imbalance, place a greater burden than would otherwise be the case on the credibility of u. s. monetary policy. in this context, it is particularly important that we preserve the high degree of confidence that now seems to exist that u. s. monetary policy will respond appropriately to the evolving balance of risks in the overall economic outlook, and particularly that we will maintain price stability. this is critically important to sustaining the current expansion, and to sustaining confidence in u. s. financial markets over time. and getting monetary policy right is one of the most important things we can to do contribute to financial stability as well.