This could be a major positive in avoiding a systematic financial meltdown from a major broker/dealer becoming illiquid - Good news IMO http://www.bloomberg.com/apps/news?pid=20601087&sid=atLO.8bAQIQA&refer=home June 9 (Bloomberg) -- 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. Edit: Another article http://www.bloomberg.com/apps/news?pid=20601109&sid=aWr5oZMeVsbU&refer=home "Wall Street Lands First Blow in Clearing Credit Swaps"
So who backs the "central counterparty", ie what assets does it have, and what if it becomes insolvent? I assume that there is some form of limitation of liability/obsfuscation of facts here, so I dont see this as a good thing. It seems like more socialized bailouts.
Its called an exchange... This enables transactions to be made with *proper* margin requirements. It is a good thing, and works. CME or NYMEX is an example of a working central counterparty. The exchangeless CDS system enabled all transactions to be taken off balance sheet, thus with no margin rules or worthwhile counterparty guarantees. This exchange will need to be accompanied by a piece of regulation to make off balance sheet CDS transactions illegal in order to be a useful piece of progress.
Based on what I heard, CDS do not have the same regulatory framework as stocks and options and currently are being heavily used for insider trading. Wonder how much would change when they are traded at exchange. At the very minimum CDS central data might give clues to where equities will be moving. Something to digest.
Hi, thanks for the thoughtful post. So is the belief that since the theoretical clearing firms that will execute the trades actually be taking risk they will be more likely to appropriately assess risks of clients that are trading thru them?
I think it would make most sense if CDS buyers and sellers had to post proper margin. It would like be similar to margin requirements on long bonds .. ie if you can go 1:10 on corporate bonds, then a margin req that makes sense on CDS might be 10% cash down at the exchange. an unexpected AAA default would still throw things off though, i think. Going from 95 -> 0 is pretty dramatic. This all points to capital raising required at banks and i-banks w/ much much lower operating leverage. because of this required operating leverage to generate earnings, banks are such a ponzi scheme. They wipe out frequently enough to destroy historic cumulative profits that make them a net worthless long term investment.