Question on Credit Default Swaps
A liberal relative of mine is blaming the current economic crisis on deregulation, especially of Credit Default Swaps (CDS). He blames Ron Paul type of people for our current problems.
So I'm looking into these things, starting with Wikipedia, and personally I don't see what the problem is. A CDS is basically like buying insurance. You pay a premium to cover yourself in the event a company fails. Suppose you think Wal-Mart will fail. You might pay $50K per year for basically an insurance policy that will pay out maybe $2 million if Wal-Mart fails, but will pay nothing if they don't fail. So you are hedging. Why would a free market type have a problem with that? Like selling short it keeps the market honest. If you have a hunch a company will fail and you bet against them, this sends a signal to the market that the company is risky, which drives the stock price down and helps to limit bubbles.
Here's what I don't understand though. The bill that passed allowing CDS's and making them unregulated was passed just prior to the Christmas break in 2000. It was 11,000 pages long. Rushed through like a typical government scam. Ron Paul voted against it. Bill Clinton approved it, and away they went. Here's the roll call for the House.
http://www.govtrack.us/congress/vote.xpd?vote=h2000-603
Though the circumstances of the passage of the bill look very suspect, still on the whole I'd think liberterians wouldn't oppose something like CDS's. Can anybody explain what is going on?
CDS are not the problem
You are right a CDS can be used as insurance. It also can be used as an outright bet on solvency. These are private contracts between private entities and should clearly be allowed. The problem arose when regulations allowed these entities to "hide" these transactions as off-balance-sheet assets. So what is happening now is that regulation reduced transparency and counter party risk is becoming serious (counter-party risk is when you don't know if the other side of the contract will be able to keep up their end of the bargain).
In a true free market, investors/depositors would have a clear look at the obligations of their financial institutions and make their decisions accordingly. That is the checks and balances system that works. If you have your checking account at a bank at risk, you can only blame yourself because all the information was readily available. But with FDIC and SIPC the checks and balances are eliminated, no need to worry about deposits.
Runs on the bank serve a necessary purpose: keep your books in order or face a run. Right now the gov't/fed are regulating away possible runs which further the problem. Still no need for transparency or reasonable balance sheets.
LISTEN TO THIS!!!!
and you will learn everything you need to know about Credit Default Swaps, complex derivatives, etc. Here is link then just click listen now. Michael Greenberger on NPR back in April. SOLID INFORMATIVE INTERVIEW
http://www.npr.org/templates/story/story.php?storyId=89338743
beephree
The only problem is ...
the CDS market is OTC and completely opague.
The only regulation should be to re-enforce property rights by mandating transparency.
And to be honest, if there were no regulations on the insurance business then the CDS market would be transparent ... the market itself would impose transparency on the CDS sector. As it stands now, it is opague because of the state insurance regulations.
Quite ironic if you ask me.
WAHOR!!
http://www.dailypaul.com/node/48994
WAHOR!!
http://www.dailypaul.com/node/48994
Opaque
When you say the market is not opaque, are you saying that the going rate for a CDS (in other words the premium paid for the insurance policy) is unknown to the market, and if it were known it would factor in to the stock price? Do you think this is why Paul opposed the law that permitted CDS's?
Opaque means...
cloudy and translucent or transparent means crystal clear.
I said the sector IS currently opague ...
I am not sure which law you are referring to.
Do you have a source?
If the market is not transparent, then yes ...
evaluation is very sketchy at best ...
and most likely full of fraud.
WAHOR!!
http://www.dailypaul.com/node/48994
WAHOR!!
http://www.dailypaul.com/node/48994
Got you on "opaque"
That was a mis-type on my part. You're saying the market IS opaque (i.e. not transparent). I think you're saying that the rates that people pay for the CDS's as well as the amount taken out as a hedge against a particular company, are unknown to the market, right?
Not quite ...
People know how much they pay for the swaps, but market forces are not placed on them to determine the value correctly.
Whether they are paying too much or too little is a very wide margin because there is no transparency.
For example; they were literally charging less than a penny on the dollar in some cases with regards to bundled property assets.
The risk was low because property values rarely went down, but no-one truely knew the contents of these assets except the buyer and the seller.
It takes the market for accuracy...
How far off can two people be?
How far off can 1 million people be?
To disclose the actual nature of the transaction would have placed a CDS at risk of being labeled insurance which would have been subjected to state laws,(50 different state regulations) which would have made them not viable instruments.
If state insurance laws were uniform and simply focused on transparency issues, property rights, and fraud penalties, then things would be much simpler.
WAHOR!!
http://www.dailypaul.com/node/48994
WAHOR!!
http://www.dailypaul.com/node/48994
The law I'm referring to
I quote Wikipedia below on the law that allowed CDS's.
Credit Default Swaps were invented in 1997 by a team working for JPMorgan Chase[7][8]. Credit Default Swaps became legal, and illegal to regulate, with the Commodity Futures Modernization Act of 2000. They were introduced and rushed through congress as a companion bill, the last day before the Christmas holiday. It was never debated in the House or the Senate. The bill was 11,000 pages long. Less than a week after it was passed by congress, President Clinton signed it into Public Law (106-554) on December 21, 2000.
I wonder what Paul's reasoning was for opposing this law, other than maybe saying an 11,000 page law cannot be approved in a week because we really don't know what we're voting for.
You would have to ask him... but I bet you are right.
WAHOR!!
http://www.dailypaul.com/node/48994
WAHOR!!
http://www.dailypaul.com/node/48994