Posts
We've been studying the Obama administration's plan to rewrite how derivatives are regulated, and one big concern shows up.
The whole point is to prevent the AIG problem: where one big company has sold so many derivatives to so many financial institutions around the world that if it collapses the whole global economy might collapse.
But the administration's proposal doesn't seem to address all of the issues.
As many of you know, AIG got in trouble by selling credit default swaps, a way to bet on how bonds will perform. So many bonds (especially those toxic asset, subprime-mortgage-related ones) did badly, that AIG didn't have enough money to cover its bets.
Worse, the government didn't know how many of these bets AIG had made, who they made them to, or the exact nature of the bets.
Each credit default swap -- like lots of over-the-counter financial products -- is custom-made. AIG or JP Morgan or whoever was selling had their own proprietary contracts that they'd custom-build for each customer.
The new rules address the problems in a few ways:
- Banks and other players have to tell the government when they buy and sell these derivatives. That means the government can know how many are out there and who has them.
- If banks and others are buying and selling standardized derivatives, they must trade them on an exchange, sort of like how stocks are traded on an exchange. That way it's more transparent and the prices should more accurately reflect the market sentiment.
- But -- and here's the big but -- banks and others are perfectly free to continue trading custom-made derivatives as private transactions between two parties.
The proposal calls for:
The encouragement of regulated institutions to make greater use of regulated exchange-traded derivatives.
"Encouragement," not "requirement." For the rest of the story click here
All Things Considered, May 14, 2009
U.S. Seeks Greater Oversight Of Derivatives
by Adam Davidson and Robert Siegel
[4 min 42 sec]
