##mediation was occurring in nonbank financial institutions. as a result, little attention was paid to the systemic implications of the actions of a large number of increasingly important financial institutions – including securities firms, insurance conglomerates and monolines. in addition, many large financial organizations were funding themselves through market - based mechanisms such as tri - party repo. this made the system as a whole much more fragile and vulnerable to runs when confidence faltered. with the benefit of hindsight, it is clear that the fed and other regulators, here and abroad, did not sufficiently understand the importance of some of these changes in our financial system. we did not see some of the critical vulnerabilities these changes had created, including the large number of self - amplifying mechanisms that were embedded in the system. nor were all the ramifications of the growth in the intermediation of credit by the nonbank or “ shadow banking ” system appreciated and their linkages back to regulated financial institutions understood until after the crisis began. with hindsight, the regulatory community undoubtedly should have raised the alarm sooner and done more to address the vulnerabilities facing our banks and our entire financial system. but this was difficult because our country didn ’ t have truly systemic oversight – oversight that would be better suited to the new world in which markets and nonbank financial institutions had become much more important in how credit was intermediated. without a truly systemic perspective, it was unlikely that any regulator would have been able to understand how the risks were building up in our contemporary, market - based system. the problem was that both banking and nonbank organizations played an important role in credit intermediation but were subject to differing degrees of regulation and supervision by different regulatory authorities. although these gaps had existed for years, their consequences were not apparent until the crisis. difficulties in one part of the system quickly exposed hidden vulnerabilities in other parts of the system, in a way that our patchwork regulatory system had not been designed to detect or readily address. in the same way, the crisis revealed the critical deficiencies in the toolkits available to the regulators to deal with nonbank institutions in duress. emergency lending by the fed might be enough to forestall the disorderly failure of a systemically important institution and all the wider damage such a failure might cause, but it was a blunt and messy solution, employed as a stopgap measure because better alternatives were not available. what is needed – what our country still lacks

have pushed u. s. commercial real estate prices down by about 40 percent to 50 percent from the peak reached in 2006. loan losses in commercial real estate and consumer and mortgage loans seem likely to continue to pressure smaller banks for some time to come. this in turn means that credit availability to households and small businesses will still be curtailed. the improvement in the overall health of the financial system and in market function has allowed the federal reserve to phase out many of the special liquidity facilities that were enacted in response to the crisis. these facilities were generally successful in achieving their objectives – helping to restore confidence and rebuild market liquidity in a way that safeguarded the taxpayers ’ interests. when a full accounting of the special liquidity facilities is complete, it seems likely that the facilities will have generated substantial incremental earnings that the federal reserve will remit to the treasury. although these incremental earnings were not the objective of these facilities, they are a pleasant outcome relative to the alternative. as the crisis has abated, our attention has shifted to what we need to do to prevent another crisis in the future. we need to take the necessary steps to build a strong and resilient financial system. in my opinion, three broad sets of actions are needed : • effective macroprudential supervision. by this, i mean conducting supervision not just vertically institution by institution, but also horizontally across institutions and markets. we need to better understand how the system operates as a whole and how problems in one area can affect financial stability elsewhere. this means both how the overall system affects individual firms and how the activities of a single firm or market affects the entire financial system. • make financial institutions and market infrastructures more robust to withstand shocks and become less prone to failure. • change the system so that no financial firm is “ too big to fail. ” macroprudential supervision is essential for two reasons. first, it addresses the problem of gaps in the regulatory regime and the regulatory arbitrage that such gaps can encourage. second, macroprudential supervision is needed because the financial system is interconnected. siloed regulatory oversight is not sufficient. supervisory practices must be revamped so that supervision is also horizontal – looking broadly across banks, nonbanks, markets and geographies. this also means that regulatory standards need to be harmonized across different regions. without harmonization, there will inevitably be a “ race to the bottom ” and regulatory arbitrage will be encouraged, rather