The biggest risk of all: Ben Bernanke's speech at Stone Mountain, Georgia.

[legion]

Clearinghouses, Financial Stability, and Financial Reform

I am pleased to speak once again at the Federal Reserve Bank of Atlanta's Financial Markets Conference. This year's conference covers an interesting mix of topics bearing on the vital ongoing global debate on how best to prevent and respond to financial crises.

Tonight I would like to discuss post-crisis reform as it relates to a prominent part of our financial market infrastructure--namely, clearinghouses for payments, securities, and derivatives transactions. This audience, I know, recognizes the importance of what is often called the "plumbing" of the financial system--a set of institutions that very safely and efficiently handles, under most circumstances, enormous volumes of financial transactions each day. Because clearinghouses and other parts of the financial infrastructure fared relatively well during the crisis--despite moments of significant stress--the public debate on financial reform has understandably focused on the risks posed by so-called too-big-to-fail financial firms, whose dramatic failures or near failures put our financial system and economy in dire jeopardy. Nevertheless, the smooth operation and financial soundness of clearinghouses and related institutions are essential for financial stability, and we must not take them for granted.

...

Conclusion

Clearinghouses around the world generally performed well in the highly stressed financial environment of the recent crisis. However, we should not take for granted that we will be as lucky in the future. Past crises, including the financial panic of 1907 and the 1987 stock market crash, led to significant reforms and improvements in clearing and settlement that paid off in subsequent periods of financial stress. Given the growing interdependencies among clearinghouses, along with the new mandates for central clearing, now is a good time to reflect on the lessons of the recent crisis and consider whether further improvements are possible.

For more than a century, financial stability has depended on the resilience under stress of clearinghouses and other parts of the financial infrastructure. As we rely even more heavily on these institutions in the United States and around the world, we must do all that we can to ensure their resilience, even as our financial system continues to evolve rapidly and in ways that we cannot fully predict. In short, I think Pudd'nhead Wilson would agree that that is one important basket.

http://www.federalreserve.gov/newsevents/speech/bernanke20110404a.htm

 

[legion]

The legal framework governing the Fedwire Securities Service, and the Fedwire-eligible securities market broadly, also offers a high degree of legal assurance that customers’ assets are protected.

Interests in Fedwire-eligible securities are held on either direct or indirect holding systems. In direct holding systems, interests in securities are held on the books of the issuer or their official registrar. For example, individuals and entities may directly hold these interests on the books of the Treasury, through TreasuryDirect. Although there is no equivalent to TreasuryDirect for non-Treasury securities, it may be possible to be a direct holder of non-Treasury securities at the official registrar in certificated form.

In indirect, or tiered, holding systems, interests in securities are recorded on the books of the securities intermediary. When securities are transferred in an indirect holding system, the transfer is reflected in accounts on the books of the securities intermediary. The Fedwire Securities Service is an indirect holding system, in which participants hold accounts with Reserve Banks and nonparticipants hold accounts on the books of a participant or some other intermediary.

In the Fedwire Securities Service, participants hold securities accounts with the Reserve Banks. The Reserve Banks are the custodians for participants’ securities. As custodians, they maintain records of the identities and interests of each participant. Because participants’ assets are held directly with the central bank, those assets are adequately protected against a custodial insolvency. Also, participants have limited rights against the Treasury, federal agencies, and GSEs for principal and interest payments.

Nonparticipants hold securities accounts or interests on the books of a participant or some other intermediary that holds its interests with a participant. The Reserve Banks do not maintain records of the identities or interests of nonparticipants. Nonparticipants do not have any rights against the issuer or any intermediary other than their direct intermediary. While Reserve Banks do not face liquidity constraints as part of the U.S. central bank, nonparticipants’ custodians may. As indicated below, however, U.S. law protects nonparticipants’ assets held at a custodian or intermediary.

The process for distributing assets held by insured depository institutions that become insolvent is governed by the liquidation provisions of the Federal Deposit Insurance Act (FDIA). The FDIA liquidation provisions generally provide that the beneficial owner of a Fedwire-eligible security held by a failed bank normally would be entitled to the security if the customer's exclusive ownership interest is properly documented.

The failure of entities other than insured depository institutions, such as nonbank broker-dealers, would require application of other statutes. The stockbroker liquidation procedures under the U.S. Bankruptcy Code and the Securities Investor Protection Act (SIPA) provide some protections to investors when a brokerage firm fails owing customers cash and securities that are missing from customer accounts. The Securities Investor Protection Corporation (SIPC) usually asks a federal court to appoint a trustee to liquidate the firm and protect its customers. With small brokerage firm failures, SIPC sometimes deals directly with customers. In general, a trustee for a failed broker-dealer will return to customers all securities that already are registered in their name or are in the process of being registered. After this step, the firm’s remaining customer assets are then divided on a pro rata basis with funds shared in proportion to the size of claims. If sufficient funds are not available in the firm’s customer accounts to satisfy claims within these limits, the reserve funds of SIPC are used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $100,000 for cash claims. Additional funds may be available to satisfy the remainder of customer claims after the cost of liquidating the brokerage firm is taken into account.

http://www.federalreserve.gov/paymentsystems/files/fedsecs_compliance.pdf

As the law stands you have next to no recourse if this clearinghouse failure occurs. None. Good luck.

 

[Petar]

I read about half of it, and if I understand this correctly, it sounds like he is trying to ever so gently introduce the idea that clearinghouses (the derivatives market?) need to be regulated in order to ensure the stability of the globally intertwined financial system.

 

[legion]

S&P downgrades DTCC and Chicago options clearer


Standard & Poor’s, the rating agency at the centre of a storm of debate over its downgrade of the US, on Monday cut its ratings for the big securities clearing houses that underpin most stock, option and bond trading in the US.

The move reflected the slightly heightened “macro volatility” that they are exposed to through the equity and bond markets, and through their clearing members, S&P said.


Clearing houses acts as buyer to every seller and seller to every buyer, ensuring deals are completed even if a party defaults. They typically hold billions of dollars worth of US Treasurys as collateral, as well as cash, which are provided by market participants and help make good trades in a default.

S&P said its had lowered to AA+, from AAA, its rating for The Depository Trust Co (DTC), National Securities Clearing Corp (NSCC) and Fixed Income Clearing Corp (FICC) - all part of The Depository Trust & Clearing Corporation, which acts as clearer for all share trading on exchanges in the US - as well as on the Options Clearing Corporation (OCC), the Chicago-based clearer for all nine US options exchanges.

...

http://www.ft.com/intl/cms/s/0/00903bb2-c19c-11e0-acb3-00144feabdc0.html



Buried among the news of S&P downgrading the US Gov't, was this story, a downgrade of the biggest clearinghouse in the US.

 

[legion]

I read about half of it, and if I understand this correctly, it sounds like he is trying to ever so gently introduce the idea that clearinghouses (the derivatives market?) need to be regulated in order to ensure the stability of the globally intertwined financial system.

Basically every security (stock, bond, derivative, swap, etc) in the US is owned by one company in Delaware.

When you buy stocks you are not buying the stock. Your name is never recorded on the certificate. What you are buying as a notation in this company's books that you are the beneficiary of their stock.

This sounds like a conspiracy, but its not. It's a public secret. The company that owns all the securities is called DTCC.

 

[Petar]

Also, the $600 trillion derivatives market is like one giant ecosystem of exotic financial instruments, that seems like it just has to blow at some point.

It's like the CDR's of the subprime crisis, times a billion.

Hearing the Bernake seem to even whisper about its potential vulnerability is enough to give me some urge to immediately run for the hills...

 

[legion]

Surprise, guess who owns all the derivatives after the Dodd-Frank act?

For OTC derivatives they call it MarkitServ or Deriv/SERV.

For interest rate swaps, New York Portfolio Clearing.

For Credit Default Swaps, the Warehouse Trust Company.

Et Cetera.

 

[Petar]

Basically every security (stock, bond, derivative, swap, etc) in the US is owned by one company in Delaware.

When you buy stocks you are not buying the stock. Your name is never recorded on the certificate. What you are buying as a notation in this company's books that you are the beneficiary of their stock.

This sounds like a conspiracy, but its not. It's a public secret. The company that owns all the securities is called DTCC.

I've heard about this before.

So are you basically saying that if clearinghouses fail, then stockholders for instance, no longer own the pieces of the companies that they thought they did?

I wonder if the same would hold true for preferred shareholders...

 

[Petar]

All of this seems like it is designed to give the head of the international financial octopus (well, one of them anyway), a single point to break itself away from all of its victims, once everything implodes...

 

[billjones]

Can someone give us cliffs of the speech?

And interpret it so that we (I) can know what it means. Thanks.

 

[legion]

I've heard about this before.

So are you basically saying that if clearinghouses fail, then stockholders for instance, no longer own the pieces of the companies that they thought they did?

I wonder if the same would hold true for preferred shareholders...

Yes.

But, the larger shareholders are very likely to get sweetheart deals in exchange for unreal amounts of cash like Buffet's BOA deal. They will hold their shares in physical certificates in their name, and so are not exposed to custodial risk.

 

[Travlyr]

Basically every security (stock, bond, derivative, swap, etc) in the US is owned by one company in Delaware.

When you buy stocks you are not buying the stock. Your name is never recorded on the certificate. What you are buying as a notation in this company's books that you are the beneficiary of their stock.

This sounds like a conspiracy, but its not. It's a public secret. The company that owns all the securities is called DTCC.

DTCC is the Depository Trust and Clearing Corporation

DTCC's depository provides custody and asset servicing for 3.6 million securities issues from the United States and 121 other countries and territories, valued at almost $34 trillion. In 2009, DTCC settled more than $1.48 quadrillion in securities transactions.

 

[legion]

DTCC is the Depository Trust and Clearing Corporation

Yes. It's difficult to imagine a number that high, isn't it?

This is one of the biggest secrets in the world, yet you never hear about it. Not even on conspiracy websites. I wonder why?

 

[legion]

Surprise, guess who owns all the derivatives after the Dodd-Frank act?

For OTC derivatives they call it MarkitServ or Deriv/SERV.

For interest rate swaps, New York Portfolio Clearing.

For Credit Default Swaps, the Warehouse Trust Company.

Et Cetera.

Just to clarify, I mean "assumes the counterparty risk" when I said owns.

Simply put, the value of every stock and bond in the world now backs the derivatives.

 

[youngbuck]

Yes. It's difficult to imagine a number that high, isn't it?

This is one of the biggest secrets in the world, yet you never hear about it. Not even on conspiracy websites. I wonder why?

Yes, difficult to imagine. But I guess if a $100 billion package were to be transferred to a different party 10 times during a year, that'd be $1 trillion. Let that happen with a thousand different "packages" and you'd have a quadrillion. But anyway, I AM surprised I've never heard about it on a conspiracy website.

 

[legion]

Lets say there are currently 100 shares of BOA stock.

Every public company has what is called a "transfer agent" who records all owners of company stock.

On the books of the transfer agent, the structure of BOA is currently like this:

Shares Owner
1 Former CEO
2 Hedge Fund LP
1 State Pension Fund
1 Huge Investment Bank LLC
95 Cede & Co.

If you have a stock broker, you will buy the Cede & Co (DTCC) shares on the open market, or not buy BOA stock. Your transactions are never recorded by the transfer agent. You don't have the privilege to own shares directly. Your name is not recorded by the TA. The TA does not have your address. They will not call you. You don't exist.

Now, lets say you are Warren Buffet and want some BOA shares. You call BOA CEO, who then calls his transfer agent. He says to the transfer agent: print 5 more shares and send them to Warren Buffet.

Now the company structure looks like this:

Shares Owner
1 Former CEO
2 Hedge Fund LP
1 State Pension Fund
1 Huge Investment Bank LLC
95 Cede & Co.
5 Warren Buffet

Notice Warren Buffet gets his name on the TA books. He is recorded as an owner.

You are not that lucky. You do not own, and are only the designated benificiary, once removed. I say once removed because your broker is the first beneficiary. You aren't even the first beneficiary.

Additionally, Cede & Co is technically the majority owner of the company. If one day they decided to not send you your proxy voting ballot, and instead voted for you, they control the destiny of the corporation. Also, they could litigate, and rightfully claim to be the majority nominee owner of the company, much like MERS does when they sue for foreclosure.

Now imagine this situation with Cede & Co for every publicly traded stock and bond in the US. That is the DTCC.

Ben Bernanke and the S&P are expressing concern that it could go bankrupt if a certain financial situation occurs.

 

[LibForestPaul]

Until I physical hold the certificate, I am not a registered owner?

 

[legion]

Until I physical hold the certificate, I am not a registered owner?

Technically, yes.

At this time, it doesn't make a practical difference that you are not the registered owner of the stock.

However, if this clearinghouse system were to fail, this would matter a lot in bankruptcy court. Who says your claim to the stock shares is greater than any other creditor? You certainly won't have the legal representation the biggest players will.

 

[Zippyjuan]

Basically every security (stock, bond, derivative, swap, etc) in the US is owned by one company in Delaware.

When you buy stocks you are not buying the stock. Your name is never recorded on the certificate. What you are buying as a notation in this company's books that you are the beneficiary of their stock.

This sounds like a conspiracy, but its not. It's a public secret. The company that owns all the securities is called DTCC.

It is my understanding that a clearing house is a trading center- not a purchaser and holder. That would be like saying that the NYSE owns every share traded on that exchange. They record the transactions there but don't own them.

 

[legion]

It is my understanding that a clearing house is a trading center- not a purchaser and holder. That would be like saying that the NYSE owns every share traded on that exchange. They record the transactions there but don't own them.

Well, your understanding is incorrect.