Streetwise Professor Warns That CCP Mandates Are Creating Liquidity Risk and Systemic Stress
Commentary by Steven Lofchie
In a recent blog post titled "Clearing Angst: Here Be Dragons Too," University of Houston Finance Professor Craig Pirrong claimed that central clearing mandates do not reduce systemic risk. "Not all financial demons have been slain," he wrote. Professor Pirrong argued that regulations intended to prevent central counterparty ("CCP") failure have forced banks and regulators to resort to "extraordinary measures" to supply liquidity and respond to systemic stresses that are created by the clearing system.
Professor Pirrong cautioned against framing the CCP issue in these terms: "CCPs are too big to fail and therefore need to be made fail-safe." He stressed that the balance sheets of CCP credit exposure can be adjusted primarily to redistribute rather than reduce credit risk. Professor Pirrong warned that responses to a "CCP crisis" are driven by political considerations at least as much as economic ones due to the "huge distributive effects" of the crisis.
Commentary
If there were a Cassandra prize for recognizing the risks of central clearing, Professor Pirrong would win it. However, his observation that after the risk is recognized, the problem of dealing with it becomes political as well as economic is an understatement. Having invested so much reputational capital in boasting of the benefits of central clearing, the government is not about to say, "Whoops! Perhaps we overstated the benefits of clearing a little (or a lot)." A broader concern is that the risk of clearinghouse failure may not be the greatest risk. The biggest risk involves clearinghouses' unconstrained ability to demand a higher margin, which means that clearinghouses' margin demands (which are made to save themselves) can (i) worsen a liquidity crisis and thereby (ii) effect a downward spiral of pricing, as clearing members and their customers are forced to liquidate positions in response to such demands.
Related Articles
-
University of Houston Finance Professor Craig Pirrong argues that synergies in clearing are pushing the proposed merger between the LSE and Eurex and suggest that consolidation in the industry is "nearly inevitable."
-
Federal Reserve Bank of Chicago Senior Policy Specialist Ivana Ruffini cautioned that the "concentration of risk in [central counterparties] must not be underestimated, as CCP failures, while rare, do happen."
-
University of Houston Finance Professor Craig Pirrong argues that the 2015 Annual Report to Congress by the Office of Financial Research "misses the real problems" concerning the systemic risks of central clearing counterparties.
-
Board of Governors of the Federal Reserve System ("FRB") Governor Jerome H. Powell reviewed the progress made in central counterparty ("CCP") clearing and offered his thoughts on expanded central clearing for the repurchase markets.
-
CFTC Chair Massad outlined regulators' ongoing efforts with central clearing. He provided an overview of the regulatory framework in an evolving market.
-