University of Houston Finance Professor Craig Pirrong analyzed volatility in the U.S. overnight funding markets in mid-September. He blamed "post-crisis regulatory 'reforms' [which] have made the funding markets more rigid/less-flexible and supple."

In his Streetwise Professor blog post, Mr. Pirrong stated that clearing mandates exacerbated the mid-September market liquidity event by causing the markets to become "more tightly coupled," which made them "more vulnerable to operational failings." In such an environment, he warned, "even modest increases in funding needs can have huge impacts on funding costs." Furthermore, these regulatory changes increase the need for margin calls "at the worst time," causing markets to go "non-linear," and creating a liquidity crisis, which he explained represents "a far graver system concern than counterparty risk" that such reforms were intended to mitigate.

Calling the market events of mid-September "a serious wake-up call," Mr. Pirrong said:

The funding markets going non-linear is the biggest systemic risk. By far. And to the extent that regulatory changes–such as mandated clearing–have increased the potential for demand surges in those markets, and have reduced the ability of those markets to respond to those surges, in their attempt to reduce systemic risks, they have increased them.

Mr. Pirrong warned that these events represent "a case in point" in support of his view that the cause of the next financial crisis will be "the regulations intended to prevent a recurrence of the last one."


Bob Zwirb

It's not just academics like Professor Pirrong who are concerned about 1) the possibility of mandated clearing making a financial network more vulnerable to precipitous failure and 2) margin calls during a downturn exacerbating a liquidity crisis. Take, for example, former Fed Chairman Ben Bernanke, who noted that clearinghouses' margin calls during the 1987 stock market crash "were widely criticized in postmortems for 'draining liquidity from the system,'" and that when called upon to provide such funds, banks initially were reluctant to comply. Ben S. Bernanke, Clearing and Settlement During the Crash, 3 Rev. Fin. Stud. 133, 147 (1990).

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