the complete evaporation of liquidity in certain market segments of the u. s. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating. ” i would like to thank my colleagues meg mcconnell, jamie mcandrews and brian peters for numerous useful comments and suggestions on these remarks. central banks immediately responded to the evaporation of liquidity in the standard manner. for example, the federal reserve issued a statement on august 10 indicating it was providing liquidity for the orderly functioning of markets, and in that statement the federal reserve emphasized that “ as always, the discount window is available as a source of funding. ” one week later it reinforced this statement with a 50 basis point cut in the discount rate and the addition of 30 - day term loan to complement the standard overnight discount window loan. at that time, the discount windows of federal reserve banks were only open to depository institutions. standard monetary economic theory and previous experience were consistent with the notion that depository institutions could act as intermediaries to pass liquidity through to the rest of the financial system. indeed, in many earlier episodes the mere fact that this backstop liquidity was present had been sufficient to calm financial markets. circumstances proved very different in this episode. for one, the rise of the shadow banking system meant that a preponderance of financial intermediation in the united states was being performed by non - depository institutions that funded themselves in wholesale rather than retail markets. further, traditional discount window loans have always been vulnerable to stigma – that is, if a bank borrows from the central bank it runs the risk that markets and counterparties may infer that it is closer to insolvency than was previously thought. the potential for stigma to damage the effectiveness of this crucial backstop facility explains why the identity of discount window borrowers is not disclosed by the federal reserve. indeed, we saw early in this crisis that many depository institutions proved unwilling to take the risk of possible stigma, the result of which was an increasingly severe impairment to the flow of liquidity to the rest of the financial system. in late august 2007, a new facility was designed to help overcome stigma through the use of an auction mechanism. as the market calmed in september to late october, this facility was shelved but was ultimately introduced on december 12, 2007, as the term auction facility in a coordinated announcement with other central banks. this phase has some obvious lessons for financial

. against this backdrop, the request for the $ 700 billion troubled asset relief program ( tarp ) appropriation was made the next day. in the short time it took congress to pass the tarp appropriation, the panic continued to spread ; on september 25, washington mutual, the sixth largest depository institution, was resolved by the fdic and just days later wachovia, the fourth largest bank holding company the recent testimony by thomas baxter and sarah dahlgren provides a detailed explanation : joint written testimony of thomas c. baxter and sarah dahlgren : the federal reserve bank of new york ’ s involvement with aig. encountered severe funding difficulties and was eventually taken over by wells fargo. as with the need to place the two largest gses into conservatorship, it became apparent that much of the supposed ample capital in the u. s. financial system was not an effective bulwark against insolvency or the perception of possible insolvency. the latter possibility, whether true or not at its inception, can ultimately become a self - fulfilling prophesy if it results in a run on the financial system. there are three broad forms of policy responses available to arrest the self - fulfilling prophesy dynamic that can take hold during a run on the financial system : lender - of - last - resort actions to assist the economy in adjusting to the severe funding strains produced by the run, guarantees issued to reassure existing liability holders, and capital injections to strengthen the actual, and therefore perceived, solvency of financial institutions. by early october 2008, it was apparent that a substantial escalation on all three fronts was required to give the financial system what was essentially a time - out in order to halt the selffulfilling prophesy dynamics. it is useful to consider the analogy of the time - outs that parents give to their children when they are misbehaving. while the analogy is not appropriate in terms of the punishment aspect of time - outs for kids, there are a number of similar problems in establishment of a robust time - out strategy. first, how to define the boundaries associated with the time - out. in the case of arresting a run on the financial system, who does and who does not have access to the lender - of - lastresort, guarantees and capital injections? next, can the parent / government credibly announce and then efficiently operate the time - out? finally, as all parents are acutely aware