In exchange . . .

By Megan McArdle

One of the smarter ideas I've heard for trying to prevent this sort of thing net time around is putting derivatives on exchanges.  Most derivatives are traded over the counter, in part because US bankruptcy law encourages it:  as I understand it, derivative counterparties don't have to get in line with the others, but can seize any collateral they can get their hands on.

Exchange trading enhances transparency, by making it clear what's out there and roughly who owns it.  It also moves the clearing risk to the exchange; while exchanges do fail, they do so much less often than financial firms, and if intervention is needed, they provide a centralized locus for any private or public action.

Apparently the Chicago Mercantile Exchange is looking at setting up a major derivatives exchange.  For those who are convinced that "more regulation", rather than "different regulation" is the answer, strongly encouraging trading on these exchanges would be a good place for the government to start.

This article available online at:

http://www.theatlantic.com/business/archive/2008/10/in-exchange/4226/