Clearinghouse Over-Confidence

In this stripped-down example, AIG, Bear Stearns, and BofA – as well as their attorneys, lobbyists, and supportive policymakers – promote the clearinghouse on the grounds that it reduces risk for its participants. And, as advertised, it does — but only for its participants. Citibank, however, now loses $50 million more, because it can’t crack into the clearinghouse’s assets. If that extra loss pushes a systemically vital Citibank over the precipice, the clearinghouse has not reduced systemic risk as advertised.

Whether the clearinghouse reduces systemic risk depends on the relative systemic importance of those inside and those outside the clearinghouse – AIG versus Citibank in this basic example – not on the clearinghouse’s capacity to reduce risk among its members. In this example, if Citibank is precarious and is as systemically vital as AIG, the clearinghouse has obscured that it has saved AIG only by transferring risk from the clearinghouse to Citibank, which then fails.

Much recent regulatory activity has focused on enabling, enhancing, and requiring clearinghouses for these kinds of financing arrangements. Yes, clearinghouses offer many benefits, including greater transparency, better pricing, and better regulatory focus, and we should try to make them viable. But regulators world have overestimated their overall benefit. Too much of what is justified as reducing systemic risk is really just offloading risk onto others.

Mark J. Roe is a professor at Harvard Law School.

Copyright: Project Syndicate, 2011.www.project-syndicate.org

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