The Fed Is Now Backstopping $25 Trillion In DTCC Cleared Credit Default Swaps

And you thought the $23 trillion in backstops for the financial system was bad, you ain't seen nothing yet. Earlier today, the Depository Trust & Clearing Corporation, best known for its Cede & Co. partnership nominee which is the holder of virtually every single physical stock certificate in the known universe, and accounts for over $2 quadrillion in stock transactions per year, announced that "the Federal Reserve Board had approved its application to establish a DTCC subsidiary that is a member of the Federal Reserve System to operate the Trade Information Warehouse (Warehouse) for over the-counter (OTC) credit derivatives." With this approval the DTCC is now the de facto legally accepted global repository for over-the-counter credit derivative transactions. Simply said, the Federal Reserve is now the guarantor behind all CDS transactions that clear via DTCC, which would be pretty much all of them (sorry CME, you lose). The total bottom line in terms of gross notional? 2.3 million contracts with a gross notional value of $25.5 trillion. When the next AIG implodes, and the CDS market is once again facing annihilation in the face, who will be on the hook? You dear taxpayer, that's who.

The new Fed-endorsed organization will settle CDS obligations in all currencies and process credit events. It will also include all OTC credit derivatives traded worldwide, and will be regulated by the Fed and the NY State Banking Department and will be overseen by other US and International regulators.

To be sure, the net notional CDS amount, which is what counterparties would be on the hook for in the case of an orderly unwind of the financial system, is materially lower than the gross total. Yet, as systemic unwinds are never orderly, gross tends to become net in those occasions when Lehman bonds go from par to 10 cents in the span of 24 hours. Should systemic risk flare up again (and this time Europe will be both shaken and stirred, thank you Mr. Hazard... Moral Hazard), and fiat-based market values quickly catch up with fair values (which in our ponzi economy can easily be calculated: they are all zero).

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http://www.zerohedge.com/article/enter-cede-co-ii-fed-now-backstopping-25-trillion-dtcc-cleared-credit-default-swaps

And now we're going to go broke handing it over to them.

That new regulations are coming down the pipeline to fix our economic system.

Wake me when it happens.

that I think I should understand; I assume I should be angry; but, truth be told...I got no idea what the heck their talkin' about. It's above my pay grade, I guess. If anyone can explain it to me in layman's terms, that would be great.

Say I sell option contracts on the superbowl coin flip.

A sell a contract which pays $1 trillion to party A if the coin ends up heads for $500B
A sell a contract which pays $1 trillion to party B if the coin ends up tails for $500B.

What is my gross notational value. Why $2 trillion. $1T + $1T. Scary huh.
What is the max net payment. $1T - ($500B + $500B in collected premimums) = $0.0.
Hell if I am good enough and sell both contracts for $550B I can clear $100B no matter which way the coin flips.
Gross notational value is an utterly BS stat and is simply used because it is large and scary.

I am not saying the Fed shouldn't heavily regulate these contracts but using GNV is a 100% scare tactic.

The establishment of a market is actually a good first step. Take a look at the options & futures market. There is no counterparty risk because the options or future contract is backed by the clearinghouse (market). There was no meltdown in options market despite contracting gaining or losing 10,000% of value in a day.

Fed guarantees the trades.

DTC does not guarantee stock transactions.

Why should the Fed have to make good on CDS tranactions when one party doesn't pay up or post collateral.

I don't see the legal obligation here.

What am I missing?

Technically you are buying from a seller however it passes through the clearinghouse:

seller-> clearinghouse -> buyer.

If there is fraud on sellers side (accounting errors, selling same stock to two parties, etc) that is on the clearinghouse.

As the buyer if you execute a valid trade against the clearinghouse (what most people call "the market") you are guaranteed the asset.

Now the clearinghouse isn't taking a lot of risk for stocks, bonds, options, futures, etc.

Why?
The clearinghouse puts restrictions on brokers, and has them pony up lots of cash held in trust. If broker screws up and allows fraud on the behalf of on of their clients you the buyer is covered and clearinghouse initially backstops that loss however they will recoup funds from broker who will attempt to recoup funds from the initial seller.

Things like margin requirements, brokers ability to sell clients assets on margin call, escrow funds etc all limit real liability the clearinghouse has.

There is no reason a similar system can't be built for CDS and other derivatives.

:rofl:

Actually this is a very good thing if you think that derivatives are dangerous.

DTC is a clearinghouse. In order to fulfill that function, they have to know both sides of the trade. Joe says "deliver these to Mary at this price." Mary says "receive these from Joe at this price" If these two instructions match then the trade clears ... ie the securities move from Joe's DTC account to Mary's at the agreed upon price.

But for DTC to do this simple task requires a LOT of information. First, BOTH parties have to be members of DTC. They have to post capital requirements with DTC. The terms of the contracts being traded have to be standardized. etc.

So there is mush to like here, it adds transparency and reduces confusion.

And the article's assertion that "Simply said, the Federal Reserve is now the guarantor behind all CDS transactions that clear via DTCC" is absolute BS. Any article that uses the Gross notional value of derivatives is lying to you and this one is no different.


DTC is not the guarantor of any trade. Does the croupier at the casino ever pay off the bettors out of his own pocket? DTC is just the croupier here. Since DTC isn't the guarantor of anything, the FEDs have no additional liability.