Clarity on Clearing Houses
By Arnold Kling
as many trades move from the banks to the clearinghouse, the clearinghouse itself will become a systemically vital institution. It will be too big to fail.
Thanks to Mark Thoma for the pointer. Often I do not agree with the pieces to which he links, but this is an exception. I have been saying for a long time that a clearinghouse is not a panacea for derivatives markets. The article makes some good points. I would add that a clearing house has to use generic products, and financial institutions have specific assets and liabilities to hedge. The use of generic derivatives to hedge specific assets creates basis risk. If you force banks to use a clearing house, then you force them to take basis risk. Odds are that the next big failure would involve basis risk.