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Non-Tech : Derivatives: Darth Vader's Revenge -- Ignore unavailable to you. Want to Upgrade?

To: axial who wrote (1484)	2/2/2010 11:41:39 AM
From: Worswick	Read Replies (2) \| Respond to of 2794

Jim ... great post.... Sheila Bair fdic.gov Eg. “Between 1985 and the third quarter of 2009, the share of mortgages (whole loans) held by banks and thrifts fell from approximately 55 percent to 25 percent. By contrast, the share of mortgages held by the GSEs increased from approximately 28 percent to just over 51 percent, over the same time period.” Derivatives Markets “Concentration, complexity and the opacity of the derivatives markets were further sources of risk in the current crisis. While these markets can perform important risk-mitigation functions, they have also proven to be a major source of contagion during the crisis. Losses on poorly underwritten mortgages products were magnified by trillions of dollars in derivative contracts whose values were derived from the performance of those mortgages. Exposure concentrations among derivatives dealers certainly helped to catalyze systemic breakdown. Derivative exposures can create collateral runs similar in many respects to the depositor runs that occurred during banking panics prior to the establishment of the FDIC. For instance, when a derivatives dealer's credit quality deteriorates, other market participants can demand collateral to protect their claims. As the situation deteriorates, collateral demands intensify and, at some point, the firm cannot meet additional collateral demands and it collapses. The resulting fire sale of collateral can depress prices, freeze market liquidity, and create risks of collapse for other firms. Derivative counterparties have every interest to demand more collateral and sell it as quickly as possible before market prices decline. One way to reduce these risks while retaining market discipline is to make derivative counterparties and others that collateralized credit exposures keep some "skin in the game" throughout the cycle. The policy argument for such an approach is even stronger if the firm's failure would expose the taxpayer or a resolution fund to losses. One approach to addressing these risks would be to haircut up to 10 percent of the secured claim for companies with derivatives or other secured claims against the failed firm if the taxpayer or a resolution fund is expected to suffer losses. To prevent market disruptions, Treasury and U.S. government-sponsored debt as collateral would be exempt from the haircut. Such a policy would limit the ability of institutions to fund themselves with potentially risky collateral and ensure that market participants always have an interest in monitoring the financial health of their counterparties. It also would limit the sudden demand for more collateral because the protection could be capped and also help to protect the taxpayer and the resolution fund from losses. It is important that we improve the resiliency of the financial markets and reduce the likelihood that the failure of any individual financial firm will create a destabilizing "run" in the markets. We should require that all standardized OTC derivatives clear through appropriately designed and central counterparty systems (CCPs) and, where possible, trade on regulated exchanges. To ensure necessary risk management, these CCPs and exchanges must be subject to comprehensive settlement systems supervision and oversight by federal regulators. We recognize that not all OTC contracts are standardized. In those limited circumstances where non-standardized OTC derivatives are necessary, those contracts must be reported to trade repositories and be subject to robust standards for documentation and confirmation of trades, netting, collateral and margin practices, and close-out practices. This is an essential reform to reduce the opacity in the OTC market that contributed to market uncertainty and greatly increased the difficulties of crisis management during this crisis. Today, trade repository information is not yet complete or available to all regulators who need it. For example, the FDIC as deposit insurer and receiver, does not currently have access to end-user data from the CDS trade repository. This gap must be closed. Improved transparency is vital for a more efficient market and for more effective regulation. The clearance of standardized trades through CCPs and the reporting of information about non-standardized derivatives will greatly improve transparency. To achieve greater transparency it is essential that CCPs and trade repositories be required to make aggregate data on trading volumes and positions available to the public and to make individual counterparty trade and position data available on a confidential basis to federal regulators, including those with responsibilities for market integrity.”