http://digital.library.okstate.edu/chronicles/v008/v008p369.html

The central bank opened lending to investment banks in March to restore stability to financial markets. New York Fed President Timothy Geithner said today that even with borrowing under the so-called Primary Dealer Credit Facility in decline, the program is still needed as a source of investor confidence.

The loan balance fell to zero after the Fed took on a portfolio of Bear Stearns Cos. assets to ensure the firm’s takeover by JPMorgan Chase & Co.

“I don’t think you can really judge the value today to the firms themselves, or the people that fund them, from looking at use day-by-day,” Geithner said at a House Financial Services Committee hearing in Washington.

As of yesterday, there were no loans outstanding in the primary-dealer program for a fourth straight week, while commercial banks had $17.7 billion of discount-window loans, the Fed reported.

Net Value

The central bank said the net value of the former Bear Stearns portfolio was valued at $29.059 billion as of yesterday, compared with $29.019 billion a week ago.

The Fed revalued the underlying assets of the portfolio as of June 30, compared with June 26, and will now assign a new “fair value” quarterly, next on Sept. 30. Weekly calculations of the net portfolio value are updated to reflect accrued earnings and expenses.

The Fed loaned $28.8 billion last month to a company it formed to purchase the Bear Stearns investments, which as of mid- March included debt backed by mortgages and other items JPMorgan deemed too risky to take on. JPMorgan is absorbing the first $1.15 billion of any losses realized on the holdings.

The average daily total of loans to dealers reached a record $38.1 billion the week ending April 2.

Fed holdings of U.S. Treasury securities rose by $85 million for a daily average of $479.1 billion. The central bank had about $740 billion of Treasuries at the start of 2008.

Aggressive Policy

Fed policy makers kept the benchmark rate at 2 percent at their last meeting June 25, ending the most aggressive monetary easing in two decades. The discount rate is now 2.25 percent, compared with the three-month London Interbank Offered Rate for the dollar of 2.80 percent.

The Fed reported no net misses in reserve projections. A net miss occurs when the actual reserve level in the banking system diverges from the Fed’s projections for a day by $2 billion or more. If the level is outside expectations, the federal funds rate can deviate from target.

The Fed also reported that the M2 money supply rose by $300 million in the week ended July 14. That left M2 growing at an annual rate of 6.2 percent for the past 52 weeks, above the target of 5 percent the Fed once set for maximum growth. The Fed no longer has a formal target.

The Fed reports two measures of the money supply each week. M1 includes all currency held by consumers and companies for spending, money held in checking accounts and travelers checks. M2, the more widely followed, adds savings and private holdings in money market mutual funds.

During the latest reporting week, M1 fell by $10.1 billion. Over the past 52 weeks, M1 has increased 0.6 percent. The Fed no longer publishes figures for M3.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aAyvatv4k6mc&refer=home

WASHINGTON — Adding fuel to the thorny debate about the future regulation of Wall Street, two of the U.S.’s top regulators staked their own, sometimes competing, claims during congressional testimony Thursday.

Making the case for the Securities and Exchange Commission, Chairman Christopher Cox called for his agency to have expanded oversight of investment banks and the lead role in managing the unwinding of a brokerage firm.

At the same hearing, New York Federal Reserve Bank President Timothy Geithner called for the central bank to have broader powers. For the Fed to protect the financial system and economy, he said, it must directly oversee firms that can borrow from the Fed and that “play a critical role in market functioning.” (Read the full remarks.)

The line-drawing comes as Congress, the Bush administration and regulators are looking to fill gaps in oversight exposed during the credit crisis. While no legislation is expected this year, the debate of future oversight is gaining momentum and will be a critical issue for the next president and Congress.

Currently, the Fed has responsibility only for commercial banks, and it has long provided direct loans to those firms. The Fed temporarily extended that lender-of-last-resort role to investment banks in March during the Bear Stearns crisis. But it doesn’t have direct oversight of investment banks.

The official regulator of investment banks is currently the SEC, which operates under a voluntary agreement hashed out with the largest investment banks in 2004. But unlike the Fed, it has no lending capability.

Mr. Geithner, a key player in the Fed’s response to the Bear Stearns crisis, wants a single regulator to oversee financial institutions that are large enough to create a systemic risk to financial markets.

“This crisis provides a stark illustration of how hard it is for a supervisory and regulatory framework designed principally around banks to contain the impact of financial shocks in a manner that mitigates the risks to the broader economy,” Mr. Geithner said. The Fed has emphasized that its lending to investment banks is temporary. Thursday, Mr. Geithner noted the lending’s importance in providing confidence to the market.

Mr. Cox, meanwhile, said the Fed’s lending facility should remain a temporary one and that the SEC should remain the lead regulator of investment banks. He said the SEC’s role should be expanded to include the setting of risk-management systems and applying “progressively more significant restrictions on operations if capital or liquidity adequacy falls, including requiring divestiture of lines of business.”

The Fed and Treasury Department have started a discussion about how to handle the dissolution of an investment bank; during Bear Stearns’s fall the decisions were made on the fly.

Thursday, Mr. Cox raised his hand for the job, and said SEC oversight should go beyond investment banks themselves to include unregulated affiliates that hold derivatives, which are insurance-like products, and other investments that, if unwound too quickly, could result in havoc in the broader financial system.

Messrs. Geithner and Cox said better infrastructure for the over-the-counter derivatives markets was needed, noting that new products have developed faster than their clearance and settlement systems. Mr. Geithner said a clearinghouse for certain derivatives could go into effect within the next year and said he was working with Mr. Cox on possible disclosure requirements. Mr. Cox said greater transparency in that market was “very important.”

Mr. Geithner also said there needs to be a “fundamental rethinking” of Fannie Mae and Freddie Mac, the quasigovernment lenders that own or back more than half of the nation’s mortgages and have been under pressure in recent weeks. He said it was hard to say how their role should be structured, but that the current approach “is probably untenable over the longer term.”

Separately, Mr. Cox said the SEC could propose as soon as next week extending its emergency order aimed at limiting certain kinds of short sales, or negative bets on a company’s stock, from 19 financial institutions to the rest of the market. The SEC took the unprecedented move after a week of heavy selling in shares of Fannie and Freddie.

He also said the SEC staff is considering several alternatives to a price test the SEC eliminated last year, which effectively said one couldn’t place a short sale until there was a higher bid in the stock. Many in the market have asked the SEC to reinstitute that rule, saying its absence has contributed to volatility in the market. One option could be a “circuit breaker” that would freeze short trading if a stock drops more than a certain percent in one day.

http://online.wsj.com/article/SB121690757837680971.html

Currently the SEC is the primary supervisor of the country’s four largest investment banks — Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz), Lehman Brothers (LEH.N: Quote, Profile, Research, Stock Buzz), Merrill Lynch (MER.N: Quote, Profile, Research, Stock Buzz) and Morgan Stanley (MS.N: Quote, Profile, Research, Stock Buzz). But that supervision is voluntary and Cox has been urging Congress to give it or another agency legal authority to oversee the banks.

“I believe Congress and regulators must recognize that different regulatory structures are needed for oversight of these industries,” Cox said in prepared remarks to be delivered to a Congressional panel.

“Put simply, regulatory reform should not and need not, amount to the elimination of the investment banking business model.

Urgent regulatory reform has been underway since the Federal Reserve rescued Bear Stearns in March and opened its discount window to other investment banks out of concern that a failure could tear apart the weakened financial system.

Earlier in July, the SEC and the Fed formalized an agreement to share information about the investment banks and commercial banks, which are overseen by a number of federal regulators including the Fed.

The agreement was something of a stop-gap measure to tide authorities over until new regulations can be debated and passed by Congress.

Cox, outlined for the first time how the securities firms should be regulated and said the SEC should be given the authority to set standards for capital, liquidity, risk management, internal controls, record keeping and reporting.

Cox told Congress that it should also give the agency the authority to “apply progressively more significant restrictions on operations if capital or liquidity adequacy fails, including requiring divestiture of lines of business.”

The SEC should also be given the authority to enforce the rules and share information with other regulators, he said.

Emergency action by the Fed in March to stem a financial market panic over U.S. subprime mortgage losses marked the first time since the Great Depression that the U.S. central bank had risked taxpayers’ money by allowing investment banks access to its lender-of-last resort liquidity facilities.

Since then, Fed officials have argued that they need more oversight of investment banks if they going to be obliged by circumstances to lend them money again in the future.

Testifying at a House Financial Services Committee hearing to examine the future of financial regulation, Cox said the SEC should be given the authority to act if investment banks fail.

“No one today has sufficient authority to take effective action if a major financial enterprise experiences rapid financial deterioration,” he said.

Cox warned against imposing the existing commercial bank regulatory regime on investment banks as their business, accounting and regulatory framework are different.

“It is conceivable that Congress could create a framework for investment banking that would intentionally discourage risk taking, reduce leverage, and restrict lines of business,” Cox said.

“But this would fundamentally alter the role that investment banks play in the capital formation that has fueled economic growth and innovation domestically and abroad,” he said.

http://www.reuters.com/article/marketsNews/idINN2437839320080724?rpc=44&sp=true

Now, I’ve never been a great fan of the financial guarantee insurers, or the rating agencies. Consider my post dealing with then over at RealMoney, Snarls in Insurance Investigation, Part 2. In it, three-plus years ago, I suggested that Eliot Spitzer should investigate the relations between the rating agencies and the financial guarantors.

Now the City of Los Angeles is bringing a suit against the financial guarantors for forcing them to buy unnecessary municipal bond insurance. Oh, please. Did the armies of MBIA and Ambac surround LA City Hall, threatening violence if you didn’t give in to their protection racket? This suit almost makes the failed efforts of regulators to split the guarantors into separate municipal and non-municipal insurers seem intelligent.

First, the real value of the municipal bond insurance was not for credit enhancement. Municipal bonds rarely default, and when they do, they often become current again. It was liquidity insurance. Now, for a city like Los Angeles, maybe that’s not needed, but most municipalities are small issuers, and there is not enough manpower at bond managers to analyze them all. The rating agencies fill part of the gap with their ratings. For most municpalities, they are the only analytical coverage at all.

Now, the municipalities had the choice of issuing insured or uninsured bonds. Insured bonds could be sold at AAA rates, and bond managers would buy them more easily because they were more liquid. The question to an issuer boiled down to which is cheaper? Pay AAA rates plus the guarantee fees and have an easy sale, or, pay at the rates that managers demand for lower-rated municipal bond? For many munipalities they chose an insured sale because it was cheaper, or not much more expensive.

Any yield premium paid could possibly be attributed to their investment bankers, who did not want the extra work of having to actually sell the bonds. With the AAA, they would fly out the door with no questions. A lower-rated bond would cause some bond managers to sit on their hands; even though they could look at the rating from the agencies, they would not trust the rating without further analysis, and that takes time and effort. (I know from my time as a bond manager, you can’t push your credit staff too hard, or they start making mistakes, because they can’t do quality work.)

The municipalities had another choice as well. They could have borrowed less money, and raised more taxes, bringning their credit profiles up to AAA. I know, the rating agencies should have rated municipalities higher, but that’s not who they are suing. (That said, credit ratings are only moderately related to the yield spreads paid.)

A suit like this would have a better chance if it alleged implicit collusion between the rating agencies and the financial guarantors, and sued them both. I still don’t think the City of Los Angeles would win such a suit, but the real flaw was not the insurers, but the ratings, including the ratings the financial guarantors themselves, which in my opinion, were always somewhat liberal. (Hint: with financials, don’t just look at the rating, but look at the implied rating from the spreads on their debt. The rating agencies holding company debt always traded at wider yields than their stated ratings would imply.)

Now, with the added fun in the space since Moody’s moved Assured Guaranty and FSA to negative watch, something I did not expect, this leaves Berky as the last man standing in the space. But one seller does not a market make. What this means, if Moody’s follows through, and S&P follows suit, is that muni bond insurance is likely dead for some time. Who loses? Small municipalities primarily. They will face higher debt issuance costs. Even large issuers have found the new issue market less than inviting recently.

In closing, could this come at a worse time for municipalities? Revenue bases are eroding even as demands for services rise. (Housing price will be a drag here for a few more years.) They can’t print money or issue debt at whim to solve the problem, so they have to make painful cuts. I will add this, even more painful cuts will come over the next 10-20 years as the pensions/ retiree healthcare crisis descends on the municipalities. Not a fun time for anyone… and I’m sure there will be more lawsuits over the whole shebang, most of them bogus.

http://alephblog.com/2008/07/24/you-can-sue-but-you-wont-win/

By William Selway

July 24 (Bloomberg) — MBIA Inc., Ambac Financial Group Inc. and four other bond insurers were sued by Los Angeles for allegedly conspiring to maintain a credit-rating system that led local governments to buy “unnecessary” policies on their bonds.

City Attorney Rocky Delgadillo filed the lawsuit yesterday in Los Angeles Superior Court. The second-most populous U.S. city after New York says it is seeking to recover damages it endured by paying “millions” for guarantees that turned worthless when the insurers lost their top credit ratings.

Borrowers in the $2.66 trillion U.S. municipal market have for decades paid insurance companies to guarantee their bonds, seeking to lower their borrowing costs by paying AAA rated companies to stand behind the securities. That practice has drawn fire this year from public officials who say it exaggerates the risk that municipal bonds will default, forcing states, cities and schools to buy backing they don’t need.

“This dual credit rating scheme is maintained by bond insurers to take advantage of the taxpayers, by compelling cities to purchase unnecessary bond insurance,” Delgadillo said in a statement.

Hundreds of state and local governments were stung by higher borrowing costs this year after bond insurers, including Armonk, New York-based MBIA and Ambac, were stripped of their top credit ratings because of losses on securities linked to U.S. home loans. Officials including California Treasurer Bill Lockyer have said that insurance wouldn’t be necessary if state and local bonds were assessed using the same criteria as corporate debt.

MBIA spokesman Willard Hill didn’t immediately return a phone call seeking comment. Ambac spokeswoman Vandana Sharma said the New York-based company doesn’t comment on lawsuits filed against it.

Second Suit

The lawsuit is at least the second to be filed against a bond guarantor since cuts to the companies’ credit-ratings roiled the municipal bond market. In Massachusetts earlier this month, an affiliate of the New England Patriots football team sued the bond insurance unit of Ambac after rates on its bonds jumped as high as 20 percent.

“California cities and public entities should not have had to buy bond insurance that is now worthless in many respects due to the failing financial conditions of the bond insurance companies,” the city said in the complaint.

The Los Angeles lawsuit doesn’t name Moody’s Investors Service, Standard & Poor’s, or Fitch Ratings. The other insurers named in the suit are XL Capital Assurance Inc., ACA Financial Guaranty Corp., Financial Guaranty Insurance Co., and CIFG Assurance North America Inc.

Not Disclosed

XL Capital Assurance spokesman Frank Constantinople, ACA spokesman Alan Roseman, Financial Guaranty spokesman Brian Moore, and Michael Ballinger, a spokesman for CIFG, didn’t return phone calls after business hours yesterday seeking comment.

Los Angeles and other municipal borrowers were never told about bond insurers’ exposure to complex financial instruments linked to home loans that undermined the guarantees they purchased, the city said in its suit.

Nanci Nishimura, an attorney with Cotchett, Pitre & McCarthy who is working on the lawsuit, said the firm is pursuing similar complaints by other California cities that were hit with higher costs brought on by ailing bond insurers.

“Public entities across the state have been hurt by this and we will be filing more,” Nishimura said.

Lower Rates

Local governments relied on the insurance companies’ guarantees when they sold floating-rate bonds whose interest rates are reset as frequently as daily, when investors such as money market funds have the opportunity to buy or sell the bonds. By effectively renting the insurer’s higher rating, borrowers such as hospitals and cities were able to borrow for long-term projects at short-term rates.

Investors fled the bonds earlier this year when the insurers’ credit ratings came under scrutiny. That slapped borrowers with soaring interest rates, forced them to refinance their debts and in some cases pay large fees to break interest- rate swap agreements tied to the securities.

Were the credit rating companies to evaluate state and local governments based on the likelihood of default, taxpayers wouldn’t have needed insurance, critics including Lockyer say.

Delgadillo, the city attorney, said that the bond insurance industry “colluded to maintain a discriminatory dual credit rating system” that costs taxpayers through “exorbitant premiums.”

“Bond insurers’ cynical use of this discriminatory credit rating system and inexcusable failure to disclose their high- risk investments in the subprime market also violates California’s antitrust laws and common law,” Delgadillo said.

Moody’s Changes

Moody’s last month said it will change the way it rates municipal bonds and rank them on the same scale it uses for corporate and sovereign debt. Fitch said it is studying whether to blend corporate and municipal ratings. S&P said it has already made a transition to one rating scale for all debt, and it has upgraded more than 5,300 municipal bonds since 2000.

Los Angeles, in a separate action yesterday, also sued more than 30 Wall Street banks, advisers, and other companies, seeking to recover any money it lost as a result of a conspiracy to rig the bidding on derivatives tied to municipal bonds. That suit follows similar actions by local governments including Fairfax County, Virginia.

http://www.bloomberg.com/apps/news?pid=20601103&sid=ayZ3CpUBOHeQ&refer=news

DOW JONES NEWSWIRES
July 24, 2008 9:07 a.m.

By Judith Burns
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)–The Federal Reserve needs to have a direct role in supervising banks that have access to its funding, New York Federal Reserve Bank President Timothy Geithner said in testimony prepared for delivery Thursday to the House Financial Services Committee.

Geithner said the Fed’s ability to directly oversee the risk profile of these institutions is essential to making judgments about acting as a lender of last resort.

“Those judgments require the knowledge that can only come from a direct, established role in supervision,” Geithner said in his prepared remarks. He warned against removing the Fed from supervising banks while leaving it on the hook as a stand-by lender in a crisis, saying that could increase uncertainty and encourage excessive risk-taking.

Geithner called for the Fed to have clear authority over “systemically important payment and settlement systems” and a hand in the over-the-counter derivatives markets. He also wants a way to provide “orderly unwinding” of regulated financial firms, similar to the process used to shutter failed commercial banks.

Better shock absorbers are needed so that individual firms are less vulnerable to pullbacks in funding and the overall system is better able to withstand fallout from the failure of a major financial institution, Geithner advised.

Looking ahead, he predicted the Fed itself will have to change and adopt a more comprehensive approach to financial supervision and market oversight. He said it will have to look beyond the stability of individual banks and instead focus on broad market developments, infrastructure that is critical to market functioning, and the role played by financial firms.

Geithner’s testimony didn’t address whether the Fed’s discount window loans, previously limited to commercial banks, should be made permanently available to investment banks that got temporary access after the collapse of Bear Stearns Cos., now part of JPMorganChase & Co. (JPM). His remarks didn’t tackle lending to federally sponsored housing-finance giants Fannie Mae (FNM) and Freddie Mac (FRE), either.

The Fed oversees commercial banks while the Securities and Exchange Commission regulates brokerage firms and has a voluntary program to oversee investment bank holding companies. Since Bear’s collapse, Geithner said the SEC and Fed have worked closely to bolster oversight of Wall Street firms, and he said the firms have made strides in reducing overall leverage and liquidity risk. For its part, the Fed has pushed for creation of a central clearing house for credit default swaps and other improvements, and Geithner said he expects to see “substantial progress over the next two quarters.”

U.S. and global markets “are going through a very challenging period of adjustment,” Geithner acknowledged. “The forces that made the system vulnerable to this crisis took a long time to build up and the system will need some time to work through their aftermath.”

Geithner blamed the crisis in part on financial innovations that outpaced the system’s capacity to measure and limit risks, as well as inadequate disclosure and “incentive problems” in mortgage-backed securities.

A U.S. regulatory system put in place decades ago and designed around commercial banks also couldn’t keep pace with financial shocks that threatened to ripple through the broader economy, Geithner stated.

While the current crisis strengthens the case for regulatory reform, Geithner said until it passes, it will be hard to know what changes will be needed. Getting the right balance between innovation and stability will be another challenge, he added.

-By Judith Burns, Dow Jones Newswires; 202-862-6692; Judith.Burns@dowjones.com

http://online.wsj.com/article/BT-CO-20080724-710136.html

DOW JONES NEWSWIRES
July 23, 2008 5:36 p.m.

By Judith Burns
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)–Wall Street got drunk, and now Congress is dealing with the hangover.

The House Financial Services Committee will hold a hearing Thursday on financial oversight of Wall Street, its second this month, with testimony from New York Federal Reserve Bank President Timothy Geithner and Securities and Exchange Commission Chairman Christopher Cox.

Lawmakers are examining recommendations to revamp U.S. financial regulation, contained in a blueprint issued this spring by U.S. Treasury Secretary Henry Paulson. Issues raised by the collapse of Bear Stearns Cos., now part of JPMorganChase & Co. (JPM) are on the agenda as well, including the Fed’s decision to lend to investment banks, something it previously reserved for commercial banks.

Investment banks got temporary access to Fed discount-window borrowing amid fears that their losses on mortgage-backed securities might close off private capital raising. President George W. Bush recently explained the banks’ frenzy for such securities by saying: “Wall Street got drunk.”

“It’s just crying out for Congress to do something,” said Robert Litan, a senior fellow in the economic studies program at Brookings Institution, a Washington, D.C., think tank. “If they don’t act, the agencies will.”

Litan figures that having opened the discount window to investment banks has set a precedent that will change how Wall Street is regulated in the future.

“I think the genie is out of the bottle, and they can’t go back,” he stated.

What the regulatory landscape will look like in the future is an open question. Litan thinks “all ideas should be on the table,” including a regulatory joint venture between the SEC, which oversees markets and brokerage firms, and the Fed, which oversees financial stability and commercial bank holding companies.

Investment bank holding companies have no designated regulator, although a handful, including Bear Stearns, had voluntarily agreed to oversight by the SEC. After Bear’s demise, Cox said Congress should plug that regulatory hole and designate a regulator for the firms. He didn’t call for the SEC be given the job.

Federal Reserve Board Chairman Ben Bernanke, testifying to the House Financial Services Committee two weeks ago, said the Fed and SEC have a written agreement on cooperation and are coordinating closely on oversight of Wall Street banks in the wake of the Bear Stearns collapse.

Longer term, Bernanke said legislation may be needed to give a regulator the ability to set requirements for capital, liquidity and risk management at investment bank holding companies. Bernanke didn’t specify whether the Fed should be given that task, however.

Some are calling for the Fed to step into the breach.

“Any institution with access to the discount window should have appropriate oversight,” said Irving Daniels, vice president for banking and securities at the Financial Services Roundtable, in Washington, D.C. “We support the Fed having that authority.”

The roundtable, whose members include insurance firms, banks and other diversified financial companies, has written legislation to do just that. The “Systemic Risk Reduction Act of 2008″ would give the Fed authority to supervise brokerages that borrow from the discount window, increase coordination among bank and securities regulators and promote “prudential supervision” to spot and resolve potential risks before they spin out of control.

Daniels said those kinds of changes might not have prevented Bear from collapse, but “it certainly would have lessened the impact.”

Although the trade group’s proposal hasn’t been introduced in Congress, Daniels said it is getting a favorable reaction, including Rep. Paul Kanjorski, D-Pa., who chairs the securities subcommittee of the House Financial Services Committee. Daniels added that the proposal “is ready to go” if lawmakers want to put regulatory reform on the fast track.

Rapid action probably isn’t in the cards, and overhauling financial-market regulation is apt to be “a two to three-year project, at least,” Litan predicted. However, he thinks it’s not too soon for Congress to dig in and work through complications, including possible turf battles between the Fed and SEC.

“The eight-hundred-pound gorilla’s obviously the Fed,” said Litan. “Whoever has the money calls the shots, and the Fed’s got the money.”

Not having the Fed’s purse is one strike against the SEC, but Litan sees another, saying it also lacks the Fed’s larger staff and resources. Still, he doesn’t think free-wheeling investment banks can be regulated in the same way as commercial banks, suggesting “a light regulatory touch” may be warranted.

Giving the Fed responsibility for oversight of Wall Street is a bad idea, according to Damon Silvers, associate general counsel at the AFL-CIO, in Washington, D.C.

“The Fed is a very poor regulator of the kind of activity that investment banks do,” said Silvers. He recommends closing the discount window to investment banks, on grounds that “socialized risks and privatized profits do not work.”

If investment banks remain free to borrow from the Fed, Silvers said, “the people who hold the checkbook have got to have some say,” including on setting stricter capital standards for Wall Street firms.

http://online.wsj.com/article/BT-CO-20080723-718275.html

The news comes just days after CME Group said it would expand clearing services to OTC interest-rate swaps and Markit and the Depository Trust and Clearing Corporation (DTCC) said they would form a joint venture for processing and confirming OTC derivatives.

Eurex says its new initiative - which is expected to launch in early 2009 - aims to “complement current US initiatives with a European solution”.

The European OTC CCP platform will utilise existing Eurex Clearing functionality, as well as new tools for trade and risk management. The system will initially focus on iTraxx index exposures that are mainly traded out of Europe. Eurex says an extension to other asset classes - such as equity, fixed income - can be “handled flexibly” according to market demand.

The exchange says it is in discussions with several infrastructure providers concerning their involvement in a new platform. Names have not been disclosed but one of the providers is rumoured to be the DTCC.

Eurex says the new service is “designed to address recent developments in the OTC market which suggest that concerns about systemic risk due to the backlog of transaction confirmation and potential counterparty defaults require improvements in the market’s infrastructure”.

Thomas Book, responsible for clearing on the Eurex executive board, says customers would profit from straight-through processing, enhanced collateral management and multilateral netting for OTC trades which currently account for 84% of all derivatives traded.

Earlier this month Nyse Euronext subsidiary Liffe previewed plans to launch a new set of contracts based on the iTraxx European indexes with integrated OTC clearing through its Bclear operation.

Meanwhile in May the US Clearing Corporation (CCorp) said it had agreed a deal with the DTCC that will result in the launch of a central clearing facility for over-the-counter (OTC) credit derivatives in the third quarter.

http://www.finextra.com/fullstory.asp?id=18763

Commentary by Jonathan Weil

July 23 (Bloomberg) — Forget naked short sellers. The fellow who isn’t wearing any clothes is Securities and Exchange Commission Chairman Christopher Cox.

The emergency order the SEC issued last week, to protect the nation’s financial system from so-called naked shorts, is so full of mixed messages and contradictory twists that the agency’s plan makes no sense. It does, however, deflect public attention from the government’s own failures in the subprime-mortgage debacle.

The SEC says its order is aimed at restoring market confidence by making it harder to bet against the stocks of Fannie Mae, Freddie Mac and 17 other “substantial financial firms,” including Wall Street’s largest investment banks. Look at how the plan works, though, and the SEC is signaling that the same banks’ judgments can’t be trusted. This isn’t exactly a confidence builder.

In a short sale, an investor borrows shares and sells them, hoping to buy them back later at a lower price and pocket the difference. In naked short sales, which sometimes are legal and sometimes aren’t, the investor sells short without having borrowed the securities to make delivery. There is no evidence to date that naked short sales were responsible for declines in any of the 19 protected companies’ stocks.

The SEC’s rules on short sales, adopted in 2004, generally prohibit broker-dealers from executing short-sale orders for customers or for their own accounts, unless they meet certain conditions. A broker must have “borrowed the security, or entered into an arrangement to borrow” it, or the broker must have “reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due.”

Be Reasonable

Whether a broker has reasonable grounds to believe such things is, partly, a judgment call. And by writing this leeway into the rules, the SEC indicated it could rely on securities dealers to exercise such judgment responsibly. That has changed.

The SEC’s emergency order, which took effect July 21 and might stay in place as long as 30 days, eliminated the “reasonable grounds” element. Now, generally speaking, when a customer wants to short one of the 19 protected companies, the stock must be in the vault already or on its way there.

Some of the dealers that lost their right to exercise such discretion are the same banks on the SEC’s emergency list. So while they are deemed worthy of the commission’s protection, the SEC’s order makes them seem unworthy of the agency’s trust, at least for the time being.

Subprime Losers

In addition to Fannie and Freddie, the protected banks include major subprime losers such as Citigroup Inc., Merrill Lynch & Co., Lehman Brothers Holdings Inc. and UBS AG. The agency might as well have issued its list under the headline: “Beware! These are the financial firms we’re worried about.”

Even so, the American Bankers Association and the Financial Services Roundtable last week sent letters to the SEC, asking it to broaden its list to include other banks. The roundtable said the SEC should cover all financial-services stocks.

They have a point: If the SEC’s order was such a good idea, everyone should be allowed in on the racket. Still, if I were in charge at Goldman Sachs Group Inc. or JPMorgan Chase & Co., which are on the emergency list notwithstanding their strength, I would be upset at the SEC for including my bank with all the others.

Other logical inconsistencies abound. On July 18, to avoid hurting liquidity, the SEC amended its order to say the “borrow and arrangement-to-borrow requirement of the order does not apply to certain bona fide market makers.”

I’m OK, You’re Not

For instance, let’s say a market maker at one of the protected banks wants to short another protected bank without arranging to borrow the stock first. That’s fine. However, it’s not OK for an ordinary investor to do the same.

What we have is a preemptive strike against an enemy that, by the SEC’s own account, hasn’t yet presented a serious threat. At least when the U.S. invaded Iraq, President George W. Bush seemed to believe Saddam Hussein had weapons of mass destruction.

Cox last week said the SEC’s order “is not a response to unbridled naked short selling in financial issues.” So far, he said, “that has not occurred.” Yet he made it look like investors should fear naked shorts anyway.

“Who profits from intentionally false information in the marketplace? Those who are in on the scam and positioned to benefit from the predictable response of others who believe the fraudulent information to be true,” Cox wrote in a July 18 op-ed for Investor’s Business Daily, under the headline “Naked Short Selling Is One Problem a Slumping Market Shouldn’t Have.”

Creating Bogeymen

“The classic `pump and dump’ scheme, in which a stock is inflated through false information and then dumped on unsuspecting investors when the perpetrators flee, is one example of how this works,” he wrote. “`Distort and short’ is the same thing in reverse. Naked short selling can turbocharge these `distort and short’ schemes.”

In other words: Boo! The SEC has presented no facts suggesting that anything like this has happened at these 19 companies, or at any other major financial firm. Meanwhile, the SEC is spreading unsubstantiated rumors that gangs of undressed, short-selling bogeymen might conspire to hurt the investing public, if left unchecked.

This isn’t inspiring confidence. It’s fear-mongering.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aOTrpoxJipZA