Central Clearing Parties: What they are and why we need them - Part 3

The CCP Advantage: Incentive and Means to Control Counterparty Risks

The case of the insurance giant, AIG, highlights the information and incentives problems that CCPs can address. In the run-up to the financial crisis, AIG’s London-based Financial Products Group managed to sell enormous amounts of credit risk insurance without the liquid resources necessary to cover potential cash calls. By end-June 2008, AIG had taken on $446 billion in notional credit risk exposure as a seller of credit risk protection via credit default swaps (CDS).

Kim SchoenholtzFebruary 21, 2014AIG, CDS, Credit default swaps, Counterparty risk, Collateral, Margin requirements, Clearinghouse, Incentives, CCP, OTC

Central Clearing Parties: What they are and why we need them - Part 2

Experience Shows CCPs Safer than OTC Trading

Experience both before and after the crisis revealed that the system of bilateral OTC derivatives transactions was far more fragile than experience with CCPs. As a result, many people began to advocate a shift to central clearing. And, the G20 leaders agreed.

Kim SchoenholtzFebruary 21, 2014CCP, OTC, Counterparty risk, Clearinghouse, Collateral

Central Clearing Parties: What they are and why we need them - Part 1

G-20 Leaders Vote for CCPs: What are they?

In September 2009, as the financial crisis was starting to slowly recede, the leaders of the twenty largest economies of the world (the G-20) met in Pittsburgh. At the end of their summit, they issued a communiqué of nearly 9000 words. Somewhere in the middle of the statement, the following sentence appeared:

All standardized OTC [over-the-counter] derivative contracts should be traded on exchanges or electronic trading platforms, where appropriate, and cleared through central counterparties by end-2012 at the latest.

Kim SchoenholtzFebruary 21, 2014G-20, CCP, Derivatives, Clearinghouse, OTC, Over-the-counter, Collateral, Counterparty risk

What will the Fed use as its operating target?

In 2012, the Federal Reserve’s Open Market Committee (FOMC) clarified its long-run goals of price stability and maximum sustainable employment in a strategic statement that included for the first time a numerical inflation objective. While these ultimate objectives have evolved over the years, the FOMC’s operating instrument has been unchanged at least since 1981, when it began to target the federal funds rate -- the overnight interest rate on unsecured interbank loans. Since December 16, 2008, the target has been 0.00 to 0.25 percent, effectively at the zero lower bound for nominal interest rates. The history of the federal funds rate target is shown in the accompanying figure (and here).

Kim SchoenholtzFebruary 18, 2014FOMC, Operating target, Repo, Federal funds rate, Excess reserves, Financial stability

What the ECB does (and what it doesn’t)

In June 2012, the balance sheet of the ECB peaked at over €3 trillion. Since then it fell every month, so that by the end of 2013 it stood at €2.2 trillion. Over this same period, the Federal Reserve’s balance sheet rose from less than $3 trillion to more than $4 trillion. That is, as the ECB’s balance sheet was falling by a quarter, the Fed’s rose by a third!

Steve Cecchetti and Kim SchoenholtzJanuary 30, 2014ECB, Operations