Before the GFC, you had a lot of options trades that had an investment bank like Lehman as the counterparty. When they got blown up for taking too much risk, the government in the US decided to make everyone use clearinghouses that will get bailed out if something bad happens.
With the guarantee comes regulation (like banks) that makes the clearinghouses reprice the collateral they need everyday based on what happened that day or the day before. So volatility could make treasuries go crazy and then the clearinghouses would demand more collateral which would cause those doing the trades to sell more to cover their margin call.
In reality, if you took a bigger perspective you'd know that the volatility in treasuries is just temporary. You might be in the 99 percentile of possible outcomes so you wouldn't need more collateral.
Did I get that right? Any pieces of yours you'd recommend to understand the alternatives.
Before GFC investment banks tended to.trade with each other as it was cheaper. The vast bulk of.trades were between investment banks.
Clearinghouses existed as an anonymous way to trade - as you don't know the counterparty to.the trade.
Risk price was set by investment banks - and Clearinghouses followed their lead.
When Lehman went bust risk pricing had been rising for a year so margin at cleqringhouse was large - so no Clearinghouse went bust.
Post GFC all trades are done via Clearinghouses- and they set risk price.
They are incentivised to price risk low. So you get sudden jumps in risk price and Clearinghouses are under collateralised. Risk then passes.back to investment banks.
while I agree we will see another financial crisis, it is not clear to me that clearinghouse reform will be the result. after all, regardless of who occupies the White House, they will be seeking political blame of their enemies, and clearinghouses are too arcane to fit the bill. either banks or hedge funds will suffer the consequences I expect, and perhaps both
Depends. Current system means that if.a huge hedge fund goes bust it could.cause systemic risk. Also when I research this I note more and more academic coming to the same conclusion re clearinghouses
I've been trying to understand this better.
Before the GFC, you had a lot of options trades that had an investment bank like Lehman as the counterparty. When they got blown up for taking too much risk, the government in the US decided to make everyone use clearinghouses that will get bailed out if something bad happens.
With the guarantee comes regulation (like banks) that makes the clearinghouses reprice the collateral they need everyday based on what happened that day or the day before. So volatility could make treasuries go crazy and then the clearinghouses would demand more collateral which would cause those doing the trades to sell more to cover their margin call.
In reality, if you took a bigger perspective you'd know that the volatility in treasuries is just temporary. You might be in the 99 percentile of possible outcomes so you wouldn't need more collateral.
Did I get that right? Any pieces of yours you'd recommend to understand the alternatives.
Before GFC investment banks tended to.trade with each other as it was cheaper. The vast bulk of.trades were between investment banks.
Clearinghouses existed as an anonymous way to trade - as you don't know the counterparty to.the trade.
Risk price was set by investment banks - and Clearinghouses followed their lead.
When Lehman went bust risk pricing had been rising for a year so margin at cleqringhouse was large - so no Clearinghouse went bust.
Post GFC all trades are done via Clearinghouses- and they set risk price.
They are incentivised to price risk low. So you get sudden jumps in risk price and Clearinghouses are under collateralised. Risk then passes.back to investment banks.
while I agree we will see another financial crisis, it is not clear to me that clearinghouse reform will be the result. after all, regardless of who occupies the White House, they will be seeking political blame of their enemies, and clearinghouses are too arcane to fit the bill. either banks or hedge funds will suffer the consequences I expect, and perhaps both
Depends. Current system means that if.a huge hedge fund goes bust it could.cause systemic risk. Also when I research this I note more and more academic coming to the same conclusion re clearinghouses