facilitate the daily “ unwind ” of the prior day ’ s transactions. 7 in the run - up to the crisis, the daily “ unwind ” practice helped make tri - party repo look like a very liquid investment while still being an apparently highly durable source of funding. this masked the underlying risks and contributed to weak risk management practices. as the concerns about the u. s. housing market escalated in 2007, participants in the tri - party repo market became increasingly concerned about the liquidity and credit risks that they faced. the clearing banks became uncomfortable with their large intraday exposures to their tri - party securities firm customers. after all, if a securities firm were to fail suddenly, the clearing banks could be stuck with huge loans to these counterparties, secured by securities that were not necessarily high quality and liquid. thus, as the condition of the most troubled securities firms deteriorated, there was a risk that one morning a clearing bank might decide not to unwind a firm ’ s tri - party transactions in order to avoid a large intraday exposure. the problem was particularly acute for those firms with large securities trading and over - the - counter derivative businesses operated outside of depository institutions. in the united states, even those securities firms that were part of bank holding companies were vulnerable because section 23a restrictions in the federal reserve act that govern transactions between the bank and the nonbank affiliates as part of a bank holding company complex sharply limited what assets the securities firm could pass through to the bank and on to the fed ’ s discount window facility. in the unwind, cash was transmitted back from securities firms to wholesale investors each morning, to hopefully be reinvested and returned back to the securities firms by the end of the day to finance their inventories of securities. bis central bankers ’ speeches this risk faced by the clearing banks, in turn, unnerved the tri - party repo investors. after all, if the unwind did not occur, they would be stuck with the collateral securing their loans from the night before. most of these investors were not prepared to take possession of and liquidate such collateral, and had no interest in doing so. the incentives for these investors were to run at the first sign of trouble to avoid getting stuck with the dealer ’ s collateral. this incentive to run was reinforced by the fact that if the investors were stuck with the collateral, they would have strong incentives to sell it quickly in order to generate the liquidity needed to meet redemption calls or

. 2012. “ proposed recommendations regarding money market mutual fund reform ”. ( november ). http : / / www. treasury. gov / initiatives / fsoc / documents / proposed % 20recommendations % 20regarding % 20money % 20market % 20mutual % 20fund % 20reform % 20 % 20november % 2013, % 202012. pdf see william c. dudley. 2012. “ for stability ’ s sake, reform money funds ”. www. bloomberg. com, august 14. http : / / www. bloomberg. com / news / 2012 - 08 - 14 / for - stability - s - sake - reform - money - funds. html. for a more detailed discussion, see “ the minimum balance at risk : a proposal to mitigate the systemic risks posed by money market ”. www. newyorkfed. org / research / staff _ reports / sr564. pdf bis central bankers ’ speeches rather than rely on their ability to get out ahead of small retail investors when trouble materializes. the larger question reforming the tri - party repo system and the money market mutual fund industry is essential and would make the financial system significantly more stable. but even after such reforms, we would still have a system in which a very significant share of financial intermediation activity vital to the economy takes place in markets and through institutions that have no direct access to an effective lender of last resort backstop. 16 the financial crisis clearly demonstrated that we can no longer assume that in periods of stress banks will be willing to access lender of last resort loans and on - lend to the nonbank financial sector at sufficient scale to stabilize the system of market - based financial intermediation, as happened in earlier periods such as the commercial paper crisis in the mid - 1970s. the financing needs outside the commercial banks may be too large relative to the capacity of the banking system, banks may be reluctant to lend to competitors, be concerned about their own liquidity and funding needs, or simply be deterred by elevated counterparty risk. we need to consider whether our current architecture is satisfactory. if we were to decide that the existing state of affairs is not acceptable in financial stability terms, there are two broad paths we could follow. the first option would be to take steps to curtail the extent of short - term wholesale finance in the system. in principle, regulators across a broader set of institutions and markets could take steps to