CLEARINGHOUSE THEORY AND PRACTICE HAS BEEN CORRECT - BUT IS POLITICS NOW FALLING IN TO PLACE TOO?
Description
If you have never read or heard me talk about the clearinghouse trade before, then there is a tab on the home page, where most of my research is housed.
The theory of the clearinghouse trade was that the regulatory driven move from an investment bank model, where there were numerous bilateral agreements to a clearinghouse model, while simplifying the financial system, had two big flaws. First, the clearinghouse cannot go bust, and prices risk on a backward basis. If yesterday was good, then today is also likely to be good. Investment banks were far more forward looking in pricing risk. And secondly, profit maximising nature of clearinghouses means they will price risk at very low levels, before a crisis forces a rapid repricing, with causes prices to fall further.
The “practice” of clearinghouse theory has broadly been correct. A good example is the gilt blow up of 2022, when the Truss budget shock caused margins to be raised, and the gilt market went no-bid. A similar thing happened in 2020 during the Covid crisis. The problem from a hedge fund perspective, is that every time the clearinghouse model has blown up, it has been bailed out by central bank buying. Fed buying in 2020, and in the gilt market in 2022 by BOE buying bonds, even as they were raising interest rates. So the problem with the clearinghouse model as a short trade is that the politics has been supportive of “pre-emptive” bail outs.
Reading Scott Bessent’s recent interview on the Federal Reserve made me wonder if the politics may be moving “anti-bailout”. So I had a look at the share prices of the main clearinghouses, and they were surprisingly weak. Time for the clearinghouse trade?
United States
