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An Open Letter to Henry Paulson

13 Oct 2008 12:15TraderF

Dear Mr Paulson

 

A Solution to the Credit Crunch

 

The critical problem to be solved is how to get credit markets liquid again and to restore confidence between banks.  The Interbank credit market is traded in London and is based on the “London Interbank Offer Rate” LIBOR interest rate for each currency.

 

The first step in the solution is to convert the LIBOR market from an Interbank market into an Exchange based market.  Exchanges have a proven track record of functional trading.  An Exchange provides clears benefits.  Firstly it creates two levels of regulation.  The Government can regulate the Exchange and the Exchange can regulate its members.  It is this membership structure that ensures members meet strict financial standards, hereby giving certainty to all participants in the marketplace.  An exchange half owned by the NYSE and the LSE would give the market confidence on both sides of the Atlantic.

 

The second part of the solution is to revalue and cash margin all financial products that have a settlement greater than two days in the future (including continuously rolling contracts).  Funds must be paid to a Clearinghouse that is Government regulated.  This has the affect of bringing all financial transactions to be “On Balance Sheet” because the payment of such margin payments will use up the institutions capital. 

 

The “Credit Crunch” grew from the combination of excessive leverage in hard to value assets coupled with effective hiding the problem by the banks placing the risks in off balance sheet structures.  The move to a transparent exchange based model will give us a time proven solution with the correct balance of regulation and market forces.

 

The solution:  Get rid of the opaque Interbank market and its evil twin the “Off Balance Sheet” exposure by moving to force banks to deal only on exchanges.

 

Well Hank, good luck, we are all relying on you!

 

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