Questions for Gary Gensler and Henry Hu


Preface: CDS traders, read the note at the end…

Tomorrow, the House Committee on Financial Services will be talking about regulating about over the counter derivatives. Committee Chair Barney Frank has already circulated a draft of the proposed legislation.

The star witnesses are Commodities Futures Trading Commission chairman Gary Gensler and Henry Hu, who is the Director, Division of Risk, Strategy, and Financial Innovation, U.S. Securities and Exchange Commission.

I urge members of the Committee to ask the following question (you’re welcome to hand this out to the witnesses):

Nobel prize-winning economist Myron Scholes – who developed much of the pricing structure used in CDS – said that existing over-the-counter CDS were so dangerous that they should be “blown up or burned”, and we should start fresh.

A Nobel prize-winning economist (George Akerlof) predicted in 1993 that CDS would cause the next meltdown.

U.S. Congresswoman Maxine Waters introduced a bill in July that tried to ban credit-default swaps because she said they permitted speculation responsible for bringing the financial system to its knees

Nassim Nicholas Taleb said this month, “To curb volatility in financial markets some financial products ‘should not trade,’ including complex derivatives.”

Warren Buffett’s sidekick Charles T. Munger, has called the prohibition of CDS the best solution, and said “it isn’t as though the economic world didn’t function quite well without it, and it isn’t as though what has happened has been so wonderfully desirable that we should logically want more of it”

George Soros says the market is still unsafe, and that credit- default swaps are “toxic” and “a very dangerous derivative” because it’s easier and potentially more profitable for investors to bet against companies using them than through so-called short sales

Satyajit Das, a leading credit default swap expert – the commonly-accepted figures for the CDS losses suffered due to Lehman’s bankruptcy have been understated. He also says that the justifications for the value of CDS for the economy are phony.

In addition, the proposed regulations of CDS won’t really fix the problem, because they will only cover “standard” derivatives contracts, not the slew of “creative” contracts.

Indeed, Das says that the new credit default swap regulations not only won’t help stabilize the economy, they might actually help to destabilize it.

The overwhelming majority of derivatives contracts are held by just 5 banks. So are we really basing our entire strategy on CDS on protecting those 5 banks?

Credit default swap counterparties drive company after company into bankruptcy, and – once a company the counterparties are betting against goes bankrupt – the counterparties cut in line in front of all of the bankruptcy creditors to get paid (and see this).

Given the above, why shouldn’t we ban or heavily tax over-the-counter credit default swaps, at least where the CDS buyers isn’t itself the referenced entity?

For background, see this.

Note to current or former CDS traders: I’m not against CDS, but I think they need to be reigned in.

And I don’t think Congress really understands CDS or their effect on the economy.

If any traders know how CDS can be reigned in without reducing the size of the CDS market, I’m all ears.

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  • http://www.blogger.com/profile/08454222098667643650 Tom Hickey

    CDS's need to be regulated for what they are, insurance. NY agrees."A credit-default swap is a contract under which the seller promises to pay the buyer if the insurance provider can't, for example, pay principle or interest of a bond held by the buyer. In those cases, the swap is insurance, because the swap buyer is like a homeowner insuring a home."New York’s new guidelines establish that when the buyer owns the underlying security on which he is buying protection the swap is an insurance contract. Under the new rules, such swaps can only be issued by entities licensed to conduct insurance business."NY: CDS's = insuranceThis means that insurers must hold adequate reserves against the policies they write."Patterson said in a press release that the goal of regulating credit-default swaps is to ensure that sellers have enough capital and adequate risk management policies in place to protect the buyers, who are, in effect, policyholders.The governor noted that AIG's insurance operations and other insurance companies regulated by the state are required to hold substantial reserves, and, as a result, they're solvent and able to pay claims. But a major part of AIG’s problems were spawned by the issuance of credit-default swaps by AIG Financial Products, a non-insurance unit that did not hold enough reserves, according to Paterson."

  • http://Anonymousnoreply@blogger.com Anonymous

    Quote:"The overwhelming majority of derivatives contracts are held by just 5 banks. So are we really basing our entire strategy on CDS on protecting those 5 banks?"There are many who can talk about this more knowledgeably and elegantly. I am merely a conveyor of blunt truth. Here goes:The banks bought Congress,the President and made sure the regulators throughout the governmental system were aware that a payday awaited them if certain issues were decided in certain ways.Hell, anyone half aware and with half a brain knows this.The corporate owned main stream media can dance around this or ignore it …. but surely anyone reading this blog knows where I coming from.Those who watch the price of Gold can understand that it rises because trust has been lost in conventional institutions. Deservingly lost. Lost because of corruption, cronyism and plain ineptitude.We need accountability. We need indictments on those who crossed the line. Our Government wants to hide this, to squelch it, and say "move along folks.. nothing to be seen here.Hell no, there is corruption galore in the U.S.It needs to stop. Anyone associated with it needs to spend time in jail.

  • http://Anonymousnoreply@blogger.com Anonymous

    On page 17 of The Hayman Capital letter March 2, 2009 pdf. Kyle Bass says the problem in the CDS market, is that some big players (AIG etc) do not have to put up collateral for their positions and argues that an even playing field for all, would automatically solve and shrink the market and or problem. Jerry

  • http://Anonymousnoreply@blogger.com Anonymous

    Classical arguments justify the credit economy saying, -it allows more people to purchase more things in a modern society. The argument seemingly shoves us toward a belief that our modern societies aren't possible without the benefit provided by the credit economy.I'm sure there are even some who have made a similar argument for CDSs, e.g., that without the benefit of the CDS our society, even our nation, would not be such a high-flyer.The reason for the laughable evidence of the frailty of human reason is the flightiness of the rational human mind. I'm going to give you each ample evidence of this right now.I can show everyone this, and still -each of you will continue in the utterly bird-brained logical methodology anyway.Most are making the same mistake with CDSs, just as is done with every argmuent in this vile economic symposium that is -itself- rapidly laying the groundwork for the next great economic debacle.Succinctly here is the mistake in logical reasoning every human makes repeatedly-It is impossible to logically determine the truth by recognizing that something is untrue. That's a complete logical disconnect -because there are always an infinitely greater number of untruths -than there are truths.Too simple, right? No. – That's the truth. So, how does this relate to what is being said here about CDSs?We can cleverly surmise that CDSs are not truth in the sense that they provide an economic benefit that is going to help matters.This in no way then can be turned around into an argument to affirm with anything approaching veracity, that -because- we have surmised CDSs are probably off the desired path of economic bliss, that we can now know where that desired path might be. It just doesn't follow.Minimally the direction such a negative assertion points to -is 360 degrees squared!The argument just made -succinctly pulls the logical rug out from under the empirical and pragmatic approach to anything.BUT!!!! We have a long history of having "solved" many problems by this approach that we need to come to grips with.How can we do that?We can do that by admitting the complexity built up by all the pragmatic fixes cumulatively adding -tenuous supposition- after -tenuous supposition- has finally gotten the better of us -and our pragmatic luck about things economic has simply run out, -hence the ongoing crash.CDSs are a symptom of the problem, and the problem began way back when someone rationalized that credit made more things available to more people. That's bullshit.Credit only makes the same people much poorer, so they end up with much less. A lot of people are quite homeless right now, -and some are living in cars that are unregistered, do not -and- will never run again.Believe me. There are no free lunches in life. I'm sixty years old, and I've never had a credit card or a loan in my life.That feeling of half-anger and half-envy you feel right now -that's- the direction toward the truth-path you should be looking for, Bird-brain.

 

 

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