Clearing Houses: The Devil Is Still in the Details

This morning’s recon mission for derivatives-related stories turned up bumper crop of realizations that should have been painfully obvious, but were not made when it could have made a difference–meaning that the real pain is to come.

First, from the FT:

Quite simply, the regulators succumbed to the sheer volume of rulemakings and an avalanche of comments from the industry. There was not enough time to meet the deadline, and it became clear that implementing Dodd Frank was going to be far more complicated than initially thought.

Thought by whom, exactly? We need to know, because anybody who admits to not foreseeing a train wreck should be disqualified from further comment or participation in these matters, (a) for not foreseeing the obvious, and (b) for copping to such cluelessness.

Next, from Financial News. In response to the rhetorical question “Are clearing houses ‘too big to fail’”, Ben Wright writes (heh):

It is a real concern that not enough people have asked this question before now and even more worrying that no one has provide a satisfactory answer. [The answer is almost certainly yes, though I guess that is unsatisfactory substantively.] As the possibility of some form of huge sovereign credit event grows ever-more imminent, a solution need to be found, and fast.

It’s a little late to start thinking about packing a parachute when you’re already 30,000 feet up. But that’s Frank-n-Dodd in a nutshell (with an emphasis on the “nuts”).

Wright also recalls a speech by the BoE’s Paul Tucker (which I blogged about in June), in which this worthy

said clearing houses had to think of themselves as system risk managers and start behaving as such. Clearing houses should, therefore, steer clear of procyclical margin practices, monitor the soundness of their members, and plan for their disappearance.

No disagreements here, except that it is insane to think that CCPs will think of themselves as “system risk managers.” Because they aren’t “the system”, but only part of it. They will act in their interest and the interest of their members. That is quite different from–and often contrary to–acting in the interest of “the system.” Clearing does not internalize most of the key externalities that create systemic risk, and all the wishing and should-ing in the world won’t change that fact.

And from Dow Jones:

Dealers and clearing experts have urged regulators to introduce so-called living wills for clearing houses, warning that a “credible” plan for unwinding critical pieces of market infrastructure is “vital to financial stability”. The comments come amid growing fears that the U.S. government’s inability to raise its debt ceiling could prompt a global credit event.

. . . .

Roger Barton, founder and managing director at Financial Reform Consultancy, said: “It is arguable that the whole issue of clearing house resolution should have been addressed earlier.”

“Arguable”? Go out on a limb there, Roger.

I wonder if it’s possible to fashion a parachute from the seat covers and a few stray blankets in the overhead bins.

Then there’s this article on portability in Risk. It’s long (and gated), but the moral of the story is easily stated: this is a major issue, with systemic implications, but which is totally up in the air. (Lot of company up there.) There’s one on portability in the FT, coming to pretty much the same conclusion.

What, never heard of portability? Apparently the Sorcerer’s Apprentices hadn’t either.

I could go on. In recent days there have been numerous articles about myriad issues in clearing–collateral, margining, capital requirements, and on and on–all of which are (a) unresolved, and (b) of first order systemic importance. All the important details were left to the end–most likely because those that demanded the system remade it, and wrote legislation demanding its remaking didn’t even know what the relevant details are.

An entire system that evolved organically with all of the complexity and interconnectedness that implies is being re-engineered on the fly. Anyone even marginally cognizant of the complexity of the system would have been too humble to even contemplate remaking it root and branch.

But unfortunately, the marginally cognizant weren’t in charge. The imperious, overconfident, ignorant, and foolish were–some were all of the above.

That never works out well.