Eliminating the insurance loophole

"New York State's proposal to start regulating part of the credit default swaps (CDS) market may accelerate oversight of an industry blamed for helping to almost bring down the U.S. financial system (...) Under NY Governor David Patterson's plan, the New York State Insurance Department would require entities selling credit default swaps to bondholders to show they can actually pay the claims if there is a default. Under the new guidelines, which will become effective in January, such contracts could "only be issued by entities licensed to conduct insurance business", Bloomberg News

Dear readers, the CDS game is over. As I stated in "this previous post" you cannot allow a $60 trillion unregulated market to exist simply because something that big can pose a serious systemic risk if it fails. Especially when this market is in effect a consequence of a regulatory loophole within banking and insurance law.

In order for you to understand what I have just written, and the implications associated to new rules put forward by the NY State, let me quote another passage from Satyajit Das' "Traders, Guns & Money" (pages 272 and 273):

"The CDS resembles a guarantee; it is like insurance against bankruptcy. The bank is effectively reinsuring its risk on the loan, but you can't call it insurance. Only licensed insurers can sell insurance; if you don't hold a license then you risk prosecution. Most importantly, the CDS contract is void ab initio - it never existed at all. (...) Insurance law is full of Latin doctrines - uberrima fides is one. It means "the utmostgood faith". The person seeking insurance must disclose all possible risks to the insurer. Credit derivatives is the world of caveat emptor - buyer beware! If a CDS contract is insurance, then the contract may not be enforceable. The person selling the protection (the investor in the example) could claim that not all risks had been disclosed. (...) The derivative industry didn't resolve the insurance issue. It relied on legal opinions".