Two items in today’s Wall Street Journal (Tuesday, March 9, 2010) capture two different views of regulatory reform of credit default swaps. The first is the emerging European view:
European leaders pushed for a ban on speculative bets against government debt following recent financial turmoil in Greece … German Chancellor Angela Merkel said Tuesday that her government is backing an initiative to curb the credit-default swaps market, together with France, Greece and Luxembourg, and she suggested Europe would forge ahead on its own even if the U.S. didn’t go along.
José Manuel Barroso, president of the European Commission, the European Union’s executive arm, said the commission would examine closely the possibility of banning outright “purely speculative” trading of the swaps …
The ban now being discussed in Europe would allow investors to use the contracts to hedge against possible defaults by government borrowers, but prevent them from taking purely speculative positions. “It’s hard to justify why market players should purchase insurance against risks to which they are not themselves exposed,” Mr. Barroso said.
There are a number of responses one could make to the EU’s Barroso (below the fold, I put what appears to be the implied Obama administration view). Contrast this, however, with the March 9, 2010 speech by CFTC Chair Gary Gensler on CDS regulatory reform. Gensler did not suggest attempting to ban “speculative” trading in CDS, but did endorse three general reforms to the CDS (and more generally the OTC derivatives) market:
The 2008 financial crisis demonstrated how over-the-counter derivatives – initially developed to help manage and lower risk – can actually concentrate and heighten risk in the economy.
A comprehensive regulatory framework governing over-the-counter derivatives should apply to all dealers and all derivatives, no matter where traded or marketed. It should include interest rate swaps, currency swaps, foreign exchange swaps, commodity swaps, equity swaps, credit default swaps and any new product that might be developed in the future. Effective reform of the marketplace requires three critical components:
First, we must explicitly regulate derivatives dealers. They should be required to have sufficient capital and to post collateral on transactions to protect the public from bearing the costs if dealers fail. Dealers should be required to meet robust standards to protect market integrity and lower risk and should be subject to stringent record-keeping requirements.
Second, to promote public transparency, standard over-the-counter derivatives should be traded on exchanges or other trading platforms. The more transparent a marketplace, the more liquid it is, the more competitive it is and the lower the costs for companies that use derivatives to hedge risk. Transparency brings better pricing and lowers risk for all parties to a derivatives transaction. During the financial crisis, Wall Street and the Federal Government had no price reference for particular assets – assets that we began to call “toxic.” Financial reform will be incomplete if we do not achieve public market transparency.
Third, to lower risk further, standard OTC derivatives should be brought to clearinghouses. Clearinghouses act as middlemen between two parties to a transaction and guarantee the obligations of both parties. With their use, transactions with counterparties can be moved off the books of financial institutions that may have become both “too big to fail” and “too interconnected to fail.” Centralized clearing has helped to lower risk in futures markets for more than a century.
Gensler’s speech is serious, plain-spoken and, even if one disagrees with particular policy prescriptions, a useful, well-organized walk through the issues. I think that most participants in the regulatory reform process would accept these proposals as commonsense, at least in the US; going beyond them to the kinds of proposals being made in Europe currently is a different matter. (There has been a lively debate going on in the Financial Times in the past few days over CDS and liquidity.) (My own view is close to Gensler’s, FWIW, and where it differs, it certainly does not head down the EU path outlined above.)
Regarding the insurable interest question and “speculative” trading in CDSs, here is Gensler on both speculative trading and the “empty creditor” problem (it’s a lengthy quote from the speech, which I include for completeness):
Market Manipulation
The CFTC and the SEC should have clear authority to police the over-the-counter derivatives markets for fraud, manipulation and other abuses. It is important that these markets serve to help people hedge risk as well as provide for efficient and transparent price discovery markets.
At the height of the crisis in the fall of 2008, stock prices, particularly of financial companies, were in a free fall. Some observers believe that CDS figured into that decline. They contend that, as buyers of credit default swaps had an incentive to see a company fail, they may have engaged in market activity to help undermine an underlying company’s prospects. This analysis has led some observers to suggest that credit default swap trading should be restricted or even prohibited when the protection buyer does not have an underlying interest.
Though credit default swaps have existed for only a relatively short period of time, the debate they evoke has parallels to debates as far back as 18th Century England over insurance and the role of speculators. English insurance underwriters in the 1700s often sold insurance on ships to individuals who did not own the vessels or their cargo. The practice was said to create an incentive to buy protection and then seek to destroy the insured property. It should come as no surprise that seaworthy ships began sinking. In 1746, the English Parliament enacted the Statute of George II, which recognized that “a mischievous kind of gaming or wagering” had caused “great numbers of ships, with their cargoes, [to] have . . . been fraudulently lost and destroyed.” The statute established that protection for shipping risks not supported by an interest in the underlying vessel would be “null and void to all intents and purposes.”
For a time, however, it remained legal to buy insurance on another person’s life in England. It took another 28 years and a new king, King George III, before Parliament banned insuring a life without an insurable interest.
The debate over the role of speculators in markets did not end in the 18th century. That debate continued as the CFTC’s predecessor and the SEC were set up following an earlier crisis and that debate continues on to this day. In the case of futures, Congress determined that speculators should be able to meet hedgers in a centralized marketplace. In the oil market, for example, a speculator that will neither produce nor purchase oil is able to buy or sell oil futures. But Congress did require that all such futures trading be regulated, that markets be protected against fraud and manipulation and that regulators be authorized to limit the size of the position that a speculator can take.
The Administration has recommended – and the House financial regulatory reform bill that passed in December includes – critical steps to address the use of CDS to manipulate markets or possibly commit other abuses. With regard to single-issuer CDS or narrow-based CDS, the SEC should have consistent authority over all financial instruments subject to its jurisdiction. The SEC should have the same general anti-fraud and anti-manipulation rulemaking authority with respect to credit default swaps under its jurisdiction as it has with regard to all securities and securities derivatives under its jurisdiction. In addition, the SEC should have authority to set position limits in single-issuer and narrow-based CDS markets as it now has for other single-issuer or narrow-based securities derivatives. The House bill allows the SEC to aggregate and limit positions with respect to an underlying entity across markets, including options, equity securities, debt and single-stock futures markets.
Bankruptcy
Credit default swaps also can play a significant role once a company has defaulted or gone into bankruptcy. Bondholders and creditors who have CDS protection that exceeds their actual credit exposure may thus benefit more from the underlying company’s bankruptcy than if the underlying company succeeds. These parties, sometimes called “empty creditors,” might have an incentive to force a company into default or bankruptcy. These so-called empty creditors also have different economic interests once a company defaults than other creditors who are not CDS holders.
These incentives result from the separation of economic risk from beneficial ownership. In the capital markets, assuming economic risk usually comes with some type of governance right. Shareholders place their investment at risk, which brings the right to vote and to inspect books and records. Debtholders may extend credit or buy bonds along with rights as outlined in various debt covenants and indentures, as well as having rights in bankruptcy court.
Though reform efforts to date have yet to address the bankruptcy laws, we should seriously consider modifications to address this new development in capital markets. One possible reform would be to require CDS-protected creditors of bankrupt companies to disclose their positions. Another is to specifically authorize bankruptcy judges to restrict or limit the participation of “empty creditors” in bankruptcy proceedings.
EMB says:
Why focus on betting against government bonds in particular? Why not just ban taking out insurance policies on any asset you don’t actually own?
March 9, 2010, 9:05 pmKenneth Anderson says:
EMB: good question. I assume the answer in Brussels has something to do with protecting the Euro, rather than with assets in general. Gensler’s concern, by contrast, is about assets in general, set against OTC derivatives based insurance.
March 9, 2010, 9:08 pmTexas Lawyer says:
It seems to me that an insurable interest should be required before people can purchase these swaps, etc. Without an insurable interest, you’re just betting. With an insurable interest, you’re engaging in legitimate hedging.
In addition, it seems that these swaps are really insurance but can’t be called that. If it’s insurance then (in addition to requiring an insurable interest) the insurer has to have actual reserves to meet anticipated claims. I believe that companies like AIG wrote huge amounts of credit-default swaps without having to set up real reserves. They cannot do that when they write life insurance or property insurance.
March 9, 2010, 9:16 pmAnderson says:
I doubt that Gensler’s proposals would have a ghost of a chance in the U.S. Senate; the GOP minority would block it.
March 9, 2010, 9:17 pmRicardo says:
I would add to what KA said that government bonds tend to have a much more active secondary market than other assets, they are frequently used as collateral for transactions or reserves for banks, and the yield on bonds is often used as a benchmark interest rate for the country. If the yields on bonds suddenly spike due to the CDS market (which is what some allege is happening to Greece — I won’t defend this view, though), it can be hugely destabilizing for the country. Banks see their reserves shrink as government bond prices fall. Moreover, corporations will also have to pay much more to borrow to the extent their own bonds and government bonds are substitutes.
In short, I think the idea is that instability in the government bond market can quickly spread to other parts of the financial system.
March 9, 2010, 9:28 pmPooblicus says:
Any regulatory scheme on CDS instruments should be limited to making sure the issuer could in fact make good on the guarantee in case the underlying debt went bad, no matter what happened elsewhere in the financial market. If the seller does in fact have the ability to pay if the risk goes bad, he adds to the stability of the market. But in the past, the market issued a total amount of guarantees that any careful examination would show couldn’t be met if the market melted down.
March 9, 2010, 10:25 pmEli Rabett says:
Wait until one of the EU countries tosses Goldman people into the clink.
March 9, 2010, 10:42 pmNunzio says:
Gensler’s position is sensible. If only Summers were as brilliant as he claims to be, this would have been done 10 years ago instead of pushing for no regulation.
March 9, 2010, 11:16 pmMnZ says:
That depends on what you mean by insurable interest. Suppose I wanted to invest in a promising Greek business. I was willing to bear all the business risks associated with the business because I thought it was a very solid business model. However, I wasn’t willing to bear the risk of the collapse of the Greek government. In your view, could I buy CDSs even if I had no interest in Greek bonds?
Now, I could see someone responding “no” and that I should directly insure the business risk. However, a problem with this response is that insurance markets for highly narrow risks can be very thin and the cost of insurance can be very high. It is easy to conceive of situations in which I would not invest unless I had the CDS market open to me.
March 10, 2010, 12:02 amStephen Lathrop says:
Insurable interest is key. Without it you incentivize deliberate creation of bad debt— so the guy who creates it can bet against it. What gets incentivized is what happens. The existence of swaps to protect against loss promotes the sale of bad debt to suckers, even fairly careful suckers. That makes it all possible. It’s a paradoxical way to make money by poisoning the financial system.
Doesn’t sound like Gensler is even close to proposing what is clearly needed—no insurable interest, no insurance.
March 10, 2010, 12:02 amSteve says:
I agree that regulation must be brought to swaps. There are too many varieties of swaps to invest in and since most investors don’t completely understand the swap contracts, the need for vanilla swaps increases.
March 10, 2010, 12:35 amProblems arise when companies, trusts, governments misuse swaps. Countries should have the ability to manage their finances. Many major countries invest in currency rate swaps in an effort to manage the currency’s risk. Managing currency risk is extremely complicated, and during an unexpected event currency rate swaps can devastate countries. There is no reason for a country like Greece, to take on an excessive currency rate swap and an excessive credit default swap. This is a recipe for disaster.
The real issue is that Greece’s swap positions were somewhat known to the public, but ignored. There was no one in Greece or the EU overseeing the derivative investments. The EU should require governments to increase transparency. Countries should be required to disclose all derivative positions to a EU central agency, to oversee the risks and to act as the oversight whistle blower, when government employees get out of control with their derivative trading.
CB says:
“English insurance underwriters in the 1700s often sold insurance on ships to individuals who did not own the vessels or their cargo. The practice was said to create an incentive to buy protection and then seek to destroy the insured property. It should come as no surprise that seaworthy ships began sinking.”
Amazing. The financial industry has simply dusted off their very old, lucrative ways. There is nothing new under the sun.
March 10, 2010, 3:26 amHow and where can i work online with no credit card? says:
[...] The Volokh Conspiracy » Blog Archive » Two Views of Credit Default … [...]
March 10, 2010, 6:09 amDavid Schwartz says:
Are people just too dumb to realize this? Or are there just lots of suckers?
Any time someone presents an “everyone is doing it wrong, they should be forced to do it this way” argument, I want to hear some kind of plausible explanation for why they don’t do it the obviously better, safer, superior way voluntarily — if it really is better.
Is there something preventing someone from creating CDS-like products that do require an insurable interest? And wouldn’t people, assuming you’re right, prefer those instruments since they would have less risk of the problems you mention?
I’m not saying you’re wrong, just that you have to overcome the fairly strong presumption that other people know what’s best for themselves and won’t intentionally chose obviously inferior choices unless something distorts their incentives. Is there some externality?
March 10, 2010, 8:19 amAdam Scales says:
David,
The insurable interest argument is that non-”interested” purchasers of CDS will have the incentive to engineer losses in the referenced entities. The whole point of this line of criticism is that this dynamic creates the externality risk.
There are, of course, CDS that involve insurable interest – but they are a relatively small portion of the market. While purchasers are free to buy them, they presumably wouldn’t be better off if the underlying debt went bad. Purchasers of “naked CDS” would be.
Whether insurable interest is worth it is an interesting and debatable question, but this is not a case of people not knowing what’s best for them (except in the long-term); it’s a suggested example of people acting against what’s best (desirable, fair, smart, etc.) for other people.
March 10, 2010, 8:58 amSlow says:
we are just rehashing problems solved over a hundred years ago. Wall Street just obscured the reality.
They are taking insurance out on their neighbors house – thats it. In this country the bank that lends you money to buy a house can’t take out in insurance on it. They can force you too, but they cannot own their own separate policy.
Seriously, this is just a mob style churn and burn scam. Run up debt on the business, then when it can’t borrow any more, burn it down (mob takes items bought with the borrowed money and the insurance money) and leaves the owner of the business on the hook for the debt.
March 10, 2010, 9:06 amStephen Lathrop says:
I think the obvious externality is cook-the-books rating agencies. People might prefer the kinds of securities you suggest if they were better rated than the others, but how could they be? Much of the junk was apparently top rated.
Aside from that, the relevant comment might be, “Anything is possible—if it happens.”
March 10, 2010, 9:51 amStephen Lathrop says:
Oh, and see Adam Scale above. He explains it well.
March 10, 2010, 9:54 amBill says:
A simple way to enforce the insurable interest requirement would be to require physical settlement of CDS contracts — if you can’t deliver an appropriate quantity of the protected but now defaulted security, you don’t get the insurance payout.
see http://en.wikipedia.org/wiki/Credit_default_swap#Settlement for the difference between physical and cash settlement.
March 10, 2010, 10:41 amMartinned says:
What he said.
My only concern is that there might be no way to preserve the possibility of hedging country risk in this way while simultaneously solving the problems we’re trying to solve. If Gensler’s proposals turn out not to go far enough, we might have to sacrifice uncovered CDSs in order to preserve/obtain some semblance of stability.
March 10, 2010, 10:49 amCREATE TABLE `%sgdsr_templates` ( | attractionmarketingpro.net says:
[...] The Volokh Conspiracy » Blog Archive » Two Views of Credit Default … [...]
March 10, 2010, 10:54 amCREATE TABLE `%sgdsr_templates` ( | attractionmarketingpro.net says:
[...] The Volokh Conspiracy » Blog Archive » Two Views of Credit Default … [...]
March 10, 2010, 10:54 amDavid Schwartz says:
I don’t see how. How can a person who refuses to buy or back a CDS that doesn’t require an insurable interest get harmed?
March 10, 2010, 11:18 amMartinned says:
If the trading in the CDS market affects the market for the principal. Eg. speculation in the Greek (bond) CDS market causes the value of those derivatives to plummet, which undermines investors’ confidence in Greek bonds, which causes the value of those bonds to plummet as well. I admit, it is hardly what a remotely efficient market looks like, but it might happen.
March 10, 2010, 11:34 amDavid Schwartz says:
Martinned: But this still comes down to protecting people from themselves, not others. Assume all of you are right and CDS’s that don’t require an insurable interest should be prohibited, and so long as they’re not, rational people should not buy them, sell them, or rely on their easily manipulable prices.
Now you need someone to offer less than the bonds are really worth (net present value of their expected payout times the probability they will pay out) because he ignores the fact that these CDS’s are manipulable. And you need someone to sell them for less than they’re really worth. And you need people to price them based on data we all know is worthless.
In other words, everyone else still has to be wrong and stupidly acting against their own interests. That’s not impossible, but there’s a strong presumption that people won’t act against their own self-interest when others claim it’s so obvious that they are being irrational. It is far, far more likely that there are complex reasons they are actually being rational.
March 10, 2010, 11:53 amAdam Scales says:
David,
I don’t think you’re following the argument here. That argument, by the way, is very debatable, but we seem to be talking past each other.
Structurally, your point denies that there is a problem with permitting individuals to buy fire insurance on homes they don’t own. After all, the protection seller (insurer) and the protection buyer (“stranger”) can see what they are doing, so no problem.
That’s not the argument here (at least, not yet). The argument is the protection buyer now is interested to see that the property does in fact burn down. How could he do this? Well, here’s where things get tricky. He could torch the place, but that’s already illegal. He could pay the owners to start smoking in bed, but they might realize that’s a bad idea. He could hire lobbyists to weaken the fire code, so that fires were more likely. These might not be successful strategies, and there are norms that reinforce their non-use. However, it is interesting to observe that insurance law has generally not abandoned the insurable interest requirement on these grounds (its strongest application remains the field of life insurance, though that has gotten very complicated).
CDS obligations are somewhat different, because 1) you don’t need to cause a catastrophic loss in order to benefit from the protection you’ve purchased, and 2) the relevant norms are difficult to specify. What I mean by 1) is that CDS obligations can define relevant “credit events” in ways that reflect the erosion of confidence – but not a total loss. Your own fire insurance policy will not start paying (you, or anyone else) if you start smoking in bed tomorrow. CDS obligations DO, as the risk of “fire” (default) rises. Moreover, the market perception of that risk lies not solely in the hands of the reference entity (in this case, you). Instead, ratings agencies and market behavior will drive the perception of risk. This is not irrational per se, and over the long term, should be about right. But it can cause very large swings in an entity’s fortunes over the short term – swings that can exaggerate the “true” long term difficulties (Relatedly, this got CDS sellers into trouble, particularly AIG. We may agree that AIG got what it deserved, but the consequences were much broader for us all).
Second, financial markets obviously have lots of rules, but behavior that might negatively affect asset values beyond their intrinsic worth are not always illegal. If you short a stock, you have a real incentive for the price to go down. As long as you are not lying, you can say whatever bad opinions you genuinely hold. On one view, CDS contracts work in this way – they permit discovery of the truly execrable value of Greek debt, or other obligations. However, rather than talk down Greek debt obligations, suppose that you, a CDS holder, perform currency trades that have the effect of making it more difficult for Greece to finance new debt, which raises fears of default. This is not obviously illegal behavior in my eyes, and I suppose there is a price discovery rationale. You will agree, I hope, that transactions thus motivated by CDS ownership will impact third parties (here, the Greeks).
Consider the incentives when 80% of the CDS market involves protection purchases who stand only to gain if the reference entity declines in value, or defaults completely. Is it conceivable that they will look for ways to make that more likely? I think it is. You may think otherwise, and that’s perfectly fine. But if you agree that its possible, I think we’ve closed the discussion of whether this debate is simply about protecting people (or not) from themselves.
As I said, insurable interest is surprisingly contentious in insurance law, and very difficult to apply in the world of finance. It may be that it is factually or conceptually inapplicable in financial markets (restrictions of futures contracts are a similar story of the market’s ability to erode a norm over time). Greece, like AIG before them, has every incentive to blame “speculators” for its continuing troubles, so we should take this with a grain of salt. I’m not sure they are completely wrong, however.
March 10, 2010, 12:25 pmMartinned says:
@David Schwartz: Actually, I argued earlier for the Gensler position, with a full ban on uncovered CDS transactions only as an option of last resort.
The – possibly irrational – interaction between the CDS market and the underlying bond market is a real problem, not only because it can work the other way as well, but also because those bonds are, in turn, the security for pretty much all other transactions in the financial system. They are security for loans to Greek banks by the ECB, they are the bank’s guarantee vis-à-vis its customers (remember, ordinary government bonds get a zero or 20% weight in Basel-II risk-weighted-capital calculations, meaning that they’re as good as cash for bank regulation purposes), etc.
Instability in the bond market affects the entire financial system, which is bad enough if that instability is justified by underlying variables, but all the worse if that instability is simply caused by speculation in a derivative market.
March 10, 2010, 12:27 pmStephen Lathrop says:
Maybe a person can get harmed because a financial market collapse is never a good thing for the bystanders?
I never bought a CDS of any description, but something has been harming me financially—I’m sure of it. My recent-college-graduate son recently called around to check up on how some of his high school friends are faring in the brave new job market, now that they too are new-minted college graduates. Two are working for collection agencies.
It would take the kind of criminal investigation we will probably never see to detail exactly what was done, when and where and by whom. But I think you can take it as a moral certainty that whatever it was, credit default swaps on bad debt had a lot to do with it. Is it your notion that all this financial ruin was actually created by something else, something we haven’t yet heard about, perhaps?
March 10, 2010, 1:13 pmgasman says:
Considering that speculation is a financial action that does not promise safety of the initial investment along with the return on the principal sum, what trading is not speculative? Are they really proposing eliminating almost all investment?
March 10, 2010, 8:12 pmDavid Schwartz says:
There are two arguments in there that I need to respond to:
1) The burn down the neighbor’s house argument: The direct victim in this case is the insurance agency which *chose* to issue a fire insurance policy without requiring me to have an insurable interest fulling knowing that this would incentivize me to burn the house down. So if you’re right that the insurance company was stupid to do this, you still have a case where the direct victim acted against their own interest. So I still don’t see a way for there to be direct victims who don’t act against their own interests. If you’re right, the victims are stupid. We don’t normally prohibit things just to prevent sophisticated people from acting against their own interests.
2) The indirect victims arguments: Absent some kind of externality, I reject the form of those arguments. If you can do something that creates indirect victims, you have every right to do that. If I decide to retire instead of working, that creates indirect victims who could benefit from me being in the labor market. If I decide to save money rather than spend it, that creates indirect victims. I can’t put my finger on precisely what more than indirect victims I need, as that’s a fact-specific and case-specific question, but the mere fact that an action can cause indirect victims without violating anyone’s rights is not nearly enough to justify prohibiting conduct. At least, not for anyone who is even remotely libertarian leaning.
March 10, 2010, 10:27 pmMartinned says:
Sure, unless the government decides that curtailing your right is a net benefit to society. (Assuming we’re not talking about constitutional rights.) I used to have the right to smoke in bars, but now I don’t. That’s a bummer, but it’s hardly an illegitimate law.
March 11, 2010, 11:37 amDavid Schwartz says:
But there the justification is not about protecting the indirect victims. The justification is to protect the other people in the bar who would be direct victims.
Do you think, for example, that it would be legitimate to ban skiing because skiing injuries are expensive for health insurance companies to cover?
The argument is always that allowing smoking in bars puts a difficult choice on people who don’t want to breathe in smoke — they either have to risk some damage to their health or they have to avoid that bar. Can you see any similar analogy with the direct victims of CDSs? I sure can’t.
March 11, 2010, 6:55 pmKip says:
What are you talking about? If someone takes an insurance policy out and then burns my house – I’m the victim! Why are you so ready to brush aside people destroying my wealth to enrich themselves? I’m the direct victim – at what point did I take any action, let alone direct action against my interest of living in my house. And regarding the insurance company, this battle was fought decades ago – every state has an insurance commission to make sure that companies adequately reserve for losses. Because, left to their own devices, they often did not.
I suggest you read this for an alternate view of CDS contracts
The Architecture Of The Scam (Goldman .et.al.)
“The simple reality is that CDOs, CDS and similar articles when used to hedge large quantities of financial instruments or events (such as by a bank) are an artifice. The only way that one can “deal in” CDS and make a profit, as the banks have done, is if someone is willing to sell you protection at less than the true risk-adjusted cost, or you can manage to sell it at higher than the risk-adjusted price.
Both require that someone be deceived – that is, that someone intentionally misrepresent either by commission or by intentional concealment of material facts.”
. . .
“It is reasonable for someone to buy insurance against a single event, as a single actor, holding a single risk. That’s because their individual risk is large for the return they receive. It is why you buy insurance against a fire in your house – the risk of a fire is small, but the damage if you suffer a fire is large.
“But if you own 100,000 properties dispersed across the nation with no particular concentration you’re an idiot to buy insurance against each and every property having a fire. Why? Because it is axiomatic that you will pay more for the insurance than you will lose to fires! You must – otherwise the insurance company that sells you the policies will go broke and be unable to pay at all!”
And what happens when the insurance company (AIG) fails – everyone (indirect victims) is taxed to pay off their debts.
March 11, 2010, 9:58 pmDavid Schwartz says:
Kip: If I burn down your house, you are the direct victim. But arson is already illegal. You are not the direct victim of the insurance transaction. Why not ban expensive cars? People might steal (and even kill their spouses for life insurance money) to be able to afford them.
Wow, that’s such complete and utter nonsense. I wouldn’t even know where to start correcting all the misinformation packed into that tiny morsel. However, I will point out that if this argument is correct, *all* insurance companies that make a profit do so by fraud. It also fundamentally misunderstands that rational people may well sacrifice some statistically-expected profit in exchange for a statistical reduction in risk. It also assumes investment is a zero-sum game, which is not true. If you make it possible for someone to invest (in a real venture) where they otherwise couldn’t (say because they couldn’t obtain financing due to risks they couldn’t hedge), everyone can be better off. And those are just the easiest of the things wrong with it to point out — literally *nothing* about it is correct.
If that’s the reasoning behind the push to ban CDS, that’s frankly very scary.
March 12, 2010, 10:52 amP1 Ah Yap says:
Excellent post very interesting article. I should get back to this website later to check some of other posts. Thank you!
March 14, 2010, 2:30 pm