SEC head calls for transparency on credit default swap

Reuters on Yahoo ^ | 10/18/08 | Chris Michaud

[NormsRevenge]

NEW YORK (Reuters) – SEC Chairman Christopher Cox has called on Congress to pass legislation that would make so-called credit default swaps more transparent, including requiring that dealers in over-the-counter swaps publicly report their trades and the trades' value.

Writing in Sunday's New York Times, Cox noted that the $55 trillion credit defaults market is more than the GNP of all the world's nations combined, and that credit default swaps "play an important role in the smooth functioning of capital markets."

But, he said, "our markets function best when they are highly transparent," while credit default swaps have "operated in the shadows," with "no public discourse nor any legal requirement for these contracts to be reported to the Securities and Exchange Commission or any other agency."

Having been bought and sold widely and in many cases anonymously," trapping large financial institutions "in a web of transactions," the swaps market has left government regulators with "no way to assess how much risk is in the system."

--snip--

He concluded that giving regulators authority "to bring the credit derivatives market into the sunshine" would constitute a "giant step forwarding in protecting our financial system and the well-being of every American."

[VOA]

But, he said, "our markets function best when they are highly transparent,"

Heck, even President Bill Clinton said that...year or two
before the tech crash.

When Cox is almost channeling Bill Clinton...
be afraid, be VERY afraid.

[Reverend Wright]

CDS are credit default/debt default insurance, but they can’t call it “insurance” for legal reasons.

Related to mortgages, (maybe someone in the industry can weigh in on this) but as i understand it, CDS were added onto alt-a and subprime mortgage backed securities (MBS) to raise their credit rating to investment grade - so they would have a larger market.

Many of the CDS including those insuring MBS were written without any loss reserves (remember, not called “insurance” so not regulated like an insurance company). When they all went bad at once, the counterparties (AIG etc) didn’t have the money to make good the losses.

[boomstick]

That’s right. In addition to “wrapping” the bonds with guarantees (which had been done for decades in the municipal bond market by so-called monoline insurers like Ambac and MBIA, enabling the rating agencies to give the securities AAA ratings), there were also explicit CDS contracts where the insurance companies sold protection on the parts that the banks couldn’t sell.

Another piece of the puzzle is that many of the insurers didn’t have to post collateral as the chance of loss increased, so long as their ratings (that word again!) were maintained.

[Reverend Wright]

“Another piece of the puzzle is that many of the insurers didn’t have to post collateral as the chance of loss increased, so long as their ratings (that word again!) were maintained.”

Rating Agency fudging (and I am guessing out and out fraud/corruption) will probably be a big part of this before we are done.

On the wraps, Jim Cramer (I know, I know...) has estimated that AIG will have $400 billion in wrap losses that the taxpayer will have to make good. If that turns out to be true, then the cost of the AIG bailout may exceed the net cost of the Paulson Plan.

[Son House]

Are the sellers of these ‘bundled’ investment vehicles are the ones getting the bail-out money?

Will the buyers eventually get paid their investment plus interest?

Watching on FOXNEWS now, so it’s a little clearer

[Reverend Wright]

“Are the sellers of these ‘bundled’ investment vehicles are the ones getting the bail-out money?”

Depends which bailout you mean: with the federal takeover of AIG the taxpayer is going to pay for the CDS written by AIG. For those the buyers of the MBS and CDS (usually, but not always the same entity) will get the AIG bailout money.

Paulson plan bailout money: my understanding that the intent was to buy MBS where the market had collapsed. The CDS contracts are specific to the particular MBS but I assume if the MBS is in partial or total default, the CDS would kick in and the writer of the CDS would owe the government.

For the CDS in default that came from AIG, the treasury will be on both sides of the CDS.

(This is becoming a 21st century version of “we owe it to ourselves!”)

[curiosity]

This is the first pro-regulatory proposal I've heard related to the crisis that makes some sense. There's no reason for a $50 trillion market to be OTC. We need to get those derivatives onto exchanges with margin requirements.

[curiosity]

Unless, of course, your trades are with two different banks, and one of them goes under. Then your risk isn’t so close to zero.

You just nailed why this market creates so much systemic risk.

Get these things onto exchanges with some margin requirements and position limits, and a lot of the problem will go away.

There's absolutely no reason to keep a market this big OTC.