Finally, we have the fact that New York Fed jumped on the CDS market after the Bear Stearns bailout – and didn’t allow Lehman to fail until after “centralized settlement among major dealers” for credit derivatives was implemented. Previous industry commitments with respect to credit derivatives were focused on back office infrastructure issues and had a leisurely timeframe.
The point of a clearinghouse is not to prevent bad banks from facing a credit-crunch. Obviously from an efficient markets point of view the sooner that happens, the better. The point is that clearinghouse should help prevent the credit crunch/failure of a bad bank from taking down other banks that could potentially be made insolvent by excessive exposure to the bad bank — and thus to prevent the bad bank from setting off the chain of failures that defines a systemic crisis. Of course, if the banks are willing to rely on collateral and choose not to limit credit to bad banks, then we’re in big trouble in either system.