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During the meeting Burry asks a key question: “I want to be certain of payment in case of solvency issues with your bank”, to which Goldman responds “um, excuse me?” This is called “default risk” – the risk that a counterparty can’t pay up in the event of unforeseen lossespic.twitter.com/IjH89uPbbw

This is a serious risk in OTC markets, because there’s no one to guarantee payment if a trader blows up. Mark Baum (played by Steve Carrell) faces this problem later in the movie – the risk that Morgan Stanley can’t pay when the market crashes and his swaps balloon in value:pic.twitter.com/nGxmG6dUOl

This is where a clearinghouse comes in. The clearinghouse puts systems in place (like position margin, trade reporting and guarantee funds) to eliminate default risk. If you send your trade through a clearinghouse, you’re effectively guaranteed payment when the trade goes thru.pic.twitter.com/IzE6lNFcdH

Why does this matter? Clearinghouses help lower costs and improve trust in the system. These lower costs show up in the products we consume – companies can hedge the prices of commodities, interest rates and even stocks more efficiently with the help of clearinghouses.pic.twitter.com/xMEG0PgsrD

Some real world clearinghouses in operation today: OCC – options DTCC – equities LCH – various CME Clearing - futures Eurex Clearing – various ICE Clear US & Europe – futures ICE Clear Credit – credit default swaps Give them a high five!pic.twitter.com/IrfrcdWgUX