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of U.S. and global markets required an internationally coordinated response. 
Throughout this process, we have been in regular contact and worked closely
with our international colleagues, particularly with the UK. At our meeting
last October, the G7 tasked the Financial Stability Forum, the FSF, to analyze
the underlying causes of the turbulence and offer proposals for change. The
FSF, which brings together the supervisors, central banks, and finance
ministries of major financial centers, has done its work quickly and
effectively, and recently produced 67 recommendations. These are consistent
with and complement efforts in the United States. 

We have already seen progress on the implementation: an updated code of conduct
for credit rating agencies has been issued and is being implemented; disclosure
practices have been published and are being put in place; and the Basel
Committee just issued updated bank liquidity guidance. A large number of other
projects are well underway, and the FSF is closely monitoring progress. The
United Kingdom and European nations are taking a number of other actions that
support and reinforce the FSF recommendations.

There is no easy solution that will immediately relieve current financial
market stress or protect against future problems and market challenges which
will inevitably occur. Together, the United States, the United Kingdom, other
nations and the FSF are addressing current challenges and the underlying
weaknesses that contributed to present economic circumstances.

Vision for a Modern U.S. Financial Regulatory Structure

That said, I believe we in the United States need to go further – to
address not only the specific policy issues that gave rise to recent turmoil,
but also the outdated nature of the U.S. financial regulatory system. Few, if
any, defend our current balkanized system as optimal.

Treasury made our recommendations for an optimal structure when we released our
Blueprint for a Modernized Financial Regulatory Structure last March. We
recommend a U.S. regulatory model based on objectives that more closely link
the regulatory structure to the reasons why we regulate. Our model proposes
three primary regulators: one focused on market stability across the entire
financial sector, another focused on safety and soundness of institutions
supported by a federal guarantee, and a third focused on protecting consumers
and investors.

A major advantage of this structure is its timelessness and its flexibility.
Because it is organized by regulatory objective rather than by financial
institution category, it can more easily respond and adapt to the ever-changing
marketplace. These recommendations eliminate regulatory competition that
creates inefficiencies and can engender a race to the bottom.

We began work on this Blueprint well before our current challenges emerged. Our
goal then, which has only accelerated now, is to modernize the U.S. financial
regulatory structure to better reflect modern financial markets. Of course,
regulation alone cannot fully protect the financial system. Market discipline
must also constrain risk-taking. Finding the right balance between market
discipline and market oversight is critical to maintaining the market stability
and innovation necessary to support vibrant economic growth.

When we released the Blueprint, I was clear that it was a long-term vision that
would take time to consider and implement. That is still the case, but today we
have both a clear need and a unique opportunity to accelerate this process. The
Bear Stearns episode and market turmoil more generally have placed in stark
relief the outdated nature of our financial regulatory system. We are working
with the Fed and the SEC on the immediate issues raised by the Fed's provision
of liquidity to the primary dealers, an extraordinary step taken in the wake of
Bear Stearns and one that was necessary to ensure the stability and orderliness
of our financial system.

The Bear Stearns episode highlighted the need for the Fed and SEC to work
constructively together including an MOU that should be helpful and inform
future decisions as our Congress considers how to modernize and improve our
regulatory structure.

In addition to the MOU, there are three important steps that the United States
should take in the near term, all of which move us further in the direction of
the optimal regulatory structure outlined in the Blueprint.

First, whether it was Long Term Capital Management in 1998 or Bear Stearns this
year, it is clear that Americans have come to expect the Federal Reserve to
step in to avert events that pose unacceptable systemic risk. But, as we noted
in our Blueprint, the Fed has neither the clear statutory authority nor the
mandate to attempt to anticipate and prevent risks across our entire financial
system. Therefore we should consider how most appropriately to give the Federal
Reserve the information and authority necessary to play its expected role of
market stability regulator. The Fed would need the authority to access
necessary information from complex financial institutions -- whether it is a
commercial bank, an investment bank, a hedge fund, or another type of financial
institution -- and the tools to intervene to mitigate systemic risk in advance
of a crisis.

This is a tall order. History teaches us that in a dynamic market economy
regulation alone cannot eliminate instability. To be clear, I do not believe
that we can eliminate, by regulation or otherwise, all future bouts of market
instability -- they are difficult to predict and past history may be a poor
predictor of the future. However, just because the overall task is difficult,
we should not stop trying to understand and mitigate instability.

To that end, we should create a system that gives us the best chance of
foreseeing a crisis, including a market stability regulator with the
authorities to avert systemic issues it foresees and providing the information,
tools and authorities to deal better with unexpected events when they
inevitably occur.

To complement this regulator's efforts, we must have strong market discipline
to reinforce the stability of our markets. For market discipline to be
effective it is imperative that market participants not have the expectation
that lending from the Fed, or any other government support, is readily
available. Otherwise, market discipline will be compromised severely. I know
from first hand experience that normal or even presumed access to a government
backstop has the potential to change behavior within financial institutions and
with their creditors. It compromises market discipline and lowers risk
premiums, ultimately putting the system at greater risk.

So how do we strengthen market discipline? Today's priority is clearly market
stability. However, looking beyond the immediate turmoil, we need to design
carefully and put in place a stronger capacity for resolution and crisis
intervention that reinforces market discipline. In an optimal system, market
discipline effectively constrains risk because the regulatory structure is
strong enough that a financial institution can fail without threatening the
overall system. For market discipline to constrain risk effectively, financial
institutions must be allowed to fail. Under optimal financial regulatory and
financial system infrastructures, such a failure would not threaten the overall
system.

However, today two concerns underpin expectations of regulatory intervention to
prevent a failure. They are that an institution may be too interconnected to
fail or too big to fail. We must take steps to reduce the perception that this
is so -- and that requires that we reduce the likelihood that it is so.

Strengthening market infrastructure will reduce the expectation that an
institution is too interconnected to fail. We need to strengthen our practices
and financial infrastructure in the OTC derivatives market and in the tri-party
repo system. Important work is underway in each of these areas, and needs to be
completed quickly.

To address the perception that some institutions are too big to fail, we must
improve the tools at our disposal for facilitating the orderly failure of a
large complex financial institution. As former Federal Reserve Chairman
Greenspan often noted, the real issue is not that an institution is too big or
too interconnected to fail, but that it is too big or interconnected to
liquidate quickly.

Today, our tools are limited. We have the Fed's broad lender of last resort
powers which are currently being used to help stabilize our markets. Current
law also allows our President to declare a national economic emergency, and
then dictate the actions of commercial banks. But this tool is both too blunt,
in that exercising it would likely spur greater concern and too narrow, in that
commercial banks are only one group of participants in today's broad financial
markets. We also have specialized resolution provisions that apply solely to
insured depository institutions, but these do not apply to a large group of
complex financial companies.

In general, bankruptcy law serves as the resolution regime for non-depository
financial institutions and most corporations. This regime has a long legal
history, and is initiated by private-sector decisions to initiate bankruptcy
proceedings, which then start a process to pay claims. In contrast, under the
administrative procedures for insured depository institutions, regulators
determine when and how to start the proceeding and in many ways regulators
largely take the place of the courts in determining the allocation of claims.

These two very different approaches for resolution have advantages and
disadvantages. Bankruptcy imposes market discipline on creditors, but in a time
of crisis could involve undue market disruption. An administrative procedure
under the control of regulators helps to mitigate market disruption, but can
reduce market discipline. For insured depository institutions, this special
insolvency regime was deemed necessary because of the role these institutions
play in the overall financing of economic activity and the presence of a
government guarantee.

As I have continually noted, the financial landscape has changed, and non-bank
financial institutions play a significantly greater role. We need to consider
broadly the resolution regime in light of these changes. It is clear that some
institutions, if they fail, can have a systemic impact, so we must give
regulators the authorities to limit that impact and facilitate an orderly
failure. In my view, looking beyond the immediate market challenges of today,
we need to create a resolution process that ensures the financial system can
withstand the failure of a large complex financial firm. To do this, we will
need to give our regulators additional emergency authority to limit temporary
disruptions. These authorities should be flexible and -- to reinforce market
discipline -- the trigger for invoking such authority should be very high, such
as a bankruptcy filing. And as part of this process we should consider ways to
ensure that costs are imposed on creditors and equity holders. Any commitment
of government support should be an extraordinary event that requires the
engagement of the Executive Branch. It should be focused on areas with the
greatest potential for market instability and should contain sufficient
criteria to ensure that the cost to the taxpayers is minimized.

In the United Kingdom, you gave recently proposed changes to your regulatory
system as the United States is doing now.  While your regulatory system is
different from ours, we both recognize the direction our systems must take to
better deal with market stability issues and today's financial markets.  In the
U.K., colleagues have recently proposed modifications to your regulatory
structure and authorities similar to what Treasury envisioned in our Blueprint.
 Under this new proposal, the Bank of England would be given specific statutory
responsibility for financial stability regulation.  A new Financial Stability
Committee, chaired by the Governor of the Bank of England, would oversee the
Bank's functions as they relate to market stability. The Bank of England would
also have new authorities to carry out this function, including access to
firm-specific information related to market stability, formal oversight of
payment systems, as we are recommending for the Federal Reserve in the U.S.,
and a lead role in working with the FSA to establish a new resolution regime.  

As U.S. and global regulators respond to recent events, we must recognize that
the stability and vitality of our markets require both robust oversight and
market discipline.

Conclusion

The United States and the United Kingdom share a long history and a bright
future. As we cooperate and work closely with you during this period of
economic difficulty we look forward to emerging, as we always do, to a new day
of promise and prosperity. Thank you. 

"I study a lot. That is one of the responsibilities of every revolutionary." Hugo Chavez.