Industrial Organization and Systemic Risk: An Agenda for Further Research, Federal Reserve Governor Daniel K. Tarullo At the Conference on the Regulation of Systemic Risk, Federal Reserve Board, Washington, D.C., September 15, 2011
“Regulators must consider how new resolution frameworks such as that created by Dodd-Frank will affect market participants’ beliefs about what will happen in the case of distress at a large financial institution and, consequently, how cooperative behavior among financial counterparties might change. Orderly liquidation authority can be understood as a “credible threat” on the part of regulators to allow a troubled institution to fail. Resolution plan requirements may allow other firms to better anticipate the consequences of such a failure and, as a result, to reduce the cost of uncertainty for those firms. Both of these features of Dodd-Frank have, in theory, the potential to weaken implicit cooperative arrangements during a crisis. Even so, game theorists would point out that the anticipated breakdown of cooperation in the future would alter the types of arrangements firms would be willing to enter into in the first place, and that this could, in turn, reduce risky behavior and the likelihood that a crisis would occur.”
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