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.
As the concerns about the U.S. housing market escalated in 2007, participants in the tri-party repo market became increasingly concerned about the liquidity and credit risks that they faced. The clearing banks became uncomfortable with their large intraday exposures to their tri-party securities firm customers. After all, if a securities firm were to fail suddenly, the clearing banks could be stuck with huge loans to these counterparties, secured by securities that were not necessarily high quality and liquid. Thus, as the condition of the most troubled securities firms deteriorated, there was a risk that one morning a clearing bank might decide not to unwind a firm’s tri-party transactions in order to avoid a large intraday exposure. 6  The problem was particularly acute for those firms with large securities trading and over-the-counter derivative businesses operated outside of depository institutions. In the United States, even those securities firms that were part of bank holding companies were vulnerable because Section 23A restrictions in the Federal Reserve Act that govern transactions between the bank and the nonbank affiliates as part of a bank holding company complex sharply limited what assets the securities firm could pass through to the bank and on to the Fed’s discount window facility. 7  In the unwind, cash was transmitted back from securities firms to wholesale investors each morning, to hopefully be reinvested and returned back to the securities firms by the end of the day to finance their inventories of securities.