The terms and the form of deferred compensation are an important tool that could be further developed to generate a better set of incentives consistent with our financial stability objectives. We must also ensure that firms can respond to financial or operational weakness of any type by having robust recovery plans that get triggered long before resolution becomes necessary. They should develop and track metrics that not only identify when they are on the verge of insolvency or default, but that trigger appropriate remediation actions whenever the firm begins to become stressed. These plans should identify actionable options that the firm can take in response to financial weakness that will restore the confidence of the firm’s counterparties without the need for extraordinary official sector support. They must also have disciplined processes that analyze the root causes of their problems and identify longer-term strategies that will need to be employed as other recovery options to restore capital and liquidity are being executed. And firms must support the viability of their contingency and recovery plans by implementing the internal governance necessary to develop, test, update and implement them credibly. Some argue that what I have proposed – higher capital requirements and better incentives that reduce the probability of failure combined with a resolution regime that makes the prospect of failure fully credible – are insufficient. Perhaps, this is correct.
The provision of liquidity had the desired effect of reducing strains in markets, narrowing the dispersion of rates, and keeping the federal funds rate within the target range.5 Moving to more recent events, in March of this year the global spread of the pandemic led to a rapid and massive movement of funds around the world as investors sought to protect themselves from the highly uncertain and darkening economic outlook. These flows threatened to overwhelm the financial system and resulted in intense strain and disruption in short-term funding markets and markets for Treasury securities and agency mortgage-backed securities.6 Measures of market functioning deteriorated to levels near, or in some cases worse than, those we saw at the peak of the 2008 global financial crisis.7 In response to the extraordinary volatility and signs of market disruption caused by the pandemic, the Federal Reserve greatly expanded its repo operations and decisively and immediately began purchasing enormous quantities of U.S. Treasury securities and agency mortgage-backed securities. Our approach was to deliver a rapid and overwhelming response that would give assurance to market participants that liquidity would be there in the coming days and months. These actions, combined with the introduction of emergency lending facilities to provide liquidity to funding and credit markets, proved successful.