What If the DTCC Depository Trust and Clearing Corporation Goes Bankrupt? In a 2015 law review article titled “Failure of the Clearinghouse: Dodd-Frank’s Fatal Flaw?,” Prof. Stephen Lubben points to a more ominous risk from pushing all derivatives onto exchanges; and that concern is shared by former hedge fund manager David Rogers Webb in his 2024 book “The Great Taking.” The exchanges are supposed to be safer than private over-the-counter trades because the exchange steps in as market maker, accepting the risk for both sides of the trade. But in a general economic depression, the exchanges themselves could go bankrupt. No provision for that is made in the Dodd-Frank Act, which purports to decree “no more bailouts.” Still, reasons Prof. Lubben, the government would undoubtedly step in to save the market from collapse.
His proposed solution is for Congress to make legislative provision for nationalizing any bankrupt exchange, brokerage or Central Clearing Counterparty before it fails. This is something to which our gridlocked Congress might agree, since under current circumstances it would not involve any major changes, wealth confiscation or new tax burdens; and it could protect their own fortunes from confiscation if the DTCC were to go bankrupt.
Other Possible Federal Solutions
Another alternative that not only could work but could fix Congress’s budget problems at the same time is to impose a 0.1% tax on all financial transactions. See Scott Smith, A Tale of Two Economies: A New Financial Operating System, showing that U.S. financial transactions (the financialized economy) are over $7.6 quadrillion, more than 350 times the U.S. national income (the productive economy). See my earlier article summarizing all that here. On a financial transaction tax curbing speculation in derivatives, see also here, here and here.
There are other possible solutions to customer title concerns. There is no longer a need for the archaic practice of holding all securitized assets in the street name of Cede & Co. The digitization of stocks and bonds was a reasonable and efficient step in the 1970s, but today digital cryptography has gotten so sophisticated that “smart contracts” can be attached by blockchain-like distributed ledger technology (DLT) to digital assets, tracking participants, dates, terms and other contractual details. The states of Delaware and Wyoming have explored maintaining corporate lists of stockholders on a state-run blockchain; but predictably, the measures were opposed. The practice of holding assets in street name has proven very lucrative for the DTCC’s member brokers and banks, as it facilitates short selling and the “rehypothecation” of collateral.
In October 2023, the DTCC reported that it has been exploring adopting DLT; but the goal seems only to be speedier and safer trades. No mention was made of returning registered title to the purchasers of the traded assets, which could be done with distributed ledger technology.
South Dakota’s Innovative Solution
The most readily achievable solution is probably that in a South Dakota bill filed on Jan. 29. The bill is detailed in a Feb. 2 article titled “You Could Lose Your Retirement Savings in the Next Financial Crash Unless Others Follow This State’s Lead”, which observes:
… [I]f your broker … were to go bankrupt, the broker’s secured creditors (the people to whom the broker owes money) would be empowered to take the investments that you paid for in order to settle outstanding debts….
To avoid a catastrophe in the future, a nationwide movement is desperately needed to alter the existing Uniform Commercial Code. Of course, that won’t be easy to accomplish, especially because bank lobbyists and other powerful financial interests will almost certainly fight kicking and screaming to stop policymakers from taking away their advantage over consumers.
The good news is, this “great taking” can be stopped at the state level. Americans don’t need to count on a divided Congress to get the job done. Because the UCC is state law, state lawmakers can take concrete steps to restore the property rights of their constituents and protect them in the event of a financial crisis.
On Monday, South Dakota legislators introduced a bill that would do just that. The legislation would ensure that individual investors have priority over securities held by brokerage firms and other intermediaries.
It would also alter jurisdictional provisions so that cases are determined in the state of the individual investor, rather than the state of the broker, custodian or clearing corporation. This would ensure that individual investors are able to rely on the laws of their local state.
Hopefully, other states will follow South Dakota’s lead. Tennessee, for one, is reported to have such a bill in the works.