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By Ronald Fink
A Democratic Senator has revived a proposal that would curb the use of naked swaps, derivative bets where neither party has an insurable economic interest in the underlying risk.
Washington State's Maria Cantwell, a member of the Senate Finance Committee, introduced a bill in November that would repeal exemptions for such derivatives from state gaming laws that were provided by the Commodities Futures Trading Commission starting in the early 1990s.
Those gaming laws make naked swaps unenforceable in court, so the parties are left to work out payment themselves. Proponents such as UCLA law professor Lynn Stout say those laws would go a long way to limit the systemic risk naked swaps pose when they're treated as contracts instead of gambling bets, as evidenced in the $182 billion taxpayer bailout of AIG and its counterparties such as Goldman Sachs.
In an article published in July on the website FinReg21, Stout wrote that prior to the CFTC exemptions, "this approach kept runaway speculation from adding intolerable risk to the financial system. And it didn't cost a penny of taxpayer money."
Opponents say subjecting such swaps to the state laws would reduce the liquidity they provide to the financial markets. Others, however, contend the derivatives absorb rather than provide liquidity because sellers put up so little collateral in the expectation that courts will enforce them as contracts.
The banking lobby quashed a similar proposal in the House, and is reportedly urging Cantwell to drop or at least soften the terms of her bill.
The provision would apply to credit default swaps and other derivatives that are traded over the counter rather than on exchanges, which impose collateral requirements and limits on margin.
Legislation about to be voted on in the House Financial Services Committee that is supported by the Obama administration and a bill introduced in the Senate Banking Committee by its chairman, Chris Dodd of Connecticut, would allow most credit default swaps to be traded over the counter instead of on exchanges and extend their exemption from state gaming laws.
http://www.charlotteobserver.com/business/story/1081297.html
http://www.cfozone.com/index.php/Risk/White-House-urged-to-ban-nudity-in-derivatives-trading-floor.html
http://www.finreg21.com/lombard-street/how-deregulating-derivatives-led-disaster-and-why-re-regulating-them-can-prevent-anot
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