##aging and paring of business lines – are likely to prove highly consequential to the near - term outlook for the real economy. changing forms of financial intermediation are expected, given higher volatility and less leverage, in some cases building on old - fashioned banking products. commercial and thrift deposits, for example, backed by a loyal customer base, may offer greater franchise value. investment banks may reconfigure capital structures and core trading businesses to maximize benefits in a higher volatility environment. asset - gatherers, whether in the form of traditional money - management firms or hedge funds, that survive this time of testing may rely more on term funding and seek equity returns across beaten - down classes of structured and debt products. and dependable, recurring revenues, even at lower levels, may warrant a premium valuation in the public markets. the case for opportunistic capital is improving. some curative steps by incumbent financial institutions are in the offing. financial institutions should continue to reassess their sources and uses of funding, their risk - management systems, risk tolerance, and human capital. generally, they should not hesitate to pare their dividend and share repurchase programs. and, they should raise new capital to strengthen their balance sheets. these actions, in my view, are important signs of strength, and will ensure that financial institutions thrive in the emerging financial architecture replete with new opportunities. these actions will have concomitant benefits on real economic activity. plot line 3 : federal reserve's policy formulation the central bank's responsibility is not to individual firms but to financial markets, and only then, to the extent that financial market stresses affect the real economy. given the fragility evidenced in financial markets, and the toll it is taking on real activity, the federal reserve agreed to take center stage. this is a role for which we did not volunteer, but one in which we are prepared to serve. the role has been thrust upon us by a loss of confidence in our existing financial architecture. hence, we should remain at center stage as long as is necessary, but no longer. the fed responded aggressively to mitigate spillovers to the real economy, exercising some authorities for the first time in decades. to prevent more serious financial fallout, the fed established and expanded various lending facilities to depository institutions and primary dealers. 7 some facilities allow daily access to variable amounts of funding, and others primary dealers are banks and securities broker -

liquidity that engendered complacency among investors and counterparties. the financial architecture grew increasingly impervious to skeptics and dissenters, perpetuating insufficient transparency and under - informed risk - taking. it was commonly believed that short - term, secured credit markets would perpetually remain open to finance high - quality assets. and the notion of liquidity risk management was anachronistic, or so it seemed. market participants now seem to be questioning the financial architecture itself. the fragility of short - term credit markets is a powerful manifestation of that loss of confidence. there are some encouraging, early signs of repair, but regaining the confidence that markets require will take time, and perhaps uncomfortably to some, patience. it may also require new forms of credit intermediation. plot line 2 : transformation of financial institutions the rise and fall of liquidity is not only changing fund flows in financial markets. it may also be transforming the business models of financial institutions themselves – no matter their size, regulatory structure, peer group, funding status, or geography. the period that preceded the recent turmoil was marked by abundant liquidity, high transaction volumes, and remarkably low volatility. that environment proved exceptionally hospitable to significant profits across classes of financial institutions. it also was supportive of high leverage, and correspondingly high returns on equity for financial intermediaries. of no less consequence, it drove a conflation of roles among commercial banks, investment banks, and asset managers. the core functions of credit intermediation – creating, distributing, and owning risk – remained constant, but more institutions came to believe that there were inescapable synergies by operating across all three primary functions. from 2002 to mid - 2007, many large financial institutions did just that, and to great effect – creating products by aggregating and reconstituting assets, distributing bespoke risks across institutional and retail channels, and retaining certain preferred positions for proprietary accounts. a changing paradigm of financial intermediation may well be on the horizon. from the market's perspective, financial institutions overproduced goods and services that now have to be warehoused or liquidated. from the perspective of financial institutions themselves, the old business models may be in the process of being upended. and from the perspective of a dispassionate central banker, the contemporaneous changes in balance sheets and income statements by incumbent financial institutions – most notably, delever