Distinguished Lecture on Economics in Government: Central Banking and Systemic Risks in Capital Markets.

This article focuses on central banking and systemic risks in capital markets in the United States (U.S.) The Federal Reserve System, as the nation's central bank, has a major responsibility in the containment of the risks which threaten to disrupt the fabric of the financial system which is so vital to the economy at large. This responsibility extends well beyond the more narrowly defined tasks of controlling the growth rates of the monetary aggregates or influencing the level and structure of interest rates. The three banking incidents involving Franklin National, Sea First and Continental Illinois illustrate the ways in which the deposit drains on individual institutions can occur in the modern money market. It they are not checked promptly, the uncertainties they create can undermine major segments of the banking system. The shock to the commercial paper market created by the failure of the Penn Central Railroad in 1970 caused the Federal Reserve to step in to minimize the risk to a special segment of the capital market. The Federal Reserve Board declined to lend directly to Penn Central, but it did allow the Federal Reserve Banks to channel funds from the discount window through commercial banks to offset the drain on liquidity in the private sector which followed the shrinkage of the commercial paper market.