Remarks by Treasury Secretary Paulson

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They will issue new rules and seek regulatory authorities as needed, evaluate progress, provide guidance and enforce laws—to ensure that implementation follows recommendation.

Covered Bonds, which allow banks to retain originated mortgage loans while accessing financial market funding, are another alternative worth considering. Covered bonds may address the current lack of liquidity in, and bring more competition to, mortgage securitization. Rule-making, not legislation, is needed to facilitate the issuance of covered bonds. Through clarification of covered bonds' status in the event of a bank-issuer's insolvency, the FDIC can reduce uncertainty and consider appropriate measures that will protect the deposit insurance fund. These steps would encourage a covered bond market in the U.S.; similar changes in Europe have resulted in more covered bond activity.

Financial Institutions

As key participants in virtually every phase of the markets, financial institutions must identify and address any weaknesses in risk management practices, especially those revealed by the current turmoil. This means enhancing internal risk measurement and reporting systems, a robust valuation of instruments and exposures, and aggregation of exposures across business lines. It also means more comprehensive disclosure of fair value estimates for complex and illiquid instruments, and of credit or liquidity enhancements provided to off-balance sheet commitments, such as conduits and SIVs.

The PWG's guidance on risk management and disclosure issues for financial institutions is important, but the quality of the top management team responsible for executing this guidance is even more important. I know from first-hand experience how increasingly difficult, yet how critical, it is to successfully manage today's large, integrated global financial institutions. The leadership challenge here is enormous. Market difficulties often expose weaknesses; weaknesses which can often only be overcome with experience. And that experience often comes from lessons learned from prior challenges and prior mistakes.

The ultimate success of any CEO is largely determined by the answer to one question: Do we have the right people in the right jobs with the right incentive structure? And these large financial institutions have a large number of key jobs to fill. They must have people with talent, judgment, expertise and motivation that best serve their institutions and, by extension, contribute to the quality and strength of our markets. I cite this management issue because I do not believe that the top jobs in our large financial institutions are going to get easier any time soon, and the markets, not regulators, will ultimately sort this out.

Investors

I will speak for a moment about investors—many of whom bought products they didn't fully understand, or bought products based solely on credit ratings. Many investors became complacent about risk and they have learned a costly lesson, one that amplifies the need for thorough due diligence. In fact, it seems that today's risk aversion is an aftermath of yesterday's risk complacency.

Going forward, investors must demand and use better information about investment risk characteristics, when they buy and as they hold. They, and the markets, will be better served by independent evaluations and by understanding that different types of instruments have different types of risks.

Credit Default Swaps and OTC Derivatives

In recent years, innovation has also facilitated the tremendous expansion in the scale, diversity and impact of credit default swaps and over-the-counter (OTC) derivatives. These instruments and markets have become important for the hedging or transfer of credit and default risk. Heightened price volatility and surging trading volumes underscore the need for the OTC derivatives market infrastructure to evolve to support this expansion. Industry has taken some, but not enough steps.

We need a dedicated industry cooperative. Market volume and instrument complexity call for a clear, functional, well-designed infrastructure that can meet the needs of the OTC derivatives markets in the years ahead.