Speakers Urge States To Tame Swaps Market

Witnesses testified at a National Conference of Insurance Legislators hearing that state insurance legislators should act to put credit default swaps under the jurisdiction of state insurance regulators.

Witnesses testified at a National Conference of Insurance Legislators hearing Saturday that state insurance legislators should act to put credit default swaps under the jurisdiction of state insurance regulators.

The Steering and Financial Services committees at NCOIL, Troy, N.Y., organized the hearing to look at oversight of the market, which gives participants vehicles for hedging against the possibility that issuers of bonds, notes and other debt securities may fail to fail to keep up their payments.

Some observers say CDS instruments insure holders against default risk.

Joseph Morelle, a member of the New York Assembly and chair of the NCOIL Financial Services and Investment Products Committee, and other NCOIL members are deciding whether to work on credit default swaps model legislation at NCOIL’s upcoming spring meeting in Washington.

Michael Greenberger, a University of Maryland law school professor, said at the hearing that state lawmakers should take the lead on the CDS issue.

No one has a full handle on the CDS problem, and the conventional wisdom in Washington is that insurance regulation has failed, Greenberger said.

Insurance regulators’ failure to take the lead on the issue is conveying the impression that “states are just not up to this responsibility,” Greenberger said.

That impression is “not only about credit default swaps, but the ability to [handle] all insurance regulation,” Greenberger warned. “You’re going to give it away.”

Greenberger said he would be “shocked” if state legislators were told to stay back because federal regulators were preempting their authority.

Greenberger said he is “very, very worried that we are not near the tip of the iceberg,” because of the possibility that CDS arrangements backed by commercial mortgages, credit card debt, auto loans and student loans could run into the same kinds of problems that residential mortgage CDS arrangements have faced.

New York Insurance Superintendent Eric Dinallo said legislators should distinguish between “covered swaps” – swaps arranged by parties that want to hedge against defaults involving securities that they themselves hold – and “naked swaps” – swaps arranged by speculators that will face no direct effect if the issuers of the securities default.

A CDS is, at the base, a security, and not insurance, because the party accepting risk offers no guarantee to make an affected party whole, as there would be in an insurance arrangement, Dinallo said.

Dinallo said that a CDS is, at base, an insurance product without the hallmarks of insurance, such as solvency and capital requirements.

The lack of transparency in the CDS market was a disturbing point that came to light in the wake of the federal government’s bailout of American International Group Inc., New York, Dinallo said.

Although AIG held about $450 billion in CDS arrangements, “we can’t say how much was written on AIG,” Dinallo said. “Nowhere was it listed where we could get a sense of it.”

All CDS arrangements should be listed on an exchange, Dinallo said.

Dinallo noted that the Generally Accepted Accounting Principles already require companies to state whether a CDS arrangement is held for hedging or non-hedging purposes.

Dinallo noted that Kirsten Gillibrand, who was a New York state lawmaker and now is serving as New York’s junior senator, recently asked whether naked CDS arrangements should be illegal.

The difficulty with that solution is defining the term “naked CDS,” Dinallo said.