by reviresco » Wed Mar 04, 2009 1:25 pm
Hello all,
Regarding Chairman Bernanke’s anger at AIG, I have read that the current estimated value of outstanding Credit Default Swaps hover somewhere around 30 trillion dollars, and with many individuals, corporations and entire countries worldwide teetering on the edge of default on debt of all types, claims may be made by many holders of these CDS. There’s only one problem:
“A policy without insurable interest is void”
A basic tenet of all insurance for hundreds of years, this asserts that one cannot insure your neighbor’s house in the hopes that it will burn down and thus profit from your neighbor’s misfortune.
While the underwriters of these contracts (and especially those that would benefit financially from defaults) argue that the lack of regulation and accounting rules that normally apply to insurance contracts prove that Credit Default Swaps are not insurance products, such facetious arguments can no longer be entertained by financial officials and regulators at this dangerous juncture. And because they’ve been traded for over a decade now, one might assume that many swaps are no longer in the possession of the party who was actually attempting to offset risk at the signing of the CDS. For arguments sake, let’s venture that at this point 2/3 of Credit Default Swaps (or Twenty Trillion Dollars worth) probably violate this basic ethical principle of insurance.
Right now, the web of recursive counterparty valuations of these CDS are so complicated that the years necessary to sort things out are simply not available, and while a clearing house or market to trade and offset these contracts lessens the murkiness, it does nothing to block the path down bankruptcy road and government bailout for the institutions who so unwisely agreed to underwrite them in the first place.
One solution might be for the Treasury or the Courts to declare that Credit Default Swaps are in fact an insurance contract and subsequently a claims office could be organized by a special committee of State Insurance Commissioners (since it is the states, after all, who regulate insurance contracts at this time) to review all Credit Default Swaps at the claim stage, and to void the claim of any holder of a triggered CDS lacking verifiable insurable interest.
This would save trillions of US taxpayer dollars that would otherwise have to be passed into insolvent institutions (i.e. AIG & others) who in turn would pay these dollars out to hedge funds and other speculators for what are legal, but de facto fraudulent insurance contracts.
And so, instead of moving trillions of dollars from the taxpayers to speculators, the SIC claims office could instead recompense any not-at-risk entities only their premiums paid, rather than the face value of the swap, since they purchased what amounted to a fraudulent insurance contract to begin with.
