A clearinghouse is often a member association, where you’re ultimately relying on the members for your capitalization and for your protection against blowing up. Seems to me that a clearinghouse has more moral hazard than a bank. I’m among those who are a little skeptical of the notion of centralizing derivatives risk into clearinghouse. LEVINE: We’re a little bit in early phases of doing it.
At the margin, do you think we’ve centralized derivatives risk too much or too little? Maybe you can bail out the clearinghouse - if you have to - more efficiently than individual investors, but that also increases moral hazard. There was a time when it was, “Derivatives are weapons of mass destruction.” Obviously, there’s a sense in which that came true, but I worked in equity derivatives, and total return swaps didn’t blow up the world.Ī specific set of exposures to specific risks were bad and were perhaps magnified by the ability to make zero-sum bets on them, but the idea that a notional of derivatives is somehow itself a risk factor was never super compelling to me.ĬOWEN: There’s a certain centralization of risk with derivatives, so you put a lot of risk into a clearinghouse. The systemic question, I don’t know the answer to. They’re a quadrillion dollar notional of short-term interest rate swaps, where the idea that you could lose a quadrillion dollars on it is quite low. Often, you see these quadrillion dollar numbers. If you have an interest rate swap, the right way to think about it is the DV01, or the right way to think about an equity swap is the delta of it. MATT LEVINE: The right way to think about it, in the way that you would do it if you’re actually working in the derivatives market, is to think about the risk exposures of it. So what’s the right way to think about how large derivatives markets are, and what’s the risk associated with that size? By some measures derivatives are over a quadrillion in value outstanding, but there’s another way you can measure the net positions and turn it into zero. Think about derivatives markets - you’ve worked in that sector. Then with Matt, having been a classics major, we’d move on to the Latin classics and maybe tie the two together a bit. TYLER COWEN: I thought we would start with Matt Levine’s greatest hits.
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