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For release on delivery
2:30 p.m. EDT
July 28, 2008

Remarks by
Kevin Warsh
Board of Governors of the Federal Reserve System
Treasury Conference on Covered Bond Framework

Washington, D.C.
July 28, 2008

On behalf of the Federal Reserve, I am pleased to join Secretaiy Paulson and my
fellow bank supervisors today.
Financial markets continue to show the ill effects of turmoil triggered by
mortgage losses. The real economy is underperforming in terms of growth and job
creation, a result in part of financial strains. And financial institutions themselves are
affected by the generalized pullback in liquidity and deteriorating credit quality. Nearly
one year after the onset of financial market distress, many financial institutions have
retreated from certain business lines, limited their participation in markets for some
financial products, delevered their balance sheets, and taken other actions aimed at
balance sheet repair. These developments are both necessary and expected.
But, the path to a new financial market architecture, however uneven and
improvised, will not only be marked by the forces of retrenchment. The path should
equally, in my view, be distinguished by the creative impulses that drive product and
market innovation. It is perhaps too convenient to denigrate the attributes of dynamism
and ingenuity, particularly late in economic cycles, when the forces of innovation can
disappoint and weaken the real economy. Policymakers and market participants alike
should recognize that innovation—in our product markets, labor markets, and yes, our
financial markets—is likely to prove a necessary net contributor to economic growth in
the coming period. We should also be reminded that financial innovation need not be
equated with product complexity.
While some take comfort in the presumption that global economies have
decoupled, I would note that our global financial markets are more integrated than ever.
Financial products successfully developed in a single geography often can be readily
exported to another; readily, that is, if the new product export befits investor preferences

and policymakers remove barriers to their adoption. Today's introduction of the
Treasury Covered Bond Framework may be illustrative of the benefits of product
innovation in globally connected financial markets.
Treasury's discussions with market participants suggest that a covered bond
framework may attract investor interest and facilitate greater access to mortgage credit.
High-quality assets might be financed if banks are allowed to manage pools of loans,
substituting new loans into the pool as others become delinquent. Newly issued covered
bonds backed by high quality mortgage loans and issued by strong financial institutions
may find a growing investor base in the United States.
The Federal Reserve has long accepted a broad range of high-quality collateral
from depository institutions at its discount window. Highly rated, high-quality covered
bonds would generally fall within that broad range as eligible collateral. Private lenders
also are likely to find such bonds attractive as collateral for credit extensions.
Financial innovation, properly understood, can increase the diversity of funding
sources, improve the distribution of risks, and provide incentives to monitor such risksall helping to promote economic growth. The Federal Reserve seeks to encourage new
and innovative sources of funding, and will continue to work with other policymakers
and market participants to accomplish this important objective.