Corporate Governance

Congress Introduces Bill to Regulate Credit Default Swaps

By Carol Straw

Last week, we reported that securitized assets are expected to survive despite the current credit crisis but with improved governmental oversight to promote transparency in the market for these kinds of investments. In 2008, the notional market in credit default swaps (CDS) climbed to a staggering $58 trillion. CDS contracts are the means by which financial institutions insure themselves against the risks of defaults on securitized assets or other corporate obligations. In addition to hedging activities, financial institutions trade credit swap protection without any ownership in the entity or obligation underlying the swap. Because of the significance of the role that CDS play in the financial market, congress has proposed new legislation to address the lack of transparency and regulatory oversight in this market also.

In his blog, Jim Hamilton reported on the bill sponsored by Senator Tom Harkin, chair of the Agriculture Committee. Harkin noted that while swaps contracts function much like future contracts, they are not regulated as future contracts because of a statutory exclusion from CFTC authority.  It is impossible to know whether credit default and other swaps are being traded at fair value or whether institutions trading them are becoming overly leveraged or dangerously overextended. Harkin emphasized that financial derivatives like credit default swaps must be traded on a regulated exchange, so that regulators can know the value of the contracts, who is trading them, and if they have enough assets to back the contract.  The recent federal bailout of AIG which sold $440 billion of CDS protection bears this out.

See Jim Hamilton?s article @ 10/18/2008 12:01:00 AM

Full post as published by PomTalk on October 21, 2008 (boomark / email).