Naked Credit Default Swaps Are “Like Buying Fire Insurance On Your Neighbor’s House —


Truth feeder
Washington’s Blog
March 2, 2010

I have repeatedly argued that naked credit default swaps should be banned. See this and this.

Savvy commentators like Wolfgang Munchau and Yves Smith are saying the same thing.

As I wrote last July:

Obama’s regulation of credit default swaps leave loopholes large enough to drive the biggest trucks through. Specifically, it forces over-the-counter credit default swap transactions to be traded through an exchange unless it is a non-standard cds. So all that the “financial innovators” who melted down the economy have to do is get a little creative in drafting their cds’ – or just to tell regulators “oh no, that wasn’t a standard contract”, and they are excepted from the regulation.

Similarly, the Obama administration has just passed a new set of regulations “getting tough” on the naked short selling of stocks, which independent economists say can manipulate stock prices and bring down otherwise healthy companies.

But the regulation will exempt hedge funds, and allow them to continue hiding their shorts from regulators.

That’s like passing a law outlawing arson to publicity and fanfare, but quietly exempting convicted arsonists from the new law.

As I wrote last September:

George Soros says … that credit default swaps are “toxic” and “a very dangerous derivative” because it’s easier and potentially more profitable for investors to bet against companies using them than through so-called short sales …

Credit default swap counterparties drive company after company into bankruptcy, and that – once a company the counterparties are betting against goes bankrupt – the counterparties cut in line in front of all of the bankruptcy creditors to get paid (and see this and this).

Now, the head of credit strategy at investment giant UniCredit is saying the same thing:

“It’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house,” said Philip Gisdakis, head of credit strategy at UniCredit in Munich.