Credit Markets – Collateral and Margin calls

In one of the speech by Jeremy Stein a Federal Reserve Governor brought on board just last year,received a lot of attention for its imagessuggestion that monetary tools might be used in addressing credit market-overheating. That is an interesting argument, but I don’t want to deal with that today. Rather, I want to look at Stein’s comments on collateral transformation:

Collateral transformation is best explained with an example.

Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral mustbe “pristine”–that is, it has to be in the form of Treasury securities. Continue reading “Credit Markets – Collateral and Margin calls”