Derivatives “Stays” – The Next Step in Corralling Investor Funds

We previously discussed the debate over the introduction of new rules that would allow money market funds to stop withdrawals – see “Redemption Gates for Money Market Funds” for details. This debate followed on the heels of similar proposals being made for bond funds. These regulations aim to “forestall panics” by preventing investors from withdrawing their funds from wobbly looking entities in the event of another financial crisis.

We personally believe that there can hardly be a better argument for holding physical gold outside of the system, but apart from that such rules are obviously weakening property rights.


Now another set of similar regulation is about to be introduced, in this case concerning derivatives:


“The $700 trillion financial derivatives industry has agreed to a fundamental rule change from January to help regulators to wind down failed banks without destabilizing markets. The International Swaps and Derivatives Association (ISDA) and 18 major banks that dominate the market will now allow financial watchdogs to apply temporary stays to prevent a rush to close derivatives contracts if a bank runs into trouble, the ISDA said on Saturday.

A delay would give regulators time to ensure that critical parts of a bank, such as customer accounts, continue smoothly while the rest is wound down or sold off in an orderly way.

That would help to avoid the type of market chaos sparked by the collapse of Lehman Brothers in 2008 and also end the problem of banks being considered too big to fail.

The Financial Stability Board (FSB), a regulatory task force for the Group of 20 economies (G20), had asked the ISDA to make the changes with the aim of ending the too-big-to-fail scenario in which banks are propped up with taxpayer money to avoid market disruption.

Under the new contract terms, default clauses in derivatives contracts such as interest rate or credit default swaps would be suspended for a maximum of 48 hours.”


(emphasis added)

A few comments on this: we can see why banks would agree to this, although we are not quite sure how a “maximum 48 hour suspension” could possibly alter the “too big to fail” problem or in fact achieve anything whatsoever (such as stopping a budding panic). This makes us think that this is a typical “getting the foot in the door” ploy. Let us say that 48 hours – predictably – turn out not to be enough, what then? Will we then simply panic a bit later than normally? It seems more likely that such “stays” will be lengthened under cover of an emergency.

It also turns out that some of the customers who are allegedly to be “protected” by these measures are none too happy about the idea:


“Mandatory rules will also mean that another big user of derivatives, the asset management industry, will have little choice but to accept stays.

Asset managers have resisted so far, arguing that they have a legal duty to their clients not to delay getting their money back from a failed bank and that agreeing to stays voluntarily could leave them open to lawsuits.”


(emphasis added)

We may assume that the clients whose lawsuits asset managers are worried about are not happy either, even though their views have apparently not been canvassed.

The real problem is of course that the modern monetary system has given birth to the greatest credit bubble of all time. If not for this rather glaring fact, there would be no attempts to forestall the “next crisis” by making the corralling of investor funds on the say-so of bureaucrats possible.


debt and GDPThe debtberg vs. real economic output in the US. In a number of countries these data look even more extreme. The vast mountain of derivatives is to a large extent merely a side effect of this credit bubble. Via Saint Louis Federal reserve Research, click to enlarge.



We strongly doubt that the system can really be made safer by such measures, as its problems are of a far more fundamental nature. They definitely abridge the rights of investors though.


Castle-Drawbridge1Medieval drawbridge.

(Photo via, author unknown)




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