Some States Want Credit Default Swaps Regulated As Insurance
A lot of attention is being paid currently to credit default swaps(CDS) and what type of regulations should be implemented to get them under control. CDS played a pivotal role in nearly bringing down AIG, formerly the world’s largest insurer.
Many critics have likened CDS a ticking time bomb and a financial Armageddon waiting to happen. AIG is a perfect case of what can happen when things go bad, although much of their liquidity issues and subsequent bailout had to do with their drops in credit ratings.
Some state regulators are pushing to CDS regulated as an insurance product and it has recently become a heated topic with good arguments on both sides of the fence. While many agree that CDS are insurance like contracts there are many differing opinions on whether they are actually insurance.
The huge growth in CDS and derivatives in general helped fuel a great credit boom as many financial institutions increased their leverage levels to take advantage of the new financial products. The big problem with the product is that while it serves a useful role when the economy is going well, they can prove disastrous when the economy goes into the tank.
Much of the problem is that most of the sellers of CDS don’t have adequate collateral to fund their potential liabilities. The major attraction of the product is it’s ability to generate large amounts of financial leverage but as mentioned above, that can be a double edged sword, magnifying both gains and losses.
However, while I agree that CDS definitely needs to be regulated, I can’t help but wonder if leaving it the hands of fifty different state regulators is the best choice. The words over matched comes to mind and I think that this is something that would probably be best regulated at the federal level.
