Thursday, September 16, 2010

Clearinghouses

Via Tyler Cowen, FLG learns of a paper from Cato arguing that financial market clearinghouses are inefficient. FLG, like Tyler, doesn't find the argument all that compelling. Indeed, FLG believes that managing leverage is really the only game in town when it comes to real financial reform. Consequently, FLG, again agreeing with Tyler, sees only one serious problem:
I would think the main argument against mandated clearinghouses for CDS is simply the hair-trigger, discrete, non-smooth nature of default-linked payoffs, and whether any centralized intermediary has the predictive power to handle that and to demand sufficient collateral.

To translate what Tyler is saying into English:
Most of the time a clearinghouse will run smoothly, but when the shit hits the fan it happens fast and all at once. Therefore, it will be difficult for them to figure how much collateral they need to require from traders to have enough money when the shit does hit the fan.

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