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Monday, June 09, 2008

The Really Important Financial News

The Fed is setting up a swaps clearinghouse:
Regulators and 17 banks that handle about 90 percent of the trading in credit-default swaps agreed to changes aimed at easing the risk of a collapse of the $62 trillion market, the Federal Reserve Bank of New York said.

Morgan Stanley, Deutsche Bank AG and Goldman Sachs Group Inc. are among the banks creating a system to move trades through a clearinghouse that would absorb a failure by one of the market- makers, the New York Fed said today in a statement following a meeting with the firms.

The central counterparty, more automated trading and settlement and other fixes ``will help improve the system's ability to manage the consequence of failure by a major institution, and we expect to make meaningful progress over the next six months,'' New York Fed President Timothy Geithner said in a speech to the Economic Club of New York.
Allowing Bear Stearns to default probably would have set off a rolling chain of crashes, and the swaps counterparty risks were a major factor. Fed statement here. One of the major protections would be that the clearinghouse would force institutions to settle up. There have been problems with cross-party trades not being settled.

Another article on the mechanism, mostly.

Do they understand the implications of what they're doing? The article says "The group will reduce the volume of outstanding contracts through multilateral trade terminations." In other words, net-zero positions will be unwound to true zero.

I suspect that, except for peripheral parties who wrote lunatic CDSes, the net CDS position is not too dangerously far from zero. If the clearinghouse-facilitated unwind shows that to be the case, then the Bear acquisition will be unmasked as a pure bailout. Ergo regulators can start tossing companies into receivership with impunity, and the Fed can simply stop rolling over the Bear bailout repos.

No doubt Goldman realizes they are about to start shooting zombies in the brain. Let's just hope they get it done before the zombies catch on and start mutating.
I'm sure they do understand it. The next step is in July. This is going to be **carefully** implemented.

You can't let this sort of thing go on if you have to bail counterparties out. That means the entire financial system is hostage to the most reckless.

Let's just say that I suspect this was the quid pro quo for the broker dealers getting access to the discount window.
So in July we get to see what the CDS swap musical chairs game looks like when the music stops.

We might get a nasty surprise on who ends up without a chair to sit in.
I don't think it's going to happen quickly. This is a multi-step process. And it is supposed to ultimately involved more derivatives than swaps.
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