America Needs an Independent Clearinghouse for OTC, CDS 18 comments
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Co-written by Jeff Carter
L. Gordon Crovitz wrote that:
...having learned the hard way that opaque markets are risky markets, the private sector is trying to bring transparency to credit derivatives, either by creating a clearinghouse to centralize information, or through an exchange with disclosure of prices and conditions. Derivatives would again reduce risk, not heighten it.
As market participants that intimately understand the issues at hand, we would like to comment at this time, especially since, according to Bloomberg’s Matt Leising, the Fed “has given US futures exchanges until Friday to present written plans on how they will make the $55 trillion credit swaps market less risky.”
Good public policy demands the most favorable outcome per dollar spent, especially when it is the taxpayers’ money that has been put at risk, as in the recent bailout of Wall Street. “The Bailout Package Must be Transparent to the American People,” wrote Congressman John Sarbanes (D, 3rd, MD). He continued, “…any plan adopted by the Congress must also give confidence to the American taxpayers that their dollars are not being used recklessly.”
What Sarbanes is also referring to is transparency.
In our view, the exchange clearing model works because it is efficient, transparent, begets fairness and puts a check on the amount of risk that can be assumed by different parties. An independent exchange-clearing system will save the American taxpayer billions of dollars.
Clearing eliminates counter-party risk. The Chicago Mercantile Exchange (CME) and others have entered the sweepstakes to begin clearing various OTC trades, especially in the $55 trillion credit default swap arena. Executive Chairman Terry Duffy has publicly stated that he embraces fair and open competition for this market. It is obvious that the interbank credit market cannot function effectively going forward without clearing.
Will there be a competitive battle for this market? Secretary of the Treasury Henry Paulson has loaded up the TARP with Goldman-Sachs (GS) employees. Already, regulatory battle lines are being drawn, and politicians like Senator Schumer are trying to dictate the terms of competition. We know that once Washington windbags sink their teeth into an issue, bad things can happen. For proof, just look at the Fannie and Freddie fiasco. This time it should be different: open competition utilizing free market principles will result in the most gain for the American taxpayer.
What causes us the most concern as the clearing sweepstakes begin? We understand intimately the operations and actions of the players in the market. The OTC market was the playground of the investment banks. They deliberately kept the market fuzzy to take advantage of their own customers, who they encouraged to trade in it. They used riskless arbitrage to generate huge profits. The insolvent investment banks will now try to keep this market opaque in the future to enable them to make even more money to try to get solvent again. If they are allowed, through regulatory fiat, or by legislative machination, to be able to park OTC trades in their own clearinghouse, then that would be akin to the fox guarding the hen house - again. An investment-banker controlled clearinghouse will just become a bucket-shop for OTC and CDS trading.
If that becomes the reality, it will only be a matter of time before we see a monstrous blow-up in our financial system again due to these same bad actors, and once again, the American taxpayer will have to foot that bill.
The only practical and ethical solution is an independent clearinghouse. The CME just so happens to have one available that has operated for over a century without a default.
Disclosure: Paul Richards is a full member of the Chicago Board of Trade and a shareholder in CME Group and CBOE. Jeff Carter is a Former Director of the Chicago Mercantile Exchange
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This article has 18 comments:
How has Schumer influenced the process? You've made an accusation without any proof.
Who are the Goldman Sachs operatives?
The public doesn't undersatnd how Fannie & Freddie fit into this fiasco.
So your saying the IBs gamed, then broke the system, took taxpayer money to avoid bankruptcy, and now plan to game the system while they re-build it into their new money machine?
Couldn't agree more!
We picked Fannie and Freddie because they are classic quasi government agencies that lead to distortions in the marketplace, and blew up. The same would happen if the IBanks ran their own clearing.
By the way, today I have been listening to people go on tv and tell the public that the interbank market is okay. The TARP is spending money, and injecting onto bank balance sheets.
They are still wrong. The counter party risk that existed before the bailout still exists. What if the assets on the banks balance sheets are worth even less than they estimate? Then more capital will need to be injected to prop them up.
The only way to find out what this stuff is worth is to create a competitive marketplace and have bids and offers. If you clear the stuff through a clearing house, you eliminate counterparty risk. This should lead to better pricing, because the sellers and buyers won't need to price in that risk.
Uniform Commercial Code Article 8 provided for the creation of “securities entitlements” or “placeholder securities” to credit to the brokerage account of the purchasers of securities that encountered delivery delays.
The shares were collateralized into debt as CDS's over and over till the companies went to zero in many cases. Whether to zero or significantly lower it is still fraud.!!
thesanitycheck.com/Blo...
The article goes on to say that Goldman, Morgan Stanley and Merrill are amongst those whose third-quarter lobbying "all equaled or exceeded the previous quarter." And this is after they went on the dole!
Imagine the chutzpah!
Does it defy belief that if they would use taxpayer money to lobby the government on their own behalf that they might also try to set up their own bucket-shop?
Let’s hope that all of these shenanigans do not end up costing we, the taxpayer, any more than they already have.
This Friday, let’s see if the Fed does the right thing and awards the $55 trillion credit swaps market to an independent clearinghouse, with a history of no defaults, or if our tax dollars were used to lobby and buy this market from Washington.
Now they want their own clearinghouse so that they can continue to front-run their customers orders and trade against their customers opaquely. That way they can make all their money back from the debacle that they themselves caused.
Well, Mr. Government – just say ‘NO.’ Not with our tax dollars, please. We prefer transparency.
So when the Fed makes this decision, it will be revealing to see if they choose ICE or CME. If they choose ICE, then we will know that the fix was in.
Now is the time for the Federal Reserve and Treasury to mandate a change for the benefit of all Americans. The select few on Wall Street must not be protected by their peers. The current system is failing each and every one of us.
The integrity and independence of the CME Group is unparalleled by any other exchange. The Federal Reserve and Treasury must protect every American by selecting an independent clearing exchange.
The Federal Reserve and Treasury must select the CME Group.
the link to the CNBC appearance is here:
www.cnbc.com/id/158402...
While “Dining at the Taxpayer Buffet,” online.wsj.com/article..., the front page of today’s Wall Street Journal highlighted their analysis that shows that financial giants, who are getting huge injections of federal cash, owed their executives more than $40 billion for past years' pay and pensions as of the end of 2007. online.wsj.com/article....
We can now confirm what those of us that have been close to the market have always known - that the investment banks that put our economy into this pickle to begin with, will now use taxpayer "bailout" money to reward those executives who caused the mess.
Not only that, but instead of lending the money out, they are using the money for mergers and acquisitions and capital expenditures to try and keep the market as it was. The government's clear intention was to increase the amount of lending and to free our economy of the credit crunch.
At least, that was the sound-bite we received on the evening news, when they railed against executive compensation.
A fiction writer would have trouble concocting a story line like this.
“Worst of all are the political incentives that are unleashed when Washington promises to spend a trillion dollars (and counting). No one can spend such money wisely even if they want to. The information about who needs to be bailed out and who needs to fail is too complicated. Inevitably, such decisions will begin to be more about politics than economics. The banks were first.” online.wsj.com/article....
Why might that be? Could it be because “Goldman’s presence in the department and around the federal response to the financial crisis is so ubiquitous that other bankers and competitors have given the star-studded firm a new nickname: Government Sachs?” www.nytimes.com/2008/1....
So Government Sachs is going to be making a decision, perhaps today, on which clearinghouse will win the sweepstakes to clear the toxic credit default swaps market. Will it be ICE or CME?
“Jeff Sprecher, chief executive of ICE, said banks are committed to the credit-default-swap market despite the prospect of tighter regulation and higher capital needs. He said ‘capital efficiency’ in this market isn't a priority of many banks, who are willing to pay more to retain their dominance in trading.” online.wsj.com/article....
So the investment banks will give up capital efficiency in order to “dominate trading.”
Just what does this mean?
It means that this whole thing does not pass the “smell test.”
That about says it all. In order to control order flow, control trading and to control the ‘game’, the investment banks, at the public trough to pay execs who caused the crash of the economy, will use their political clout and government connections to ensure that they continue to ‘dominate trading.’
Ask yourself, how is it that they derive such a huge percentage of their gross income from their proprietary trading groups? No one can be that good, can they?
Then ask yourself, why is it that they trying to create dark pools of liquidity?
What could possibly be wrong about exposing some sunshine in there? Just what exactly are they trying to hide?
The SEC should change the rules to make sure that the playing field is level and not rigged in favor of these banks. All orders should see the market so that everyone can compete, and the markets should be transparent.
This should not be done by federal mandate, which may be compromised by circumstance, or in some shady, smoke-filled back room.
The American taxpayer is demanding that there be a fair, open, and free-market competition for this CDS clearing business.
And let the best exchange win.
The Bloomberg link to Peterfly is interesting. Terry Duffy on CNBC said that they have a mathematical algorithm that figures out the amount of margin needed for CDO's. This will protect the clearing house from systemic risk. Today for futures, they use SPAN, CME's patented and proprietary software to figure out margin on futures.
I would like to thank you and Paul for a well contrived article that covers the need of a GENUINE third party clearer in these markets, such as CME. Anyone that reads the Peterfly article needs to know that he has a well noted general disdain for CDS and anything OTC, he stands to gain nothing from the CME venture so naturally he will be opposed. The risk system his company, Interactive Brokers, developed is limited to standardized exchange traded products only, I suspect he will get pressure from customers that want to use these products and may lose them if he denies use. He also hates Citadel, they directly compete in options market making and Citadel does double the business IBKR does. He is a straight arrow and unlike other major firms, IBKR does not extend “special” credit to hedge funds via offshore “credit facilities” or by doing OTC derivatives trades or swaps with hedge fund customers as counterparties. As it stands in an industry that is losing customers in general, he can't afford to lose customers if he further limits has product offerings.
CME rolled out SPAN in 1988 and it has become the standard for risk analysis for the entire industry. In terms of clearing and risk management, nobody does it better than CME. Interesting little fact here, even The Clearing Corp uses SPAN. SPAN analyzes calculates risk using scenarios that take into account individual and broad market situations and assesses necessary margins. CME is a genuine 3rd party regulator has interest in protecting itself from risk, the banks will control The Clearing Corp and required margin under the guise of ICE as a "3rd party".
And an article from the WSJ that back's up our claim:
online.wsj.com/article...
Paul and I were way out in front of everyone when it came to this issue.
We are continuing to post articles here that support what we were saying long ago.
The part that is especially compelling deals with the Clearinghouse:
powerhost.powerstream....