Geithner on Reducing Systemic Risk
June 23, 2008
On June 9, Wall Street's largest broker-dealers met with the Federal Reserve Bank of New York to outline initiatives to beef up the operational infrastructure of the over-the-counter derivatives market. Earlier that day, New York Fed president and CEO Timothy Geithner called the agenda of that meeting "a bridge to a broader set of necessary changes to the regulatory framework in the U.S. and globally." Speaking at the Economic Club of New York, Geithner laid out a series of broad proposals to reduce systemic risk in the financial markets in light of the vulnerabilities exposed by the recent crisis. Focusing on three areas--regulatory policy, structure and crisis management--Geithner explained how the U.S. financial system might first be repaired and then reformed. An excerpt of his speech follows.
Since the summer of 2007, the major financial centers have experienced a very severe and complex financial crisis. The fabric of confidence that is essential to the viability of individual institutions and to market functioning in the United States and in Europe proved exceptionally fragile. Money and funding markets became severely impaired, impeding the effective transmission of U.S. monetary policy to the economy. ...
Our first and most immediate priority remains to help the economy and the financial system get through this crisis.
A range of different measures of liquidity premia and credit risk premia have eased somewhat relative to the adverse peaks of mid-March. Part of this improvement--this modest and tentative improvement--is the result of the range of policy actions by the Federal Reserve System, the U.S. Treasury and other central banks. Part is the consequence of the substantial adjustments already undertaken by financial institutions to reduce risk, raise capital and build liquidity.
These actions by institutions and by the official sector have helped to reduce the risk of a deeper downturn in economic activity and of a systemic financial crisis. But the U.S. economy and economies worldwide are still in the process of adjusting to the aftermath of rapid asset price growth and unsustainably low risk premiums. This process will take time.
As we continue to work with other central banks to ease the adjustment now under way in the U.S. economy and globally, we are working to make the financial system more resilient and to improve its capacity to deal with future crises.
We are working closely with the Securities and Exchange Commission, with banking supervisors in the U.S. and the other major economies, and with the U.S. Treasury to strengthen the financial foundation of the major investment and commercial banks. We have encouraged a significant increase in the quality of public disclosure. We have supported efforts that have brought a very substantial amount of new equity capital into many financial institutions. These efforts will help mitigate the risk of a deeper credit crunch. And even as the Federal Reserve has worked to mitigate the liquidity pressures in markets by implementing a new set of lending facilities, we have worked with the SEC and others to ensure that the major institutions are strengthening their liquidity positions and funding strategies.
We are also initiating important steps to strengthen the financial infrastructure. We are in the process of encouraging a substantial increase in the resources held against the risk of default by a major market participant across the set of private sector and cooperative arrangements for funding, trading, clearing and settlement of financial transactions that form the centralized infrastructure of the financial system. We have begun to review how to reduce the vulnerability of secured lending markets, including tri-party repo, by reducing, in part, the scale of potentially illiquid assets financed at very short maturities. ...
