Companies going belly-up is a normal and entirely acceptable feature of a capitalist economy. A clearing system that cannot withstand a company going belly-up does not work, any more than a Swedish railway that ceases to run when it starts snowing.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
The state is the ultimate solvent, neutral third party (you forgot that the third party in question has to be solvent too... that's the problem with AIG, not that they are not trusted to be neutral).
If the state is not a solvent, neutral third party, then you have bigger problems than the fate of your monetary system.
Let's not lose sight of these distinctions in the process of remote transactions. As with power generation, brokerage, and distribution, many different entities may and do own or operate parts of (i, ii) while a state may hold exclusive right enforce (ii).
Lehman's problem, AIG's problem isn't clearing system failure. It was margin calls by its creditors that neither company was able to resolve -- pay. If Lehman or AIG had sufficient funding, they would have wired the money. No one has reported that Lehman or AIG tried to pay their creditors and beneficiaries but could not because clearing system apparatus or clearing checks failed. Diversity is the key to economic and political evolution.
So trust in the counterparties matters as much as trust in the pipes. So why create a system where you need to worry about both, when you can a system where you only need to worry about the pipes? In the long run, we're all dead. John Maynard Keynes
I offered it, because it seemed to me, reading the convo, that vlad and Jake were at cross purposes about characteristics and structure of this particular "system" of verification.
Some specificity about clearing operations apart from clearing system clients' counterparty expectations, or trust, being disputed would help to illustrate, for me at any rate, under what conditions either vlad or Jake believe verification likely fails.
trust in the counterparties matters as much as trust in the pipes.
Oh, I agree. If a loan officer of one bank mistrusts the willingness or ability of another bank's loan officer to fulfill an obligation, failure to verify a trust is the foregone conclusion to the question, Does the formal clearing system function (as designed or intended)?
A margin call is, among financiers trading on earnest money a/k/a reserve req, the quintessential declaration of mistrust. That's why I mentioned it. Diversity is the key to economic and political evolution.
A margin call is, among financiers trading on earnest money a/k/a reserve req, the quintessential declaration of mistrust. That's why I mentioned it.
The reason mistrust among banks makes the clearing system break down is because if I want to pay you, you have to accept my promise that my bank will pay your bank the amount we agree: my payment to you is cleared by our respective banks. When banks don't trust each other and you know it, you can't take my word for the fact that the transaction will clear.
Which is why both of us are better off having our current accounts at the same institution - QED on the "natural monopoly" nature of clearing.
There were two solutions to the banking panic of ca. 1930: to introduce deposit insurance or to nationalise the deposit-taking and payment clearing part of banking. The brainless should not be in banking. — Willem Buitler
Um, a margin call is normally a contractual obligation. Exercising an option to call a loan is a declaration of mistrust.
I don't understand the distinction offered between credit instruments. Pls elaborate.
The reason mistrust among banks makes the clearing system break down is because if I want to pay you, you have to accept my promise that my bank will pay your bank the amount we agree: my payment to you is cleared by our respective banks.
A non sequitur.
"My payment to you is cleared by our respective banks" Yes, the clearing system to which both banks subscribe allows both banks to verify the payment amount is available for transfer. Otherwise your bank will NOT ordinarily transfer funds to the payee. It cannot, for there are insufficient funds to transfer. (A bank may however extend credit to an account holder to honor presentment in the event the account is insufficiently funded.) The clearing operations function as designed and intended --whether or not "my promise" to the payee is true or false.
"My promise" is not the same (contractual) obligation as that of the bank to honor a draft on another bank's (deposit or credit) account. What stands to reason though, with respect to the so-called liquidity freeze of 2008Q4, is the frequency of overdrafts and fails (distrust), verified by testing the "clearing system," proved for bank officers the high probability (mistrust) their counterparties could not pay the full, known and unknown, amounts outstanding. So bankers suspended further demands for payment and demand for credit.
Until such time treasuries started distributing the dough to honor their "promises." Diversity is the key to economic and political evolution.
There is evidence of mistrust only when discretion is exercised. The brainless should not be in banking. — Willem Buitler
Let's examine a generic definition of the credit instrument provided by securities brokers to prospective buyers. Various terms of the agreement proferred --including but not limited to closing share price, buyer's reserve requirement (unobligated capital requirement), minimum margin requirement, and timely payment of service fees-- constitute a contract, an agreement, between them.
Buying on margin involves taking out a partial loan from one's broker in order to cover a larger investment than one's capital could directly cover. A margin call most often occurs when the amount of actual capital the investor has drops below a set percent of the total investment. A margin call may also be triggered if the broker changes their minimum margin requirement --- the absolute minimum percentage of the total investment that one must have in direct equity*.
Note that effective demand for payment (to seller, to broker, to reserve account) rests exclusively at the discretion of the creditor/broker. Uncertainty (mistrust) about valuations, the buyer's liquidity or portfolio exposure informs the creditor's decision to alter terms of margin agreements outstanding. Timing/schedule of such emendments however may or may not be stipulated in a contract. I don't know, but I would imagine such limitation is a marketing feature that differentiates brokerages' range of services as well as individual client risk profiles.
---- *I suppose, sales-speak for dividend bearing securities. <urp. ahh> See investopedia.com Diversity is the key to economic and political evolution.
