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State Lawmakers Seek Swap Oversight

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Washington Bureau

A New York state lawmaker Wednesday called on Congress to allow states to regulate credit default swaps, saying they are “species of insurance.”

The comments by New York Assemblyman Joseph Morelle, D-N.Y., on behalf of the National Conference of Insurance Legislators, Troy, N.Y., took part at a hearing on legislation introduced by Rep. Collin Peterson, D-Minn., chairman of the House Agriculture Committee.

The bill Peterson is drafting would require most over-the-counter derivatives to be cleared by federally regulated clearinghouses and would ban “naked” credit default swaps.

“Frankly, this discussion is not only appropriate but, perhaps, sadly overdue,” Morelle said in his testimony. “It is a discussion with implications beyond even the very broad horizons of its specific subject matter, for it relates to our fundamental notions of the free market system.”

He added that if Congress concludes that CDS “are a species of insurance, and I would strongly suggest that they are, then authority in relation to CDS must accrue to the states.”

NCOIL takes the position “that state regulators, with their extensive experience at regulating insurance products, are extremely qualified to regulate covered CDS as insurance products,” Morelle said.

He also said that it is NCOIL’s position that Congress erred when it preempted the states from regulating CDS “under our gaming and bucket shop laws” when it passed the Commodities Futures Modernization Act of 2000.

The CFMA “permitted so-called ‘naked swaps’–those CDS contracts that are speculative in nature and are merely directional bets on market outcomes–to proliferate to the point where they now constitute 80 percent of the CDS market, which has a notional value of around $54 trillion, with no regulatory framework,” he said.

The NCOIL Financial Services Committee will discuss the hearing and chart a formal policy course for the organization when it meets Feb. 28, during the NCOIL Spring Meeting in Washington, DC, he said.

The hearing and the legislation introduced by Rep. Peterson–as well as similar legislation introduced in the Senate Agriculture Committee–represent the opening bell in what is expected to be a knock-out, drag-out fight by legislators of all stripes to win oversight over CDS.

Currently, agricultural committees in the House and Senate oversee the Commodity Futures Exchange Commission, which regulates trading in derivatives for both commodities and financial products.

But regulation of CDS–or lack of regulation–has become a hot issue. That’s because losses by companies that speculated on the products, for example by American International Group and monoline insurers, have cost these companies billions of dollars and threatened their solvency.

At a briefing for reporters Tuesday, for example, Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, said imposing strong oversight of CDS and other highly speculative financial products would be the top priority for his committee this year.

He proposed that shifting oversight of trading in derivatives of financial products to his committee from the House Agriculture Committee was just one of several means of ensuring strong oversight of financial services firms who participate in these markets.

What he is proposing, Rep. Frank said, is to leave the House and Senate agricultural committees only to oversee trading in “the edibles,” i.e., agricultural commodities, as well as, probably, trading in oil and other natural resources.

Rep. Frank also suggested that a systemic regulator, probably the Federal Reserve Board, which is overseen by his committee, be given authority to monitor companies involved in this industry.

He also noted that his committee will also look at legislation combining the Securities and Exchange with the CFTC sometime later this year.

The issue also came up Wednesday at a hearing before the Capital Markets Subcommittee of the panel chaired by Frank, which is looking into how federal regulators failed to turn up evidence that New York financier Bernard Madoff was engaging in a Ponzi scheme that cost investors throughout the world up to $50 billion.

Expressing frustration with answers from SEC officials about how Madoff could be allowed to conduct his scheme for decades, Rep. Paul Kanjorski (D – Pa.), chairman of the subcommittee, told SEC officials that they were refusing to cooperate with a branch of government that could wipe their entire agency off the regulator map, if necessary.