Central Clearning Of derivatives & Dodd – Frank continues…

Continuing from my yesterday’s post why Central clearing is one of the solution if we just analyse recent crisis.In the financial crisis of 2008, banks feared that their trading partners might not be able to meet obligations to make good on the credit-default swaps,and on derivatives plus other financial arrangements. The situation set off a chain reaction that paralyzed global markets until governments and central banks provided enormous financial support.

To prevent a similar disaster from happening again, finance ministers in the United States and Europe committed in 2009 to move derivatives like credit-default swaps onto clearinghouse. These organizations, if they work properly, can sharply reduce the chances that a large bank will not make good on such contracts.

Just to put in prospective under Dodd-Frank reform law no fewer than 10 such derivatives bills have been introduced in the House; two have passed and several more have cleared committee in US.

Yesterday Roger Lowenstein author of When Genius Failed: The Rise and Fall of Long-Term Capital Management.” did a column on the topic Derivatives Lobby Has U.S. Regulators on the Run

The derivative lobby and law-maker having a tough time as derivatives were a wunderkind innovation, a less cumbersome way to invest, speculate or hedge than traditional instruments such as stocks and bonds. Their very ease promoted use, like a pill that was easy to pop. You can use a derivative, of course, to reduce risk or to enhance it. The emblematic example is of the farmer selling wheat futures to lock in his price ahead of the harvest. (Futures are derivatives that trade on regulated exchanges.) Clearly, the farmer is hedging — reducing risk. But traders might also be people with an opinion about wheat prices — that is, speculators.

As I quoted above Dodd frank central clearing could be one idea not every rule is perfect and industry is free to make its case to the agencies.

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