The present financial epidemic has broadly mirrored those dynamics. The failure of a core set of large, interconnected institutions – Fannie and Freddie, Bear Stearns, Lehman Brothers, AIG – contributed disproportionately to the spread of financial panic. Epidemiology provides a second key lesson for financial policymakers – the importance of targeted vaccination of these “super-spreaders” of financial contagion. Historically, financial regulation has tended not to heed that message. As Chart 4 demonstrates, larger polygamous financial institutions have if anything run with lower capital buffers than their smaller monogamous partners. There are two potential explanations for this seemingly perverse result. First, Basel II conferred diversification benefits on larger firms. Second, even ahead of crisis there was a market expectation that larger firms were more likely to receive government support. As Chart 5 illustrates, those expectations have subsequently been validated by events, with the largest packages of official sector capital support having gone to the biggest global banks. Hastily convened marriages between institutions during the crisis have increased the size and degree of concentration within the banking industry. So regulation may have contributed to perverse risk-taking incentives among large, interconnected firms. And subsequent interventions may have worsened those incentives. In response, the authorities in a number of countries have recently announced their intention to tackle this incentive problem, by better aligning regulatory taxes with firms’ systemic importance. No country has as yet turned that statement of intent into an operational framework for systemic regulation.

These innovations effectively removed principal counterparty risk from the transactions equation. This infrastructural revolution largely went unnoticed at the time and risks going unnoticed now. Its effects can be seen by counter-factually asking what might have happened during the present crisis without it. With counterparty risk preserved, banks would have delayed payments or transactions for fear of extending uncollateralized credit to institutions of unknown credit quality. Payment systems may have suffered the same seizures felt by  3  Miller, M and Modigliani, F (1958), “The Cost of Capital, Corporation Finance and the Theory of Investment”, American Economic Review 48 (3). 4  BIS Review 85/2009  money markets during the crisis. There would have been an irreparable blockage in the plumbing. In the event, activity in most financial markets has remained strong, allowing risk to be traded and relocated. Robust payments infrastructure played a key, if largely silent, role in this positive outcome. Though neither visible nor audible, this underscores the importance of systemic oversight, and redesign, of payment and settlement infrastructures by central banks. Lesson 6: But some plumbing was missing The infrastructure of financial markets extends well beyond payment and settlement systems – for example, into the area of trading and clearing systems. Here, crisis events suggest scope for improvement. A number of markets have seized during the past 18 months, including at various times the foreign exchange swap market, the corporate bond market, structured credit markets, various derivative markets such as CDS and, perhaps most strikingly, the money market.