Religion & Law

Thanks to those who have have responded to my original inquiry regarding the financial crisis.  Fractional reserve banking, questionable mortgage lending practices, stewardship, and the role of regulation were some of the topics I was hoping we would address.  One issue that has not been mentioned but is perhaps the elephant in the room is the role of derivatives, and credit default swaps in particular.  Mortgage defaults and bank failures are terrible problems, but I don't believe that these alone motivated President Bush to responded with such urgency.  Credit default swaps and similar instruments have allowed corporate debt to be leveraged (perhaps ten fold), so that as corporations are unable to make payments on debt, the impact is amplified throughout the ecomony. 

A credit default swap is an agreement to exchange periodic payments for a promise to make a payout upon a specified default of payment on corporate debt.  It functions as a form of insurance except that the party promising payout is not regulated as an insurer and the purchasing party does not necessarily have an interest in the underlying debt instrument.  The result is an unregulated tradable contract that is structured like insurance but is often entered into for purely speculative purposes.  Some current estimates place the notional value of these contracts at between 50 and 60 trillion dollars (perhaps ten times the value of the corporate debt market and four times the US GDP).  While such contracts serve a valuable hedging purpose for holders of debt, they have also magnified the potential severity of the housing bubble and its effects.  A number of analysts have likened credit default swaps to gambling, something which Catholic teaching certainly speaks to.  At the very least, this problem invites discussion regarding appropriate regulation of these types of financial instruments.