Unfinished Business in Financial Reform 133

securities and guarantees outstanding that exceed the amount of marketable US Treasury securities. The interest rates on GSE securities have been close to those on government obligations.

That was possible because it was broadly assumed, quite accurately as it has turned out, that in case of difficulty those agencies would be supported by the Treasury to whatever extent necessary to maintain their operations. That support was triggered in 2008, confirming the moral hazard implicit in the high degree of confidence that government-sponsored enterprises would not be allowed to fail.

The residential mortgage market today remains almost completely dependent on government support. It will be a matter of years before a healthy, privately supported market can be developed. But it is important that planning proceed now on the assumption that Government Sponsored Enterprises will no longer be a part of the structure of the market.

We cannot, and should not, contemplate a financial world so constrained by capital requirements and regulation that all failures are avoided and innovation and risk-taking is lost. As I noted earlier, we need to develop arrangements to deal with such failures that do occur in a manner that will minimize market continuity and contagion.

Success will be dependent on complementary approaches in major markets – New York, London, Continental European centres and Tokyo, Hong Kong and before long other growing Asian markets. In essence, the authorities need to be able to cut through existing and typically laborious national bankruptcy proce- dures. The need is for new ‘resolution authorities’ that can maintain necessary services and the immediate need for day-to-day financing while failing organiza- tions are liquidated, merged or sold, whether in their entirety or piece by piece. Shareholders and management will be gone. Creditors will be placed at risk.

Such arrangements are incorporated in Dodd–Frank. I think it fair to say that there is a great deal of skepticism as to whether such arrangements will be effective in the midst of crises, and whether market participants will continue to presume that governments will again ‘ride to the rescue’. Surely, that skepticism is likely to remain until the most important of jurisdictions can be brought into reasonable alignment.

My sense is that efforts are, in fact, well underway to clear away some of the technical underbrush and to agree on procedures for intervention and exchang- ing information. An important element in that effort is the concept of requiring institutions to develop ‘living wills’. The idea is to have clarity as to parts of their operations could stand alone or be sold or merged as part of an orderly and rapid resolution process.

It is evident that there is not yet full agreement on elements of the basic struc- tural framework for banking and other financial operations. Some jurisdictions seem content with what is termed ‘universal banks’, whatever the conflicting

C© 2012 Blackwell Publishing Ltd.


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