Wednesday, May 19, 2010


When everything is connected, "fail-safe" is a misnomer. The following is from an article on my reading list for today:

The risk comes if the defaults burn through these member resources. In that case, Mr. Dodd is signaling that taxpayers will be called upon to help. Regulators are selling this Beltway re-engineering as a way to offset the "interconnectedness" of financial firms in the over-the-counter derivatives market. But clearinghouses are the most interconnected of all institutions—by design.

Clearinghouses do have a generally good record for trading in futures and other things, but they can and have failed. They didn't fail during the 2008 crisis, but a senior financial regulator in office at the time tells us that one or more clearinghouses might have been in distress if the feds had not rescued the commercial paper market.

Clearinghouses had traditionally held the margin they collected in cash or Treasurys, but over time some of this money was invested in instruments with a higher yield and a triple-A rating from one of the government-selected credit-rating agencies. These assets became much more difficult to sell in the fall of 2008. Regulators thought about raising the issue at the time but didn't want to add to the panic. They have since pressed clearing organizations to keep only the most liquid financial instruments.

No comments: