The second option is to have a mechanism or process to facilitate the orderly liquidation of a defaulted dealer’s collateral. One could imagine a mechanism that was funded by tri-party repo market participants and potentially backstopped by the central bank. This would have the advantage of dealing with the entire tri-party repo market and not artificially favoring one type of collateral over another. It would also push against the underpricing of liquidity and credit risk during good times by forcing market participants to pay for the costs of a liquidation facility up front. 11  OMO eligible is collateral that the Fed can purchase or repo in its open market operations. 12  In addition, because the Federal Reserve is authorized to intervene in the Treasury, agency debt, and agency MBS markets, it could act to stabilize these markets during times of stress. This would make it easier to liquidate such collateral without unduly depressing prices. 6  BIS central bankers’ speeches  Because no single market participant has a strong incentive to develop such a mechanism, however, sustained regulatory pressure may be required to reach such a solution. From the perspective of the tri-party repo borrowers and investors, the status quo undoubtedly is viewed as superior because neither group is forced to fully bear the externalities associated with their actions. Instead they anticipate that emergency liquidity would be made available in the event of a future systemic crisis.
The other path would be to expand the range of financial intermediation activity that is directly backstopped by the central bank’s lender of last resort function. This expanded range  16  Although the largest stand-alone securities firms adopted bank holding company status during the crisis, their non-depository institution arms do not have access to the discount window backstop because Section 23A of the Federal Reserve Act restricts the ability of the holding company to transfer assets from the non-depository institution to the commercial bank affiliate that has access to the discount window. 17  See Daniel K. Tarullo. 2012. “Industry Structure and Systemic Risk Regulation”. December 4. http://www.federalreserve.gov/newsevents/speech/tarullo20121204a.htm. In this speech, he explores three policy proposals: (1) breaking up large financial institutions by reinstating Glass-Steagall restrictions or by imposing other prohibitions on affiliations of commercial banks with certain business lines; (2) placing a cap on the nondeposit liabilities of financial institutions; and (3) requiring financial institutions above a specified size to hold minimum amounts of long-term debt available for conversion to equity to avoid or facilitate an orderly resolution of a troubled firm  8  BIS central bankers’ speeches  could be defined either in terms of access by the types of firms that are systemically important in market-based finance, or by types of activity or assets. It is worth pausing here to review in a little more detail the two key functions performed by a lender of last resort.