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AOFM: Derivatives market ~ at high risk to "player" fraud / ratings collusion

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Australian Office of Financial (mis)Managememt [AOFM] pretend to be "none the wiser", but Australia's tainted derivatives market stinks to high heaven. However, notwithstanding the ridiculously obvious, the ever smart Govt [by half] decided in late 2008 to place substantial taxpayer cash "bets" on this twisted caper via it's AOFM [on-going] toxic programme purchasing an astonishing $15b to $25b of fraud-laced, ratings distorted [FedCrt2012: S&P liable] residential-mortgage-backed-securities{RMBS].

These RMBS 'liar' products are increasingly complex - to evade the truth, avoid liability - with associated absurd risks being taken in this Govt folly of buying-up "site-unseen" tranches of tainted mortgages - as favours to banksters - with these "risks" being hidden from regulators and the public alike.

In Aust local councils were able to gain a court judgment against the rating agency S&P because S&P gave knowingly false triple-A ratings status to a complex set of derivatives. In essence the rating agency chose not to declare & appropriately factor-in the "real" risk ratings associated with, and that were being taken in, those disastrous derivatives packages:~ 


Staring down America's next CDS liability--



Published  9 Nov 2012--

Sleeping deep in the US president’s home town of Chicago is a time bomb that one day could do real damage to American and global economies. And there is another one in Atlanta.
Last night world markets were battling on two fronts – yet another Greek crisis and the substantial US tax rises and expenditure cuts that comprise the so-called fiscal cliff. They are nasty situations but on their own they will not bring the world to its knees, and indeed in late sessions share buyers appeared.

But Gretchen Morgenson, writing in The New York Times,(One Safety Net That Needs to Shrink, November 3) has highlighted the amazing situation of the so-called clearing houses led by the Chicago Mercantile Exchange and the Atlanta based Intercontinental Exchange.

The Chicago Merc clears derivatives contracts with a notional value in the trillions of dollars. I.C.E. clears most of the credit default swaps in the United States – billions of dollars a day, on paper. Both organisations are good operators and know derivatives markets but among the big risk takers in this market are some of the large European banks who on any normal tests have insufficient capital. The derivatives market is high risk. 

Yet under the Dodd-Frank laws introduced after the global financial crisis, clearing houses were granted the right to tap the Federal Reserve for funding when the next crisis hits – in other words they were declared too big or important to fail. But in a strange twist the clearing houses can avoid the Dodd-Frank complex regulations that aim to avoid another Lehman style situation where the collapse of a financial organisation brings the world to its knees.

The risks being taken in the derivatives are hidden from regulators. In Australia local councils were able to gain a court judgment against the rating agency S&P because S&P gave triple-A ratings status to a complex set of derivatives. In essence the rating agency did not understand the risks that were being taken in those disastrous derivatives packages. 

Local councils are wiser now but if anything the derivatives market has become more complex and the risks being taken are greater.

If we have a major collapse it will be multiplied many times if the derivatives markets go into a tail spin. The solvency of the clearing houses would be tested. But now that the Dodd Frank laws have brought them under the “too big to fail” umbrella it means that the American government will have to stand as an effective guarantor for large chunks of the global derivatives system and European banks.

As The New York Times points out these clearing houses, which could bring the US to its knees, operate outside the main regulatory areas. I guess we must keep our fingers crossed.

One Safety Net That Needs to Shrink

Published: November 3, 2012
"These financial market utilities are the new [US] government-sponsored enterprises.”


ELECTION Day is upon us, and neither President Obama nor Mitt Romney has really addressed one of the nation’s most pressing economic issues: the risk that one day taxpayers might have to bail out swashbuckling financial institutions again.


Granted, the economic pain many are feeling now — the snail’s pace recovery, the stubbornly high unemployment — is foremost in voters’ minds. But given all we’ve gone through after the last binge in the financial industry, failing to confront the too-big-to-fail question is a serious oversight.

Many Americans probably think the Dodd-Frank financial reform law will protect taxpayers from future bailouts. Wrong. In fact, Dodd-Frank actually widened the federal safety net for big institutions. Under that law, eight more giants were granted the right to tap the Federal Reserve for funding when the next crisis hits. At the same time, those eight may avoid Dodd-Frank measures that govern how we’re supposed to wind down institutions that get into trouble.

In other words, these lucky eight got the best of both worlds: access to the Fed’s money and no penalty for failure.

Which institutions hit this jackpot? Clearinghouses. These are large, powerful institutions that clear or settle options, bond and derivativestrades. They include the Chicago Mercantile Exchange, the Intercontinental Exchange and the Options Clearing Corporation. All were designated as systemically important financial market utilitiesunder Title VIII of Dodd-Frank. People often refer to these institutions as utilities, but that’s not quite right. Many of these enterprises run lucrative businesses, have shareholders and reward their executives handsomely. Last year, the CME Group, the parent company of the Chicago Mercantile Exchange, generated almost $3.3 billion in revenue. Its chief executive, Craig S. Donohue, received $3.9 million in compensation and held an additional $10 million worth of equity awards outstanding, according to the company’s proxy statement.

Make no mistake: these institutions are stretching the federal safety net. The Chicago Merc clears derivatives contracts with a notional value in the trillions of dollars. I.C.E. clears most of the credit default swapsin the United States — billions of dollars a day, on paper. No wonder they are considered major players in our financial system.

But placing them at the bailout trough is wrong, according to Sheila Bair, the former head of the Federal Deposit Insurance Corporation. In a recently published book, Ms. Bair wrote that top officials at the Treasury and the Fed, over the objections of the F.D.I.C., pushed to gain access for the clearinghouses to Fed lending.

The clearinghouses “were drooling at the prospect of having access to loans from the Fed,” she wrote. “I thought it was a terrible precedent and still do. It was the first time in the history of the Fed that any entity besides an insured bank could borrow from the discount window.” .

“The Treasury’s and the Fed’s reasoning was that since another part of Dodd-Frank was trying to encourage more activity to move to clearinghouses, we should provide some liquidity support to them,” she said in an interview last week. “Our argument back was, if you have an event beyond their control with systemwide consequences, then you have the ability to lend on a generally available basis. What they wanted was the ability to lend to individual clearinghouses.”

The clearinghouses have considerable clout in Washington. From the beginning of 2010 through this year, the CME Group has spent $6 million lobbying, according to the Center for Responsive Politics.

Did these players push for special treatment while avoiding other aspects of Dodd-Frank? Representatives of the Chicago Mercantile Exchange and the Options Clearing Corporation say no, noting that access to the Fed meant they would also be overseen by the central bank, in addition to the Securities and Exchange Commission or the Commodities Futures Trading Commission.

But the Fed’s involvement is not likely to be intrusive, because Dodd-Frank directed it to take a back seat to a financial utility’s primary regulator, either the S.E.C. or the C.F.T.C.

The CME said that it did not support Dodd-Frank’s designation of clearinghouses as systemically important, but once it received the designation, it believed the Fed should provide access to emergency lending. The O.C.C. echoed this point.

Whatever the case, the CME Group has argued that it should be exempt from the orderly liquidation authority set up under Dodd-Frank. This authority was designed to unwind complex and interconnected financial firms that could threaten the financial system if they failed. The law appointed the F.D.I.C. as receiver to resolve teetering entities. That authority is supposed to end the problem of institutions that are too big to be allowed to fail and also to hold their managers accountable.

BUT in a letter to the F.D.I.C. a few months after Dodd-Frank became law, the CME Group asked the F.D.I.C. to confirm that the exchange wouldn’t fall under that authority’s jurisdiction. It is not a financial company as defined by the law, the CME contended, and therefore should not be subject to the resolution process.

The F.D.I.C. has not confirmed the C.M.E.’s view on the matter. But it seems to be gaining traction among other regulators. At an Aug. 2012 presentation last August on resolving financial market utilities, Robert S. Steigerwald of the Federal Reserve Bank of Chicago noted that it was unclear whether a financial utility such as the Chicago Merc would have to be wound down as required under Dodd-Frank.

So these large and systemically important financial utilities that together trade and clear trillions of dollars in transactions appear to have won the daily double — access to federal money, without the accountability.

“Dodd-Frank should have been all about contracting the safety net,” Ms. Bair said last week.  “But this was a huge and unprecedented expansion of the safety net that provided expressed government support for for-profit entities. These financial market utilities are the new government-sponsored enterprises.”

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