The financial crisis that was seeded with a flood of cheap credit in the fall of 2008 affected millions of people and reduced the wealth of American households by over $7 trillion dollars. As the biggest names on Wall St. and the brightest scholars in academia tried to make sense of this catastrophe, average investors were stuck holding the bag asking, "How did no one see this coming?" Has the financial system become so complex that the people whose job it is to manage and regulate it can no longer effectively perform their duties? The actions and policies of the federal government(s) that followed were inherently reactionary and have done little to suppress the high-risk behavior of the remaining financial powerhouses.
When Lehman Brothers filed for bankruptcy in September of 2008, it set in motion a domino effect that nearly brought down the financial system and spurred the biggest economic contraction since the Great Depression. Governments all over the world were abruptly faced with the imminent failure of an essential, yet complex system. The reactionary measures that followed promoted a new wave of new regulations that aimed to reduce systemic risk; the effects of which are yet to be seen.
As a response to the Lehman default and other market concerns, a new market intermediary emerged in 2009; the central counterparty (CCP). This new institution was designed to pool counterparty risk and creates market and operational efficiencies. Specifically, the benefits were intended to create:
- A reduction of counterparty risk exposure by spreading risk across members
- A single point of contact for multiple agreements and credit evaluation
- Anonymity for transactions cleared through the CCP
- Guaranteed redelivery of stock or collateral
- Access to a wider market
From a systemic perspective, the emergence of this entity represents a potential leverage point from which a transparent and risk adverse market will flourish. In theory, the new credit entity should alleviate the counterparty risk concerns of beneficial owners, governments, and investors.
Will this work? Or is this setting the stage for a larger crisis in the not-so-distant-future? The fact that the industry is slow to adopt the CCP model speaks to its limitations as a one-size-fits-all solution. Reactionary policies never get completely vetted and often lead to unintended consequences. In a fire-drill scenario, how will the CCP manage a run of cascading defaults? Can they really guarantee assets and collateral? As history has proven, there are no sure bets in global finance. A comprehensive systemic analysis is needed in order to understand the leverage points in an adaptive system. Action is necessary, but it should not be reactionary; with an independent assessment and the support of policy makers, there may be hope in preventing future crises.