I don’t know who had the idea to actually put this red hot topic on the air, but it made it! I was on Huffington Post Live yesterday talking about how the futures markets are taking trading volume away from the swaps market, and why this is good.
The segment turned out pretty well. There are a few points about futures vs. swaps which “everyone” should know:
1. Clearinghouse systems are inherently safer than bi-lateral agreement based systems.
2. Futures are well (and largely properly) regulated
3. Futures markets are probably the fairest markets in the world.
4. Modern clearing houses have fantastic risk management (despite what the swaps guy says in this video)
5. Swaps have been practicing regulatory arbitrage against the futures markets for several decades.
6. Credit Default Swaps are far more risky than Interest Rate Swaps. Interest rates swaps are not all that risky. Credit default swaps are like options on corporate debt.
7. Futures markets have reportable positions. This means once your total position gets large, you must report this to the regulators. Additionally, there are typically position limits as well. These two rules would have prevented AIG from putting on so many positions in one direction.
This could actually be an entire series of blog posts, but I’ve been really short on time.
On a day to day basis, it does not matter to the wider economy if these transactions take place on an exchange or in the OTC market. The macro effects of this discussion are not large, except when the system is near failure or fails.
The swaps market is at a huge disadvantage in the case of a near system failure. There is a clear and predetermined failure plan within a clearinghouse structure. The clearinghouse structure has massive transparency compared to the swaps market, and it’s quickly known who is going to take losses, and how large those losses are going to be.
But even more importantly, the rest of the market is priced. Futures markets get priced everyday, and the gains and losses are debited/credited to accounts on a daily basis. There isn’t a question who is holding radioactive bad contracts, or who is hiding losses, because these show up immediately.
In the swaps market failure, there can be weeks or days of sheer panic where nobody knows who is taking losses. Then at the end, some bankers get together in a back room with the feds and make a deal with the feds for a bailout.
The clearinghouse structure is simply much more transparent on every important point when the system is near failure.