Derivatives Clearinghouses

This past weekend edition of the Wall Street Journal featured a lead staff editorial commenting on mandates for derivatives clearinghouses contained in Dodd-Frank.

The editorial made much of the many warnings now being uttered by people who either voted for the bill or were silent when their comments would have mattered. Specifically, the piece cites Ben Bernanke's reference to Pudd'nhead Wilson and the matter of 'watching that basket' very closely.

Perhaps I'm in the minority, but I believe that well-run clearinghouses or exchanges for derivatives would be an improvement over what went before.

Remember how Lehman's demise triggered concerns over daisy-chains of various derivatives? How AIG was seized because of fears of too many little-understood connections among its financial products unit's many credit default swap positions?

Back then, the fear was unknown linkages among many derivatives, some of which may have even been sold by parties which could not actually fulfill their obligations under the agreement.

Shouldn't we then welcome having well-capitalized, monitored exchanges where parties have posted sequestered collateral for their derivatives? Where sellers are vetted for their financial capability to perform? Or at least are clearly analyzed by counterparties? Where rules are clear regarding what happens when a counterparty fails to perform?

I'd rather see a separate, well-run exchange for derivatives than rely on the same type of inept regulators who allowed the last financial crisis to occur. Mind you, nobody has either proven or determined that derivatives, per se, brought about the collapse. But because of derivatives risks at firms like Lehman and AIG, which were affected by the mortgage market collapse, regulators and legislators pulled those instruments into the maelstrom when new, excessive, poorly-understood regulations were written and passed.

Of course, if we truly expect and want federal bailouts for any large financial entities, then it may be moot to observe that exchanges can fail, too.

But, absent that, I would expect a standalone exchange for derivatives to provide much more clarity regarding their risks to firms and counterparties, going forward.