August 2, 2013 Update

DJIA:15,628 S&P 500:1,707 NASDAQ:3,676 Gold:$1,288 Oil:$107.89 EURO:$1.32 YEN:99.79

The Next “Too Big To Fail”

The role of a clearinghouse is to act as a third party between two member firms in order to provide unbiased clearing and settlement services for a variety of products, including those that are traded on and off exchanges. In other words, a clearinghouse will sit between a trade and guarantee the trade even if one party defaults. Traditionally, clearinghouses have been seen simply as a way to unclog the markets and to outsource the back office work of complex trades. The burst of the housing bubble in 2008 ruptured the financial markets, which caused a multi-billionaire dollar institution like Lehman Brothers to default on its trades; leaving the clearinghouses to unweave the systemic dangers of default. And because of the role clearinghouses played in unclogging the tangled web of defaulted trades in the height of the crisis, regulators are passing laws that increase the impact clearinghouses have in the global financial system. Neither CME or ICE have ever had to rely on their default fund in order to guarantee a defaulted counterparty, even when the market suffered extreme volatile pressures. Regulatory pressure has been placed on traders of derivate instruments (like CDS and MBS) to use these back office services in order to reduce their risk exposure. In March 2010, the Options Clearing Corporation announced that it had decided that it was going to clear equity derivates, a huge leap forward for the industry.The regulation in Dodd-Frank requires that more trades clear, which pushes out tail risk to create fat tails by simply shifting the risk from counterparties to clearinghouses. The increase in regulation has led, and will continue to lead, to increased volumes for clearinghouses. Poorly written regulatory requirements like these may have the power to make large investment banks less influential on the financial system, but has the potential to convert clearinghouses into “too big to fail” institutions. Through the regulation that was meant to make monstrous investment banks less impactful on the global community, it could be possible that the laws might transform these large institution’s outsourced back offices into interconnected industry giants that cover the default risk for nearly every institution on the street. It is now more important than ever before to determine the adequacy of clearinghouses’ margin requirements and determine if the capital reserves will be sufficient to cover another monstrous tail risk event. 

Domestic News

• Market Update Futures are trading up ahead of employment statistics after the market ended exceptionally well yesterday, the DJIA hit a new high of 15,650.
• Information on the employment situation will be released at 8:30, unemployment is expected to drop to 7.5% for July from 7.6% in June. Nonfarm payrolls are expected to fall to 175 vs. 195k. Average hourly earnings are also expected to decline to 0.2% vs. 0.4%, the average workweek is expected to remain the same (which is unfortunate for many). 
• Personal incomes and outlays data will be released at 8:30, as well. Personal income expected to have fallen 0.4% in June from 0.5% in May, contrasting with expectations for consumer spending where analysts are anticipating an increase of 0.4%, up slightly from 0.3% in the previous period. 
• Factory order data for June will be released at 10:00, which is expected to have risen 2.3% from 2.1% in May.  

International Updates

Asia

• Market Update  Markets performed well, with Japanese markets finishing the strongest as the yen weakened.    

Europe

• Market Update  Markets traded up as investors remain hopeful that the Fed will continue to pump liquidity into the system. 

Corporate

• Bank of American (BAC) is facing multiple civil lawsuits from regulators about one or two “jumbo” mortgage bonds that comprised loans which were too big to be guaranteed by Fannie Mae and Freddie Mac. It is uncertain whether the SEC will file charges, as well. 
• The Dell committee announced that the buyout group will close the deal. 
• AIG is still in talks about selling its aircraft leasing unit, the International Lease Finance Corp (ILFC), to a Chinese business for $4.8B even though its missed its 7/31 deadline. AIG also announced that it will pay a dividend for the first time since 2008