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Trump Advisor Warns of Derivatives/Brexit Threat, Begs Glass-Steagall Question

Oct. 16, 2017 (EIRNS)—Speaking to the Group of 30 consultative group on banking after the International Monetary Fund/World Bank annual meetings in Washington, D.C., President Donald Trump’s chief economic advisor Gary Cohn gave some warnings about the derivatives markets and too-big financial institutions, according to the Financial Times. Cohn said, as had the U.S. Treasury in a recent report, that the clearinghouses which are supposed to reduce counterparty risk in the hundreds of trillions in unregulated derivatives bets, were themselves becoming, instead, concentrations of systemic risk.

One of Cohn’s emphases, according to the Financial Times, was that

"The post-crisis regulatory system is fostering increasing complexity and growth of massive financial firms, ignoring the lessons of the meltdown."

He stressed that the regulations enacted after the 2008 crash, including the Dodd-Frank Act in the United States, which were supposed to remove the "too-big-to-fail" threat, were in fact "leading to the consolidation of more activity in a handful of vast companies." He called these "perverse effects," including the inability of any new banks to enter the system.

While this statement of the problem clearly begged the known solution—reinstating the Glass-Steagall Act to break the megabanks of Wall Street up—Cohn did not propose that this time, but claimed that the Treasury’s elimination of some regulations on Wall Street, would enable newer, smaller banks to establish themselves.

Cohn warned in particular about the increasing derivatives activity run through clearing houses: "something that is starting to resonate as an important systemic risk." Clearinghouses were set up as partnerships of the big banks, after the 2008 crash, to guarantee derivatives speculators against loss from bankruptcy of their counterparties on the other side of the bets, or against dramatic singularities in the exchange rates, interest rates, etc. being bet on. Operating largely in London, where 40-50% of all derivatives contracts originate, the clearinghouses are not adequately capitalized because they make assumptions about "netting out" of derivatives bets in a crisis, reducing what has to be guaranteed, when that is very likely not to be possible at just that conjuncture.

Since the $600 trillion-plus derivatives markets are obviously systemic, the dozen or so major clearinghouses are just as systemic, but undercapitalized, and instead of taking away risk, they are concentrating it. Cohn noted that a U.S. Treasury report said the UK’s "Brexit" raises the urgency of this.

The Economist on Oct. 12, in "Brexit will give the derivatives markets a nasty headache," says clearinghouses are a major profit center for City of London Banks.

"LCH, a clearing-house in London, clears over 50% of interest-rate swaps [by far the most common derivatives—ed.] across all currencies; London houses clear 75% of swaps in euros and 97% of those in dollars."

Even Bank of England head Mark Carney has acknowledged these clearings may become "legally invalid" in a disorderly Brexit. That this would cause financial chaos, would rank among the great understatements.

The Financial Times quoted Gary Cohn,

"‘We don’t understand the magnitude of continuously putting things in clearing houses without the proper guardrails in the clearing house,’ Mr. Cohn argued. ‘As we get less transparency and as we get less liquid assets in the clearing house, it does start to resonate to me to be a new systemic problem.’"