While I think your case about clearinghouses is completely valid, and my experience showed me that smart firms set limits on how much they would transact there, I take issue with your comment that Trump is the cause of these problems. Biden confiscated Russian assets in 2022 and set off the alarm bells for central banks as to the nature of their reserve holdings, not Trump. and Trump did not get inaugurated and issue $36 trillion in bonds, that has been a long-term process.
The way clearinghouses are set up now is that when the losses exceed the capital they contribute, they basically can access members balance sheets.
In essence, lets say one member is the wrong side of a trade, and burns through all its equity. That means it can not pay its variation margin. In this case, the clearinghouse goes to the "winner" of the trade (all trades are matched) - and says, sorry we can't pay you.
They then seize the loss making positions from the now bankrupt member, and go to the other members of clearinghouse are ask them to buy this portfolio. (remember, this will be the same group the clearinghouse has just informed that their "winning" trade or hedges are bust). Because their hedge are blown, they rarely have capital available, so you need to see a steep decrease in price to get buyers to come in.
In a ultra extreme scenario, without government intervention, one member bankruptcy would cause pricing to keep falling until all the members were bankrupt, as margin call after margin call keep driving prices lower. This is why banks want to be able to bankrupt clearinghouses, but regulators keep ignoring.
If you are bullish, the good news is that governments will always bail you out, as they have created a system that cannot allow one bad player to go bust. The bad news is that it leads to higher inflation and yields as risk is socialised.
Russell has been forecasting some kind of systemic break-down of the clearinghouse model for over 10 years now. In reality, there are very stringent risk management protocls taken by the major exchanges which keep the system safe
Sorry Varun - you are incorrect. Clearinghouses have failed many times - but have been bailed out by regulators. The Nordic Power clearinghouses was the most extreme example, but the regular disappearance of liqiuidity in treasuries and gilts are also another example.
Prior to the clearinghouse reform, there was never a period of illiquidity in government securities - now it is common.
As I have said, if clearinghouse reform was meant to get rid of "too big to fail" and moral hazard it has failed. If clearinghouse reform was meant as a way to backdoor bail out markets - it has been a resounding success.
When talking about risk management - pre clearinghouse reform - every major back kept an eye on every other bank - and there was real risk of failure of if you were wrong. Thousands of very highly paid people kept an eye on market pricing. Now, we have pricing done by a smaller number of essentially public servants - even when wrong, they keep their jobs. The results are predictable.
From a market perspective - its is probably a resounding success, as government has backstopped markets, and there has been no bear market. But we are now starting to see payback in ever rising yields and inflation - the definition of socialise risk.
If that good or bad - I leave up to you. But clearinghouses are not good at their jobs.
It has been for the best not to know about them... its a bit like not buying LA property for fear of the "big one". LA property has soared - and maybe the "big one" never happens. Same thing.
While I think your case about clearinghouses is completely valid, and my experience showed me that smart firms set limits on how much they would transact there, I take issue with your comment that Trump is the cause of these problems. Biden confiscated Russian assets in 2022 and set off the alarm bells for central banks as to the nature of their reserve holdings, not Trump. and Trump did not get inaugurated and issue $36 trillion in bonds, that has been a long-term process.
Obama definitely tried to balance the budget - and that has gone by the wayside since Trump 1. Biden helped, and Trump 2 is accelerating the process
no, I disagree. Clinton was forced to balance the budget. there has been limited effort since although the Tea Party wanted that outcome
Obama was forced to cut spending heavily too
What would it take for clearing houses to get into trouble?
The way clearinghouses are set up now is that when the losses exceed the capital they contribute, they basically can access members balance sheets.
In essence, lets say one member is the wrong side of a trade, and burns through all its equity. That means it can not pay its variation margin. In this case, the clearinghouse goes to the "winner" of the trade (all trades are matched) - and says, sorry we can't pay you.
They then seize the loss making positions from the now bankrupt member, and go to the other members of clearinghouse are ask them to buy this portfolio. (remember, this will be the same group the clearinghouse has just informed that their "winning" trade or hedges are bust). Because their hedge are blown, they rarely have capital available, so you need to see a steep decrease in price to get buyers to come in.
In a ultra extreme scenario, without government intervention, one member bankruptcy would cause pricing to keep falling until all the members were bankrupt, as margin call after margin call keep driving prices lower. This is why banks want to be able to bankrupt clearinghouses, but regulators keep ignoring.
If you are bullish, the good news is that governments will always bail you out, as they have created a system that cannot allow one bad player to go bust. The bad news is that it leads to higher inflation and yields as risk is socialised.
Russell has been forecasting some kind of systemic break-down of the clearinghouse model for over 10 years now. In reality, there are very stringent risk management protocls taken by the major exchanges which keep the system safe
Sorry Varun - you are incorrect. Clearinghouses have failed many times - but have been bailed out by regulators. The Nordic Power clearinghouses was the most extreme example, but the regular disappearance of liqiuidity in treasuries and gilts are also another example.
Prior to the clearinghouse reform, there was never a period of illiquidity in government securities - now it is common.
As I have said, if clearinghouse reform was meant to get rid of "too big to fail" and moral hazard it has failed. If clearinghouse reform was meant as a way to backdoor bail out markets - it has been a resounding success.
When talking about risk management - pre clearinghouse reform - every major back kept an eye on every other bank - and there was real risk of failure of if you were wrong. Thousands of very highly paid people kept an eye on market pricing. Now, we have pricing done by a smaller number of essentially public servants - even when wrong, they keep their jobs. The results are predictable.
From a market perspective - its is probably a resounding success, as government has backstopped markets, and there has been no bear market. But we are now starting to see payback in ever rising yields and inflation - the definition of socialise risk.
If that good or bad - I leave up to you. But clearinghouses are not good at their jobs.
If the 10 year note goes to 8% (let alone 10%) what happens to Private Equity?
Hopefully gets smoked
*retail here
I don't have a useful opinion on clearing houses, but I love love your passion for them.
It has been for the best not to know about them... its a bit like not buying LA property for fear of the "big one". LA property has soared - and maybe the "big one" never happens. Same thing.