"A system that appeared resilient (and enormously profitable) in times of low volatility has proven brittle in the face of shocks."

Mark Carney with a good post in the FT:

"Our response to the financial crisis will be as important as the event itself. We can never eliminate financial crises, but we can reduce their likelihood and severity. By taking a macro-prudential approach to capital and committing to continuously open markets, we can both limit the downturn and build a more resilient financial system."

This sounds a lot like Prof. Mankiw's post.

"This crisis marks the reversal of a decades-long transition from a bank-dominated to a market-dominated financial system. The market-based model has the potential to price risk and to allocate capital more efficiently. In some cases, however, the development of markets ran well ahead of the supporting infrastructure. A system that appeared resilient (and enormously profitable) in times of low volatility has proven brittle in the face of shocks."

So we need to build resiliency into the now Market-Dominated Financial System. Is this Prof. Mankiw's robustness?

"In many parts of the world, market-based finance has weakened core financial institutions and put large non-bank financial sectors under great strain. Certain markets are now frozen. Consequently, there is a sudden re-emphasis on bank-based intermediation that has led to an urgent need for banks to raise very large amounts of capital. This threatens to intensify the global economic slowdown if not managed properly.

We must ensure that banks continue to lend. We must also ensure that core markets – such as interbank lending, commercial paper and repo markets for high-quality securities – are kept continuously open. There are two related strategies to achieve these imperatives."

If the banks do not do it, and it's an imperative, doesn't that mean that the government should do it? This looks like a rationale for a small national bank.

"The first is the action plan of the Group of Seven leading industrialised nations to make banks resilient so that they can resume their market-making roles. The G7 made a firm commitment that no systemically important institution will be allowed to fail and that sufficient capital – public and private – will be provided to restore confidence. In recent weeks, G7 governments have acted with bold measures to honour these principles. In tandem, central banks have fulfilled their commitments to “ensure that banks and other financial institutions have broad access to liquidity and funding”. The liquidity they provide to core institutions should cascade through the system to other market participants and, ultimately, through private credit creation, to the real economy."

I don't know how much firmer they could be, since they're throwing the kitchen sink at the problem. All they could do now is tattoo their commitment on all our bodies.

"The G7 action plan will work, but it will take time for capital and confidence to return. In those systems with weaker core financial institutions and larger shadow banking systems, the adjustment process could take longer, making it all the more important that financial guarantee programmes instituted in many countries are used to maximum effect. The explicit G7 commitments should secure cost-effective funding while the necessary capital increases are spread over time."

Keep it going.

"In parallel, policymakers must have the courage of their (new-found) macro-prudential convictions. In line with the G20 leaders’ call for regulators to mitigate pro-cyclicality in capital, we should not push capital standards up too high, too rapidly. Through-the-cycle capital means that capital ratios should fall in a downturn. Just as bad loans are made in good times, now is the time to finance business investment for the inevitable global recovery."

I'm fine with slowly but surely, but wonder if getting to higher capital levels sooner than later would help.

"The second strategy recognises that the transition towards a market-based financial system has increased the importance of core money markets. In economies with weak banks and large non-bank sectors, massive central bank liquidity is not yet cascading through the system. Non-bank participants – such as money market funds, pension funds and hedge funds – fear that liquidity may not be continuously available. Their fears will not fade without structural changes to markets."

We need to change markets.

"This is a situation where central banks should consider acting as market-makers of last resort by becoming a counterparty to a broad range of market participants. Some central banks are already acting as de facto central counterparties by taking in deposits from institutions with excess liquidity and providing it to those with deficient liquidity. Depending on the importance of non-bank participants to our core money markets, central banks should expand the range of our counterparties and the frequency of our interventions."

If so, then these institutions should obey stricter guidelines. I'm not sure about this one.

"In the medium term, we could adapt regulations and standards, for example, with higher capital requirements for securities that trade outside continuously open markets; and the application of fair-value accounting could be limited to those securities that trade on exchanges or in continuously open markets. If the central bank were the market-maker of last resort, it could reinforce such standards."

If the Central Bank is the last resort for any financial concern, it should be regulated with the taxpayer's interests in line.

"Behind these strategies is a single purpose: to rebuild the financial system on a network of continuously open markets so that credit again flows to the real economy – the industries that create the products, services and jobs that underpin our shared prosperity.

The writer is governor of the Bank of Canada. The piece was based on a speech to the UK-Canada Chamber of Commerce in London on 19 November"

I like Carney, and basically agree about the market-system approach, but I think that we should consider having a well regulated and government guaranteed part of the financial system, and a non-guaranteed part of the financial system which is supervised, but less regulated, and monitored for problems that can lead to a cascading effect.

The bottom line, of course, is that the government is the lender of last resort, and so how much risk are the taxpayers willing to accept under these conditions? Given the reality, they might demand a system more or less like Carney's, since this bailout has weakened the taste for another possible bailout.