And, of course, the higher costs of assets with poor liquidity characteristics may have changed the economics for issuers of liabilities such as corporate treasurers which may encourage more standardisation of terms to improve liquidity and reduce costs. It is, however, important to look not only at how to improve the resilience of markets to imbalances between sellers and buyers at times of stress. We need also to look at whether and how the features of financial markets can amplify these imbalances by creating selling pressure. Correlated trading is one example. Such trades arise when the demand for an asset ceases to fall materially as prices rise, and vice versa. They turn the law of supply and demand on its head. This may be caused by the prevalence of algorithmic momentum traders in a market or the use of industry standards and benchmarks that influence asset allocation and peer assessment. Consensus trades are another example. They occur when investors take positions on the basis of prevailing market norms as opposed to conviction in their view of the future path of economic fundamentals. Consequently, these positions may be particularly susceptible and adversely affected by comparatively little bad news. Investment funds and asset managers Finally, I want to look briefly at the potential role of investment funds and asset managers in creating selling pressure in markets at times of stress. To state the obvious, investment funds and asset managers are not banks. They do not offer the promise that you will get your money back.

As demonstrated by the thrift crisis, if many firms are all vulnerable to the same shock, ensuring that these firms are small and numerous won’t necessarily reduce the systemic risk they collectively pose to the financial system. Third, the costs incurred in breaking up such firms also need to be considered. Others have argued in favor of separating commercial and investment banking activities of the large banks. In my opinion, there are shortcomings to re-imposing Glass-Steagall-type activity restrictions. It is not obvious to me that the pairing of securities and banking businesses was an important causal element behind the financial crisis. In fact, independent investment banks were much more vulnerable during 2008 than the universal banking firms which conducted both banking and securities activities. More important is to address the well-known sources of instability in wholesale funding markets and to give careful consideration to whether there should be a more robust lender of last resort regime for securities activities. Evaluating the socially optimal size, scope and organizational structure of financial firms is a complicated exercise, and so is establishing a viable transition path to a system of much smaller banks. It would be helpful in this regard if advocates of the break-up solutions would develop detailed proposals that address the essential questions of how such downsizing or functional separation would be accomplished, and what the expected benefits and costs could be from such a restructuring. The recent financial crisis underscores the importance of financial stability as a necessary condition for a vibrant economy.