as the sole measure of quality. a more subtle form of the quality assurance problem arises when a transaction results in future contingent obligations by the counterparties. future obligations are common in financial markets, where the risk of nonperformance is known as counterparty credit risk. in a credit default swap, for example, each side is seeking to alter credit exposure to the reference entity. the resulting contingent credit exposure to the counterparty is entirely incidental to the reason for the transaction, yet may be a first - order determinant of future performance. financial markets have developed mechanisms that are specific to the control of counterparty risk. the simplest of these is the posting of collateral against counterparty exposures. ensuring the efficacy of collateral is challenging even under ordinary circumstances, and may leave counterparties especially vulnerable to large sudden changes in market prices, also called gap risk. a more sophisticated convention for mitigating counterparty credit risk is a central counterparty or a clearinghouse. in markets with a clearinghouse, all trades are intermediated through a central counterparty. this arrangement can and, in practice, does vastly reduce counterparty risk. the central counterparty runs a balanced book, so generally has no direct market exposure. in the case of a member's default, the central counterparty can draw upon the proprietary margin of the defaulting member, its own reserve fund, and the assessment of members for share purchase. as you know, plans are currently being developed to establish one or more central counterparties in the credit derivatives market. so why do we not find a central counterparty in every financial market? a key reason is that the gain in safety may come at the expense of flexibility. like an exchange, a central the early antecedents to the new york stock exchange and other fascinating stories of market formation are elegantly and insightfully recounted in john mcmillan, " reinventing the bazaar, " w. w. norton & co, 2002. see section 1 in randall s. kroszner, " can the financial markets privately regulate risk? ", journal of money, credit, and banking 31 ( 3 ), august 1999. counterparty imposes a degree of standardization upon contracts. as noted earlier, otc derivative markets have grown so rapidly in large part due to the demand for variety and customization of contracts. that said, many otc contracts are already eligible for clearing through a central counterparty. for example, swapclear, a central counterparty for interest

##economic level, financial distress in the household sector seems unlikely to cut off the expansion. conclusion overall, the macroeconomic outlook for the united states is favorable. over the past year, the economy has made considerable progress : aggregate income is growing rapidly, business investment has begun to recover, the stock market has rebounded, and interest rates and inflation remain very low. to be sure, there are uncertainties regarding the outlook. while my concern about the labor market is somewhat alleviated by the most recent data, it remains at the top of my list. another important uncertainty is the possibility that an adverse shock will expose an underlying weakness in the financial condition of households. but, i believe the economy most likely will steer clear of substantial damage from this source.