The largest firms must be prepared for a rapid and orderly resolution under the US Bankruptcy Code.6 Among other things, these firms must now also ensure that critical activities or services provided to the market will not be disrupted in the event they find themselves in recovery or resolution. Moreover, if an institution fails, there must be sufficient tools to manage its failure in a way that reduces the chance that its failure will cascade systemically through the financial system. In other words, if one institution gets a cold—or worse—it should not become an epidemic. The Fed’s use of Section 13(3) during the crisis was not uncontroversial. Concerns were expressed about moral hazard—that the Fed was somehow “bailing out” troubled institutions and that this would only lead to excessive risk taking in the future.7 As a result of this concern and others, Congress amended Section 13(3) to prevent the Fed from engaging in the kind of institution-specific lending that was directed at Bear Stearns and AIG. Going forward, the Fed may only lend under Section 13(3) as a part of a broad-based program directed at providing liquidity to the financial system and not to aid an individual failing firm.
The OLF is not prefunded, and the FDIC’s capacity to borrow to fund the OLF is capped at 90 percent of the fair value of the assets of the institution that are available for repayment. The provision of OLF liquidity does not fall ultimately on the American taxpayer. Shareholders may not recover until the OLF is repaid. The FDIC is authorized to assess financial sector participants if necessary to repay the funds advanced by the Treasury to fund the OLF. Reevaluate, but don’t forget the disorder of the crisis The breadth of changes that have been made to the regulatory landscape since the onset of the financial crisis is huge. Given the scale of the changes, it is entirely appropriate to take stock of these changes and reevaluate their effectiveness. It is not surprising to think that some recalibration might be necessary. It is also worth considering what additional reforms are needed to make the financial system more resilient and resistant to future, unanticipated shocks. Sometimes I get asked the question of whether the financial sector is where it needs to be in terms of resilience. My answer is usually that things are better, but they can get even better still. And I suspect that, in even the best case scenario, that will always be my answer. Because threats and risks evolve. Financial institutions, and regulators for that matter, must recognize changing risks and ensure that their approaches evolve in kind.