Monday, February 2, 2009

The Debts of the Spenders: It's the ClearingHouse, Stupid! Part 2

This is an update to the older post - "It's the Clearinghouse, Stupid!" from earlier in January.

Some readers pointed out that I failed to properly define a clearinghouse. Ok. I thought I did but here goes:

A clearinghouse is a central party that nets trades. It is the equivalent of the plumbing or maintenance crew working inside the bowels of a building. They handle the boring, mechanical back office work of "netting trades" or making sure that for every buyer there is a seller.

A clearing member is a member of a clearing house. You can find out who they are on the bottom of your brokerage slips or elsewhere in the tiny disclosure agreement that you signed. Most traders and investors don't even know (or care) whom their clearing firm is unless there is a problem (like a margin call or federal securities investigation). That is the way the industry prefers it. Nice and quiet.

There are 4 groups out there jockeying for position in the CDS clearing market:

A) CME Group and Citadel
B) Eurex
C) NYSE Euronext, Liffe, LCH. Clearnet
D) The Clearing Corporation (since sold to Intercontinental Exchange or ICE)

The NY Fed Reserve - formerly headed by one Timothy Geithner - is pushing for a US solution. But they are encountering problems w/the recalcitrant Europeans who are advocating a European standard. The trans-Atlantic spat is an issue over sovereignty, e.g. which political body would have jurisdiction over any clearinghouse(s).

The issue also revolves around the elimination or marginalization (depending on who you talk to) of the OTC (over the counter) CDS market.

For years, the large investment banks such as JP Morgan, Goldman Sachs, Deutsche Bank, HSBC, RBS, and the other members of the Libor cartel (see Sept 2008 article) were content to gamble away the world's economy among themselves on private, bi-lateral computer networks using Bloomberg and Reuters terminals. When THAT trade started to implode last fall, regulators (most of who did not even know the difference between a stock and bond) swooped in and demanded a clear way of settling the mess.

The futures exchanges, who had been observing the crisis all this time, decided this was their chance to score the big money. Unlike OTC markets (where the participants were free to play "hide the trading losses" through offshore subsidiaries and other accounting shells), exchanges mark to market trades on a regular basis - daily or semi-weekly depending on the trade.
Transparency is a given - well as much as you can get in the financial trading world.

The exchange lobbyists arrived, faces thoughtfully grave and fingers rubbing chins, to "advise" the regulators that this entire mess could be solved. . . through routing AND clearing the trades on THEIR networks through THEIR members. The OTC market participants have their own clearinghouses - but most of these tend to be basically vestiges of the same parent w/no real independence (and thus their accountability was suspect to say the least).

The investment banks are loathe to give away their business to the exchanges. This is about more than just money. It is also about maintaining privacy (e.g. hiding their true losses from the public)! But they are not in a particularly advantageous bargaining position right now (to say the least). Politicians are screaming for their heads. So is the public. And laughing quietly among themselves are the exchanges.

I am not an expert on the clearinghouses or the exchanges. Nor am I privy to the high stakes poker game going on behind closed doors.

BUT I do know that the first 3 groups -

A) CME Group and Citadel
B) Eurex
C) NYSE Euronext, Liffe, LCH. Clearnet

are about as pure an exchange interests as you can get. A) represents the Chicago traders partnering w/reclusive private equity. B) represents the German and Swiss traders C) is a loose gathering of NY, London, and various European trading firms unaffiliated or disgruntled w/B).

D) The Clearing Corporation

was formerly owned by several prominent NY firms (such as Goldman Sachs and Morgan Stanley) before being sold to ICE. Although the transfer has already been effected, it is likely that some old banking affiliated staff (e.g. investment bank allies) remain behind to unofficially represent the investment banks' interests.


Lockstep said...

I like the blog. I found it based on your comments on Accrued Interest. Keep it up.

I agree that the trading community is challenging the Fed by shorting the 30 year. I think they will lose that bet. It is still too early to make all these calls about "hyperinflation" and "currency debasing". The US treasury is still the closest thing to a risk free trade and I think we will see that in the auction coming up this week.

In Debt We Trust said...

Thank you Lockstep. I try to keep things more colloquial and friendly than other sites. I know some equity traders read the blog because they have commented in private messages to me that is is educational. In exchange I have referred them to Accrued Interest and other fixed income sites.

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