Tuesday, March 16, 2010

Gensler on CDS regulation: many a mixed metaphor

CFTC Chairman Gary Gensler is no fan of derivatives in general, and credit default swaps in particular.

As he told attendees of a Markit conference on derivatives (via Risk magazine):

“I really do think CDSs directly contributed to the financial crisis of the past year-and-a-half,” commented Gensler, during his keynote address.


Gensler affirmed his belief in the empty creditor hypothesis, in which holders of CDSs and bonds seek to push companies towards bankruptcy for their own economic benefit. He evoked parallels with the English insurance industry of the 1700s, when individuals were able to buy insurance for ships they didn’t own. “It should come as no surprise that seaworthy ships began sinking,” he said.

The chairman used a more incendiary analogy in a recent op-ed in the FT:

In the autumn of 2008, certain financial institutions kicked over the lantern that set off the financial crisis – a fire that nearly burned down the global economy. In America, more than a year later, unemployment is at nearly 10 per cent. Most of those who have lost their jobs never used the flammable financial contracts that helped create the crisis.

(As an aside, we completely agree with Lex that comparing naked CDS to buying insurance against your neighbour’s house burning down is a strong contender for the year’s most overused analogy, to say nothing of being inaccurate)

But even Gensler does not believe in banning naked sovereign CDS outright, as he told the European parliament on Tuesday.

From the FT’s report on the matter:

In the face of repeated questions from MEPs, with a clear appetite for regulatory action in the wake of the Greek crisis, Mr Gensler said: “I’m not sure I know how an outright ban would work technically.”

One technical hurdle, he added, was distinguishing between speculators and genuine hedging activity. And, even if such issues could be solved, he indicated that he believed speculators were a legitimate part of the overall market.

Still, Genlser couldn’t resist a spot of metaphor:

“This is a dark ocean, this marketplace,” he commented.

Where is Lucy Kellaway when you need her?

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