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Strategies & Market Trends : Value Investing
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To: petal who wrote (66358)1/31/2021 11:34:07 AM
From: E_K_S1 Recommendation

Recommended By
pak73

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OT - Fluid functioning markets - requires liquidity

The one thing that surprised me after reading through that article is there is really only one clearing firm DTC Corp w/ APEX. DTC appears to have the safe guards in place requiring members to maintain the required cash reserves to cover the 2-day clearing process and the electronic APEX system manages the 'title' assignment of securities for margin account clients through their hypothecation 3rd party assignments.

The potential weak link in clearing trades is the possibility that too many shares may have been 'hypothecated' to 3rd parties (or hedged by derivative products w/ no hypothecation of the underlining security) and/or multiple shorting of same shares (exceeding the stated float).

I would also think there should be multiple clearing organizations. So if one freeze up (reserves dry up) other systems can still clear/process trades (especially for those retail clients that use 'Cash' accounts).

FWIW, that was not the case at Schwab, My taxable account was set up specifically to be a 'Cash' account, and I wasl still shut out of their ordering system when they shut the 'back office' system down. I can only conclude it was the clearing side (DTC & APEX) system that shut it down.

As I understand at Schwab, they first match shares short through their own book then go out to a depository to search for other shares available from other brokers. You only get put into that depository if your shares are held in a margin account. Is there the chance shares are hypothecated by more than one party and if/when the system is 'stressed' these ownership chains may/could blowup?

Solution/Safeguard:

Brokers can change margin requirement on individual stocks and/or on all stocks and user accounts as necessary. I suspect Brokerages could also terminate the Buy/Sell of ALL option derivative products (for some period of time) OR do BOTH.

This may/could cause forced liquidation which could create an endless selling cycle until (1) leverage is reduced in the system and/or (2) Government intervention is done (i.e. Plunge Protecting Team).

Buffet said
"My partner Charlie Munger ( Trades, Portfolio) says there are only three ways a smart person can go broke: liquor, ladies, and leverage. Now the truth is - the first two he just added because they started with L - it's leverage."
He also said this in 2018:
“There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren't immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions."
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