Back in September, the Chicago Fed hosted a symposium on OTC derivatives clearing. (Bear with me, don’t fall asleep just yet.) The luncheon keynote was given by Ken Griffin, and summarized by Craig Pirrong, who was there:
Griffin gave a paean to central clearing, and to Dodd-Frank more generally. Clearing is cheaper operationally and administratively. It reduces risk. It economizes on capital. It is the cure for all that ails the financial markets.
So if it is so wonderful, what stands in the way of its adoption? Per Griffin: a small, self-interested cabal of dealers who reap billions and billions of profits at the expense of end users, and who will lose their ill-gotten gains in a cleared world.
This narrative is a familiar one, the stock theme of the advocates of central clearing
The NYT‘s Louise Story took Griffin’s complaint and elevated it to the status of the main front-page story of the Sunday paper. It’s a long and powerful piece, which alleges that a small group of powerful investment banks are doing their utmost to keep the lucrative OTC derivatives business for themselves; the cabal even has a secret meeting, in midtown Manhattan, on the third Wednesday of every month.
I’m sympathetic to Story’s case here, even if it’s hard to have much sympathy for Griffin, a billionaire who clearly wants to export his high-frequency trading techniques from the stock market to the options and futures markets. I think that Story and Griffin are right that we would be better off with much more derivatives trading centrally cleared, and that the biggest derivatives dealers are doing their best to stymie such a move.
But that said, Story’s story is quite one-sided. She doesn’t talk about Griffin’s profit motive, and she’s far too credulous when it comes to other would-be competitors in the derivatives space. Look at this, for instance:
The Bank of New York Mellon’s origins go back to 1784, when it was founded by Alexander Hamilton. Today, it provides administrative services on more than $23 trillion of institutional money.
Recently, the bank has been seeking to enter the inner circle of the derivatives market, but so far, it has been rebuffed.
Bank of New York officials say they have been thwarted by competitors who control important committees at the new clearinghouses, which were set up in the wake of the financial crisis.
Bank of New York Mellon has been trying to become a so-called clearing member since early this year. But three of the four main clearinghouses told the bank that its derivatives operation has too little capital, and thus potentially poses too much risk to the overall market.
The bank dismisses that explanation as absurd. “We are not a nobody,” said Sanjay Kannambadi, chief executive of BNY Mellon Clearing, a subsidiary created to get into the business. “But we don’t qualify. We certainly think that’s kind of crazy.”
It’s pretty obvious that being founded by Alexander Hamilton in 1784 and being “not a nobody” are not sufficient to be admitted to a central clearinghouse. The way those clearinghouses work, the strongest members bear a lot of risk should one of the weaker members fail, and so it’s reasonable for them to want to try to minimize that risk by forcing members to put lots of capital into their derivatives arms — especially would-be members who think such demands are “kind of crazy”.
So a bit of third-party adjudication would have been welcome here: does BNY Mellon really have so much capital that its acceptance into the derivatives-counterparty club is a no-brainer, as Kannambadi would have us believe? We don’t know: Story simply gives him the last word, and moves on.
More generally, there’s no evidence that Story ever talked to Pirrong or any other third party who takes the other side of the argument. And the other side, as presented by Pirrong in response to Story, does make a certain amount of sense:
The Citadel commander’s argument presumes that end users-who, as he properly notes, must be the ultimate source of any dealer market power profits-are the victims of some sort of battered spouse syndrome. For end users are among the most vociferous opponents of clearing mandates. FMC Treasurer Thomas Deas was quite outspoken on this score at the session immediately prior to Griffin’s speech. Why are end users the most ardent defenders of a system that is supposedly rigged against them, and robs them blind?…
Criticisms like Kenneth Griffin’s and Louise Story’s remind me of what Yogi Berra said about Ruggeri’s (a restaurant on The Hill in St. Louis): “Nobody goes there anymore. It’s too crowded.” The OTC markets are big and crowded with customers. If they’re such a bad deal for these customers, why is that true? Why hasn’t entry, or the movement of customers to available substitutes, constrained market power and prevented exploitation of customers? Not to say that such an outcome is inconceivable, just that Louise Story, Kenneth Griffen, and the cast of thousands who criticize OTC derivatives markets haven’t come close to answering these questions.
I long for the day when there will be serious consideration of these issues, rather than superficial black hat-white-hat narratives.
Story took an extremely recondite subject and did a masterful job of explaining it in easy-to-understand terms; what’s more, her heart is clearly in the right place. As such, it feels a bit churlish to accuse her of oversimplifying matters: in an important sense, it’s her job to take complex subjects and simplify them to the point at which they can be generally understood.
But the front page of the Sunday NYT is an extremely powerful bully pulpit, and comes with a lot of responsibility to deliver a balanced and nuanced take on such subjects. Story’s piece is long enough as it is, and maybe couldn’t be extended any further. But I would have loved to have seen a good-faith effort to explain the big banks’ side of the argument, and also to give the banks’ opponents opportunity to respond to those arguments, much as Steve Waldman did online. But maybe that’s what the blogosphere is for, these days.
Felix Salmon is a financial writer, editor, and podcaster. A former finance blogger for Reuters and Condé Nast Portfolio, his work can be found at publications including Slate and Wired, as well as his own Substack newsletter.