I look forward to a growing chorus of voices arguing that credit defaults swaps, being essentially insurance contracts, be regulated as insurance. This piece, by Tom Armistad at SeekingAlpha, is a good start.
Credit default swaps are insurance, and should be regulated as such, with a requirement of insurable interest for the buyer and adequate capital for the seller.
Briefly, insurance may be defined as the transfer of risk for a consideration, or premium. The insurance business has been in existence for centuries, and its underlying principles are clearly understood. It is a business affected with the public interest, and effective methods of regulation have been developed and are in place globally, with certain exceptions.
The exception with which we are concerned is CDS. Congress, aided and abetted by the machinations of Larry Summers, made them exempt from regulation by means of the Commodity Futures Modernization Act of 2000.
Not only were CDS made exempt from regulation as insurance, they also got a pass from regulation as gambling. CFMA carefully exempts them from the provisions of “bucket shop” laws, passed in the wake of the financial crisis of 1907 to prevent gambling in the financial markets.
Recall that, at the height of the credit crisis, wild, speculation-driven swings in the (smallish, relatively illiquid) CDS market only added to the panic running through the much-larger fixed-income markets. Most of the CDS moves turned out to be meaningless noise. That wasn’t helpful. . . .