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Our nation has come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk, Paulson said. However, the Central Bank has neither the clear statutory authority nor the mandate to anticipate and deal with risks across our entire financial system; he explained noting that the financial regulatory structure has not kept pace with market evolution.
The SEC and the Fed should coordinate regarding capital and liquidity requirements for primary dealers’, he said outlining that the transformation process of the current regulatory structure into something that meets the objectives we laid out in the Blueprint will take time.
“Perhaps the most difficult question is how to create an entity that performs the function of the market stability regulator”, he said. “The Fed would need appropriate authority to respond to and proactively address systemic risks – whether it be a risk posed by a commercial bank, an investment bank, a hedge fund, or another type of financial institution”, he explained.
To avoid moral hazard, “we must limit the perception that some institutions are either too big or too interconnected to fail”, he said. “To do that, we must strengthen market infrastructure and operating practices in the OTC derivatives market and the tri-party repo system and clarify the resolution, or wind down, procedures for non-depository institutions.”
Paulson drew three clear lessons from the experience of recent months: