Financial Market Infrastructure: Too Important to Fail

A major focus of this book is the development of failure resolution methods, including bankruptcy and administrative forms of insolvency management, that reduce to a manageable level the damage to the economy caused by any financial firm’s failure. The alternative is the moral hazard of allowing a financial firm to believe that its failure would be dangerous to the financial system and that it would therefore likely receive significant government assistance when its solvency is suddenly threatened. While orderly failure resolution is a desirable principle, I do not believe that it currently applies to all financial firms. In this chapter, I argue that failure resolution could not yet be safely applied to certain firms that operate key financial market infrastructures (FMIs) used for clearing over-the-counter derivatives or tri-party repurchase agreements (repos). The failure of key FMIs could indeed be dangerous to the financial system, even with the best available approaches to failure resolution. By implication, a financial institution should not operate key financial market infrastructure backed by the same capital that supports much more discretionary forms of risk-taking, such as speculative trading or general lending. Not only would such