This is the Cato Daily Podcast for Tuesday, October 21st, 2008.

I'm Caleb Brown.

Much of the contagion associated with the trading of Icky mortgage assets may have been prevented with a clearing-iky mortgage assets may have been prevented with a clearinghouse, an often

for-profit firm that can help everyone in a market avoid certain risks.

Though such a clearinghouse was approved in late 2000 by Congress and nominally supported

by industry, it was never operational.

Did it pose a prisoner's dilemma for actors in the trading of those assets? Were the events of recent weeks really necessary to convince an industry that maybe a

clearinghouse was a good idea?

Craig Perong, a professor of finance at the University of Houston Houston is author of the new article in

Regulation magazine clearing up misconceptions on clearing. We spoke yesterday.

Well a clearinghouse is a way of sharing the default risk on contracts.

So usually these are associated with futures exchange or some other derivatives market and these

derivatives are just promises that promise to do something in the future and

the clearinghouse is a mechanism for sharing the risk that somebody's not going to live up to their promise.

Okay, and clearinghouses typically have capital of their own and therefore have some skin in the game to make sure that the default rate is sufficiently low, right?

That's correct. So the first line of defense that a clearinghouse has is that it collects collateral margin from the firms that trade on it.

If the some firm incurs losses that aren't that are bigger than its margin,

then the clearinghouse can dip into its own

capital and into the capital of other members of the clearinghouse to make good that

loss. One debate that exists is whether industries generally want this type of institution to exist.

What have you found?

Well, I mean, that's a very interesting question.

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