XYZ, a small investment management firm, specializes in structuring small business loans and selling the government guaranteed portion to other institutional investors while retaining the riskier portions for high net worth investors. XYZ funds its operations by engaging in overnight repurchase agreements (repos) with three firms, but primarily with ABC, a firm that specializes in pooling funds from community banks and local government agencies and investing them in short-term, high-quality, government-secured investments.

Last week, XYZ was informed by ABC that its line had been frozen. XYZ learned that ABC had been defrauded by Repo Co., another repo borrower, who had provided false documentation of non-existent collateral of government-guaranteed loans. ABC feared a run by its investors as news of the fraud spread.

The diagram below illustrates the parties involved:

      ABC Co.
     /     \
XYZ Co.   Repo Co.

      ABC Co.
     /     \
XYZ Co.   Repo Co.

The use of a central clearinghouse to handle the transactions executed between XYZ's main funding source, ABC and ABC's client, Repo Co., would likely have resulted in a reduction in: