Harold BradleyRobert FawlsRobert E. LitanFred Sommers
Financial plumbing is taken for granted, except when things go wrong. It was only a few years ago, for example, that the Federal Reserve Bank of New York saw the mess in the derivatives market, where transactions were recorded on slips of paper and sometimes misplaced before the Fed forced the major banks that were part of that market to clean up their act.
In this essay, we focus on other parts of the financial plumbing that now must be fixed, sooner rather than later. In particular, we address:
Our central conclusion is this: Every fail introduces a cumulative and potentially compounding liquidity risk into the orderly process of settling the $7.5 trillion of security transactions completed each day, which could be especially dangerous during times when financial institutions are short of liquidity (as was true during the financial crisis of 2008).
The settlement fails problem is readily resolvable. Both the Federal Reserve and the Securities and Exchange Commission (SEC) have penalized fails in the U.S. Treasury and equities markets with successful outcomes. The appropriate federal regulators therefore should:
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