, significant in their own right, can cause distortions in monetary policy, render monetary policy tools less effective, and put at risk the integrity of the payments system. in an integrated international financial system, it is increasingly difficult to contain a banking crisis within a country ’ s borders. finally, we must not forget the human consequences of a financial and broader economic crisis, which disproportionately fall on those least able to weather the storm. clearly we need to learn what we can from recent history and take steps now to make domestic and international financial systems more resilient. crises are opportunities for implementing change, and in the us and internationally, significant reforms traditionally have been born of crisis. to effect meaningful and appropriate reform, however, we must fully understand cause and effect and the broader trends of international financial intermediation. today, i would like to share with you my perspective on these issues based on us and international experience, with special emphasis on the need for additional preventive measures. importance of sound banking systems over the long run, a nation must be able to mobilize domestic savings and other sources of funds needed to finance investment and other productive expenditures. this requires the development of an effective banking system that transfers surplus funds of households and businesses to borrowers and investors. fair and impartial allocation of credit accommodates the economic development that results in improved national living standards. notwithstanding broad changes in the intermediation process which have reduced the role of banks in favor of the capital markets, banks retain a critical role in direct intermediation and as managers of financial risk. sound financial institutions, and banks particularly, remain integral to a sound economy. effective financial intermediation is particularly important in the context of most emerging market countries given the relative scarcity of savings, a relatively underbanked population, and large - scale investment needs. the banking sector in emerging market countries also tends to be more concentrated and represents a larger share of the domestic financial system, suggesting that problems there will have an amplified effect on the economy and on the fiscal costs associated with bank rescues. causes of banking system problems banking system crises have many and complex causes, both macro and microeconomic. macroeconomic causes include exogenous shocks, sustained or sharp declines in real growth, accelerating inflation, deterioration in the terms of trade, and changes in the policy regime. macroeconomic shocks also typically expose underlying microeconomic deficiencies in risk management practices and internal controls at financial institutions such as weak underwriting standards,

in the third quarter of 2010. 1 this inflow of new foreclosures exceeded the outflow due to completed foreclosures and properties sold through short sales and deeds in lieu. as a result, the foreclosure pipeline increased to 1. 9 million mortgages – double the level from a year earlier ( chart 6 ). efforts to modify mortgages have not managed to prevent the foreclosure pipeline from increasing. as a consequence, distressed sales are expected to grow even further over the coming year. the combination of declining house prices and increasing delays in the foreclosure process will put upward pressure on default rates as well as losses on defaulted mortgages. corelogic estimates that in the third quarter of 2010 there were 10. 8 million borrowers in negative equity where the balance on the mortgage exceeds the current value of the property. they estimated that there were an additional 2. 4 million borrowers estimated to be in “ near negative equity ” where the borrower has less than 5 percent equity remaining. declining house prices will push these near negative equity borrowers into negative equity. this increases the risk that these borrowers will default on their mortgages either out of necessity – say as the result of a job loss – or out of choice, which is called strategic default as borrowers determine that there is little economic advantage to keep paying the mortgage. longer delays in the foreclosure process further increase the incentive for a borrower to strategically default by extending the period of time that they can live “ rent free ” in the house. in addition, declining house prices increase the expected losses on those mortgages that do default. problems in housing markets can impact economic growth. housing directly effects growth through incentives for builders to build new houses. housing starts will likely remain depressed as long as house prices are declining. falling house prices can also negatively impact consumption growth to the extent that homeowners increase their savings in an effort to offset declines in their housing wealth. the degree to which housing markets deteriorate over 2011 and the impact that this will have on overall growth is hard to predict with any accuracy. the most likely outcome is that the economy will continue to improve as the year progresses despite the ongoing drag from housing. however, the protracted process of resolving the overhang of negative equity resulting from the overvaluation of housing during the boom will remain a headwind restraining economic growth for several years to come. let me conclude with an observation regarding the housing outlook for