Clearinghouses and the Rapid Resolution of Bankrupt Financial Firms

Abstract:     
This Article argues that the principal economic benefit of a financial clearinghouse is faster payouts to creditors when a trading firm fails. By expanding setoff opportunities, a clearinghouse provides immediate payouts to creditors who otherwise would have to wait for slower bankruptcy payouts. Quicker payouts reduce illiquidity and uncertainty, two sources of systemic risk. Through setoffs, a clearinghouse can reduce illiquidity and uncertainty even if the clearinghouse is itself insolvent. Unlike the benefits of clearinghouses asserted by other scholars, faster payouts are not zero-sum in their impact on creditors: besides accelerating payouts to members, a clearinghouse eases the administrative burden on the failed member’s bankruptcy trustee or receiver, permitting quicker payouts to non-clearinghouse creditors as well. By identifying faster payouts as the main systemic benefit of clearinghouses, this Article shows that there is a high degree of complementarity between the Dodd-Frank Act’s clearing mandate, which requires central clearing of swap contracts, and the statute’s “orderly liquidation authority” for large financial firms. The clearing mandate will reduce the need for the liquidation authority to be invoked, and when the authority is invoked the mandate will simplify the FDIC’s duties as receiver.
 

Number of Pages in PDF File: 51

Keywords: clearinghouse, bankruptcy, systemic risk, liquidity, orderly liquidation authority, asset partitioning, netting, setoff, Dodd-Frank

JEL Classification: G21, G28, G33, G38, K20

Accepted Paper Series