Are Your Secrets Safe?

A shift in banks' business model raises questions about conflicts.

Finally, Heinlein recommends that, when the situation permits, companies should structure deals with fast turnarounds, such as overnight bond deals, to minimize the likelihood of leaks. Above all, remember Benjamin Franklin’s wise words the next time you set up a deal with your bankers: “Three can keep a secret if two are dead.”

Alix Nyberg Stuart is senior writer at CFO.

Who’s on First?

Banks routinely bundle corporate loans and sell them off, often to other banks or hedge funds, as a way to manage risk. The problem with those derivatives, though, is that slow transaction-clearing processes and the resulting backlog make it unclear who is legally responsible for paying up in the event of a credit default. Should banks be left holding the bag for multiple bankruptcies, their reserves would quickly be depleted, raising fears of a systemwide meltdown.

Such fears spurred the New York Federal Reserve Bank to call a meeting of 14 large banks last fall, asking them to standardize and computerize the process, rather than rely on an outmoded system based on scraps of paper and ad hoc negotiations. By the end of June, the number of uncleared transactions more than 30 days old had been reduced on average by 80 percent, and backlogs at large firms showed a marked decline. Some 60 percent of all swaps now go through the Depository Trust and Clearing Corp., the main clearinghouse for the derivatives, up from 15 percent two years ago.

But don’t breathe easy just yet. “Taking care of the backlog [via automation] certainly won’t be a panacea,” warns Dimitri Papadimitriou, head of the Levy Economics Institute at Bard College. “When we get caught up, we might find that banks’ exposure is much larger than we thought.” — A.N.S.

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