Speculation and uncertainty are the Devil

What is it with politicians and CDS?
Available at http://ftalphaville.ft.com/blog/2009/01/29/51850/what-is-it-with-politicians-and-cds/

FT Alphaville does not believe credit default swaps are The Devil, but many politicians and a host of people who really should know better are convinced that the CDS market is the cause of all the world’s ills, and should be regulated out of existence – immediately. Take the draft bill proposed by Collin Peterson, chairman of the agriculture committee of the US House of Representatives. His bill would require all CDS trades to be processed by a clearing house; more significantly, it would ban “naked” CDS trading – i.e. any trades in which protection buyers did not own the underlying bond referenced by the contract. Naked CDS trades account for about 80 per cent of the market.

This approximates to requiring anyone who is trading in the oil market to be prepared to take physical delivery of barrels of oil, or, as professor Mark Williams of Boston University put it to Bloomberg:
Saying you only can trade if you have the physical is like saying you only can write calls if you own the underlying. Imagine what impact that would have on our existing options market if such a ‘naked’ rule was mandated.

ISDA, the de-facto voice of the industy, is less than impressed, as per this terse statement:
“This bill would increase the cost and reduce the availability of essential risk management tools while failing to address the true causes of the credit crisis,” said Eraj Shirvani, ISDA Chairman and Head of European and Pacific Credit Sales and Trading at Credit Suisse.” Throughout the crisis, credit default swaps have remained available and liquid. They have been the only means of hedging credit exposures or expressing a view at a critical time for the industry. Impairing their use would be counterproductive to efforts to return the credit markets to a healthy, functioning state.”Not even the lawyers like the proposal. Robert Claassen, who chairs the derivatives and structured products group at Paul Hastings in New York, finds it “difficult to understand where the House agricultural committee is coming from”:

To the extent the committee is concerned about speculation in CDS, they should consider giving the CFTC or the Federal Reserve Board the right to establish margin requirements for CDS exchange trades that are not ‘bona fide hedges’ or the like, similar to the rules governing futures contracts. But an outright ban? While they are at it, why not prohibit the writing of any call option that isn’t a covered call? Or perhaps prohibit anyone from owning a house unless they intend to live there … the possibilities are endless! The CDS market has become a whipping boy for politicians, policy makers and talking heads attempting to earn some populist credentials. Is it too much to ask that they also seek to understand the role of the markets they are so fond of vilifying?

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