Streetwise Professor

June 10, 2009

Surprise, Surprise

Filed under: Commodities,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 2:37 pm

I was somewhat surprised to see both CME and ICE come out in opposition to mandatory OTC derivatives clearing:

Top managers from two major financial exchange groups on Monday warned the U.S. government not to go too far in forcing central clearing of over-the-counter derivatives, a troubled, multi-trillion-dollar market whose future is central to both companies.

Terrence Duffy, executive chairman of CME Group Inc <CME.O>, said in prepared remarks to be delivered on Tuesday to a congressional panel that government-mandated clearing of all over-the-counter derivatives could drive business overseas.

. . . .

ICE’s Sprecher said in prepared remarks that forcing illiquid, unstandardized derivatives contracts into a clearinghouse could actually increase market risk.

“While ICE certainly supports clearing as much standardized product as possible, there will always be products which are either non-standard, not sufficiently liquid, or that do not have enough interest in them for clearing to be practical, economic or necessary,” he said.

“While the illiquid and unstandardized contracts should not be forced to be cleared, firms dealing in these derivatives should report them to regulators, so regulators have a clear and total view of the markets.”

Jeff Sprecher has it exactly right.  You can get the transparency without going to the full risk sharing inherent in clearing.  What’s more, mandatory clearing can actually increase risks.  

I was invited to testify at these hearings, but had to decline due to my prior commitment to a conference.  Hopefully I’ll have the opportunity to do so at a later date, and give it to them with the bark off, for it is evident that there is much ignorance on these issues in both the press and Congress:

First, the press:

Many OTC derivatives flew off the rails in 2007 when the housing bubble burst and credit tightened, leaving banks, such as the now defunct Lehman Brothers, with huge losses. Credit default swaps played a major role in the troubles at American International Group <AIG.N> that led to its government bailout.

The connections in the sentence about Lehman Borthers are completely incoherent.  This is just stringing together a bunch of things that happened and asserting a causal connection.  Lehman had OTC derivatives.  There were housing and credit crises.  Lehman had huge losses.  The OTC derivatives of the kind at issue in clearing were not Lehman’s main problem.  How about some real reporting, and some real forensics, about the connection between OTC derivatives, including CDS and interest rate swaps, and what happened to Lehman.  What I’ve quoted above is far to common, and is just lazy repackaging of somebody else’s lazy BS.  And for the billionth time, AIG is the reddest of herrings in the OTC derivatives debate.  Give it a rest.  Please.  

Now, Congress:

As lawmakers and the Obama administration move to crack down on OTC derivatives, the House Capital Markets Subcommittee is set to hold a hearing to “advance the discussion in Congress on … meaningful regulation of this dark corner of the financial services industry,” said Representative Paul Kanjorski, Democratic subcommittee chairman, in a statement.

Can we please give the “dark corner” and “dark market” metaphors a rest too?  Yesterday, maybe?  And WTF does “meaningful” mean?  Bad regulation can be meaningful.  Just what is the appropriate regulation, and how do the proposed regulations–especially mandatory clearing–make the markets more efficient?    

Don’t wait up for an answer.  These people don’t even know to ask the questions.  We just get bromides about dark markets.  

I know who’s in the dark.  And it ain’t the markets.

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