, systemically critical firm. institutions should not be permitted to receive assistance while open, but authorities must be empowered to sell, merge, or break up an institution as necessary to avoid a disorderly unraveling that threatens the financial system as a whole. the resolution agency should not be allowed to protect shareholders and other capital providers and it should have clear authority to impose losses on debt holders, override contracts, and replace managers and directors as appropriate. if, in the end, funds must be injected to resolve a systemically critical institution safely, the ultimate cost must not fall on taxpayers or small financial institutions, but on those institutions that are the source of the too - big - to - fail problem. i don ’ t want to understate the difficulties of creating an effective resolution framework for large, interconnected firms. such firms can be extraordinarily complex, both in terms of their legal structure and in the range and sophistication of their activities. the resolution of large institutions whose operations span many countries poses particular challenges, as legal frameworks vary across countries, and the authorities in each country naturally seek to protect the interests of depositors and creditors in their own jurisdictions. we must also recognize that such resolutions might well take place in the context of a broader crisis, in which the government might be forced to address problems at multiple firms simultaneously. careful planning is therefore essential. an idea worth exploring is to require firms to develop and maintain a so - called living will, which will help firms and regulators identify ways to simplify and untangle the firm before a crisis occurs. 1 see daniel k. tarullo ( 2009 ), “ supervising and resolving large financial institutions, ” speech delivered at the institute of international bankers conference on cross - border insolvency issues, new york, n. y., november 10. the federal reserve and community banks the federal reserve and community banks have much in common beyond our mutual concerns about the too - big - to - fail problem. our interest in community banks has its roots in the founding of the federal reserve in 1913, nearly a century ago. president woodrow wilson and the other founders of the fed, taking note of two previous failed attempts to establish a u. s. central bank, intentionally avoided creating a single, monolithic institution located in washington or new york. instead, they established a system of 12 reserve banks located in major cities around the country. ( it was a federal system – hence the term, “ federal reserve

financial system as a whole, and not just those to individual firms in isolation. implementing supervision in a way that seeks to identify systemic risks as well as risks to individual institutions is a difficult challenge, but the fact is that the traditional approach of focusing narrowly on individual firms did not succeed in preventing this crisis and likely would not succeed in the future. consequently, we at the federal reserve have been working with international colleagues to require that the most systemically critical firms increase their holdings of capital and liquidity and improve their risk management ; and we are overhauling our supervisory framework for the largest institutions, both to improve the effectiveness of consolidated supervision and to incorporate in our oversight a more comprehensive, systemic perspective. the second component of the strategy to end too - big - to - fail is to increase the resilience of the financial system itself, to reduce the potential damage from a systemic event like the failure of a major firm. for example, the federal reserve has been leading collaborative efforts to improve the clearing and settlement of credit default swaps and other derivatives and to enhance the stability of markets for repurchase agreements. limiting the fallout from the failure of a major firm is not only directly beneficial in a crisis, it also helps to reduce the too - big - to - fail problem, because the government has much less reason to intervene if it believes that the financial system is resilient enough to handle a significant failure without excessive disruption. third, because government oversight alone will never be sufficient to anticipate all risks, increasing market discipline is an essential piece of any strategy for combating too - big - to - fail. to create real market discipline for the largest firms, market participants must be convinced that if one of these firms is unable to meet its obligations, its shareholders, creditors, and counterparties will not be protected from losses by government action. to make such a threat credible, we need a new legal framework that will allow the government to wind down a failing, systemically critical firm without doing serious damage to the broader financial system. in other words, we need an alternative for resolving failing firms that is neither a disorderly bankruptcy nor a bailout. a prototype for such a framework already exists – namely, the rules set forth in the federal deposit insurance corporation improvement act of 1991 for dealing with a failing bank. as the fdic is now able to do with a failing bank, the government should, under appropriate circumstances and with appropriate safeguards, be able to seize and wind down a failing