The July 2nd Remarks of Treasury Secretary Henry Paulson, on the World Economy and Markets before the Chatham House were quite remarkable. Let’s have a look at a few of them.

Whether it was Long Term Capital Management in 1998 or Bear Stearns this year, it is clear that Americans have come to expect the Federal Reserve to step in to avert events that pose unacceptable systemic risk. But, as we noted in our Blueprint, the Fed has neither the clear statutory authority nor the mandate to attempt to anticipate and prevent risks across our entire financial system.

We need to strengthen our practices and financial infrastructure in the OTC derivatives market and in the tri-party repo system. Important work is underway in each of these areas, and needs to be completed quickly.

To address the perception that some institutions are too big to fail, we must improve the tools at our disposal for facilitating the orderly failure of a large complex financial institution.

It is clear that some institutions, if they fail, can have a systemic impact, so we must give regulators the authorities to limit that impact and facilitate an orderly failure.

In my estimation this is tacit admission that large financial institutions are poised to fail, and the tools are not in place “to limit that impact and facilitate an orderly failure”.

Mike “Mish” Shedlock
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