The real bailout (of our future)

[Aeson]

I had missed that this was happening. Read at the Market Ticker that it's a done deal, but haven't found a good source so far.

CME and Citadel are putting together an exchange and central clearing house for CDS. (One of the things the bailout bill should have had as a requirement IMO.) Short term it could hurt if prices crash, but it hopefully can advert future CDS asshattery from ****ing everyone over.

http://www.cnbc.com/id/27066831/

CME Group and Citadel Investment Group said on Tuesday they are creating a platform for electronic trading of credit default swaps, amid calls by regulators to migrate trading of the $55 trillion private market onto exchanges.

The platform will be integrated with a central clearing house, the companies said in a release.

Regulators and industry participants have voiced concern that the private nature of the credit default swap market poses systemic risks as no one knows the size of a counterparty's derivative portfolio, and the failure of a large counterparty can create massive losses globally.

Proponents argue that exchange trading, by contrast, would remove the system risk posed by a counterparty failure, provide price transparency and offer simpler, more standardized settlement of contracts when an issuer defaults.

CME Group [CME 282.15 6.48 (+2.35%) ] and Citadel will launch a joint venture for the platform within 30 days, and are offering major participants in the market equity stakes in the company to encourage them to support trading on the exchange.

"This joint venture is a best-of-both-worlds solution that will reduce much of the systemic risk inherent in the current CDS market structure," CME Group Executive Chairman Terry Duffy said in the release.

The launch comes at a time of increasing calls for the market to be regulated, and trading of swaps to move to exchanges.

The New York Federal Reserve is hosting a meeting with banks and institutional investors on Tuesday to discuss establishing a central counterparty for the global credit default swap market.

The collapse of major counterparty Lehman Brothers last month brought fresh urgency to the calls for rules to improve the transparency and safety of the market.

"It is imperative to bring stability and transparency to the CDS market," said Ken Griffin, Chief Executive of Citadel said in the release.

Challenges

Despite the plan, CME and Citadel may face an uphill struggle in convincing dealers to provide the exchange with the liquidity it will require to be successful.

Dealers have been hesitant to support exchange trading in the past as they generate more profit from the private nature of the market.

Attempts to shift foreign exchange trading from over-the-counter (OTC) onto exchanges have failed, which demonstrates "how difficult is for an exchange to shift OTC business without dealers support," said Diego Perfumo, analyst at Equity Research Desk, a Connecticut -based advisory firm specializing in exchanges.

Nonetheless, Citadel has a good track record in competing against dealers, he added.

"Citadel has demonstrated its strength to compete against dealers when it captured 20 percent share in Treasuries-an OTC market previously controlled entirely by the 'club' of dealers," Perfumo said. "Citadel may do it again in CDS."

[DanS]

I wonder whether anybody will use it.

[Aeson]

Hopefully. It's got a far better chance of solving the problems than just throwing money at the symptoms...

[KrazyHorse]

Originally posted by DanS
I wonder whether anybody will use it.

Apparently the CME has had one up and running for over a year, but the banks were boycotting it.

We might need a regulatory push toward the clearinghouse model.

[Aeson]

What I read on the Market Ticker was that the NY Fed was gonna make it work. Not sure where he got that info.

http://market-ticker.denninger.net/archives/638-My-God,-One-Intelligent-Act!.html

CDS to be exchange-listed shortly; The NY Fed apparently has pulled their head out of the place where the sun doesn't shine and is going make sure this gets done. For once the jawboning comes with actual results.

He's been calling for this (the Fed/SEC/Congress to force CDS onto an exchange/clearing house) to happen since last october, so hopefully it's not just wishful delusion on his part.

[Impaler[WrG]]

I'm very doubtful that CDS should be allowed to exist at all. They are the equivalent of letting Bob buying Fire Insurance on Joe's house and thats a huge morale hazard. By their nature they incentivate the holder to trigger the financial ruin of a third party. On top of that their nature creates a 'chain-reaction' potential of financial institutes to fail. I think that only the owner of an asset should be allowed to buy insurance on that asset.

[KrazyHorse]

Originally posted by Impaler[WrG]
I'm very doubtful that CDS should be allowed to exist at all. They are the equivalent of letting Bob buying Fire Insurance on Joe's house and thats a huge morale hazard. By their nature they incentivate the holder to trigger the financial ruin of a third party.

Knocking off a company is not as easy as setting fire to a house. Nor am I aware of any evidence to suggest that this type of manipulation was widespread (and from what I know, it would be illegal, though I could be wrong on this).

This is precisely the type of overreaction I suspect we'll be seeing a lot more of over the coming months. The whole point of financial markets is to provide a means to distribute risk. The CDS market has existed for decades. The real problem is that people underpriced counterparty risk in dealing with large companies like AIG.

[KrazyHorse]

On top of that their nature creates a 'chain-reaction' potential of financial institutes to fail

No. The way they were traded does.

[KrazyHorse]

I think that only the owner of an asset should be allowed to buy insurance on that asset.

And I think that such simple-minded attempts at regulation will simply mean more work for creative financiers, who will easily circumvent them.

[Colonâ„¢]

Originally posted by Impaler[WrG]
I'm very doubtful that CDS should be allowed to exist at all. They are the equivalent of letting Bob buying Fire Insurance on Joe's house and thats a huge morale hazard. By their nature they incentivate the holder to trigger the financial ruin of a third party. On top of that their nature creates a 'chain-reaction' potential of financial institutes to fail. I think that only the owner of an asset should be allowed to buy insurance on that asset.

Why aren't you giving a good example and cancel any insurance policies you may have? After all, you're being morally hazarded by those.

[Impaler[WrG]]

The whole point of financial markets is to provide a means to distribute risk.

And that is exactly the problem, being able to spread risk encourages excessive risk and opens up the whole system to failure. Risk spreading is a suckers game, those who create the risks have high information being closest to it, and sell them the risk to parties with lower information, its inherently a swindle. I prescribe to the principle that those that create risks should hold those risks. It is not 'simple-minded' to think that financial transactions which are moral-hazards should be out-lawed or reduced, the entire history of financial regulation consists of curtailing such hazards. You admit that un-regulated CDS is a hazard, I just perceive more hazard then you do.

[KrazyHorse]

Originally posted by Impaler[WrG]


And that is exactly the problem, being able to spread risk encourages excessive risk and opens up the whole system to failure.

Say goodbye to joint-stock limited liability companies then.

[KrazyHorse]

Originally posted by Impaler[WrG]
Risk spreading is a suckers game, those who create the risks have high information being closest to it, and sell them the risk to parties with lower information, its inherently a swindle

If it was such a sucker's game then why does the 15 trillion dollar equity market exist?

[Colonâ„¢]

Originally posted by Impaler[WrG]


And that is exactly the problem, being able to spread risk encourages excessive risk and opens up the whole system to failure. Risk spreading is a suckers game, those who create the risks have high information being closest to it, and sell them the risk to parties with lower information, its inherently a swindle. I prescribe to the principle that those that create risks should hold those risks. It is not 'simple-minded' to think that financial transactions which are moral-hazards should be out-lawed or reduced, the entire history of financial regulation consists of curtailing such hazards. You admit that un-regulated CDS is a hazard, I just perceive more hazard then you do.

For ****'s sake. Second time I'm saying this. The entire, millenia-old, insurance industry is based on spreading risks. It's not because it's got an unfamiliar name it's inherently the devil's tool.

[KrazyHorse]

Part of me hopes really strongly that something like a total ban on non-linkage of CDS to underlyings goes into force. I can already think of three or four ways to circumvent it, depending on the language which goes into the law. The modeling of the assets will be more complex too.

I love it when the government creates work for people with strong math backgrounds