Bleak midwinter in the swaps market December 24, 2012 at 4:32 pm

Brrrr again

Bloomberg has a story on what it terms the looming swaps armageddon. I would not perhaps go that far, but the article is interesting.

I was spluttering at the first part of this sentence from Bloomberg about OTC derivatives clearing “This arrangement can withstand almost any shock, including defaults by four of the biggest lenders,” but the authors redeemed themselves with the kicker “according to the clearinghouses”. That’s pretty much like `Christmas is bah humbug stay home alone and eat pasta… according to turkeys.’

Craig Pirrong kicks in with a useful corrective in the next paragraph: “I just don’t think that realistically you can exclude the possibility that taxpayers could be at risk.” Indeed. Still, we can’t say that the supervisors have not been generous for Christmas. As Bloomberg points out, the Dodd-Frank rules could mean as much as $1 billion in new annual revenue for clearinghouses. This is of course the reason ICE can afford to buy NYSE Euronext: their stock price reflects the expectation of these future profits.

What we have really done with OTC clearing, it is increasingly clear, is to turn the low probability high severity event of a big OTC derivatives dealer failure into the perhaps lower probability probably higher severity event of CCP failure. This is exactly the wrong direction. Bloomberg quotes Blankfein on this: “We have to make sure that something that we do to reduce the risk in a once-in-a-20-year storm doesn’t increase the risk in a once-in-a-50-year storm.” Yes, we do: but we haven’t.

Meanwhile CCP resolution remains jejune and their disclosures are not sufficient to permit outsiders to assess their risk properly. “None of the major clearinghouses are providing sufficient detail on their default-management plans,” said Darrell Duffie, quoted in Bloomberg. “They don’t want to talk about that.” Meanwhile according to Bloomberg, “in non-public meetings this year at the New York Fed, Citigroup and JPMorgan pushed CME Group, Intercontinental and LCH to reveal more about their finances and risk-management policies, people with knowledge of the matter said.” There is a certainly going to be a lot to do on this in 2013. For the next few days, I am ignoring the advice of the Turkeys.

Comments are closed.