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Some Say Credit Default Swaps Should Be Regulated As Insurance

"Credit default swaps nearly brought down the world financial system last fall when it was discovered that AIG Financial Products had written hundreds of billions of dollars worth of credit protection without setting aside sufficient reserves. Yet since then, pathetically little has been done to get this corner of the derivatives market under control"  Today's Insurance Journal discusses credit default swaps and the notion of having them regulated as insurance that is currently being mooted.

Read the excellent Reuters' credit default swap commentary edited by Martin Langfield in the July 7, 2009 Insurance Journal

Credit Default Swaps and Your Insurance Company

by John Darer CLU ChFC MSSC CeFT RSP CLTC

Credit default swaps are financial contracts that "insure" against the default of financial instruments such as

Credit Default Swaps

and corporate debt which are also traded as a hedge against bond defaults.

Credit default swaps played a major role in the credit crisis that brought the downfall of Lehman Brothers Holdings, the bailout and restructuring of American International Group Inc., and Merrill Lynch & Co. being absorbed by Bank of America Corp.

Today Insurance Journal's Valerie Bauman cites New York Insurance Commisisoner Eric Dinallo:

"I have said for more than a year that credit default swaps should be regulated and that those who write them should be required to hold adequate reserves,'' Dinallo said. "But one thing should be clear. While the credit default swap market is not regulated, insurance company use of credit default swaps is.In New York, no insurance company can use credit default swaps except under very specific and limited ways and only with approval.''

AIG and Feds Reach Agreement to Clear $53.5B Per Regulatory Filing w SEC, Website

American International Group, Inc. (AIG) announced December 2, 2008 via its website that a financing entity recently created by the Federal Reserve Bank of New York (FRBNY) and designed to mitigate AIG's liquidity issues in connection with its credit default swaps and similar derivative instruments (CDS) written on multi-sector collateralized debt obligations (CDOs) has been launched. The new entity, "Maiden Lane* II, LLC", which was announced on November 10, is designed to purchase CDOs on which AIG Financial Products Corp. (AIGFP) has written CDS contracts. AIGFP has been publicized in the press as the AIG subsidiary company at the eye of the storm.

To date, the new entity has entered into agreements with AIGFP's CDS counterparties to purchase approximately $53.5 billion principal amount of CDOs. To date, $46.1 billion principal amount of such CDOs have been purchased, and the associated notional amount of CDS transactions have been terminated in connection with such purchases.

AIG has provided $5 billion in equity funding, and the FRBNY will provide up to approximately $30 billion in senior funding to the financing entity, of which approximately $15.1 billion has been funded to effect purchases of CDOs. The entity will collect cash flows from the assets it owns and pay a distribution to AIG for its equity interest once principal and interest owing to the FRBNY on the senior loan have been paid down in full. Upon payment in full of the FRBNY's senior loan and AIG's equity interest, all remaining amounts received by the entity will be paid 67 percent to the FRBNY and 33 percent to AIG.

Federal Reserve Board Press Release November 10, 2008

* for those who may be curious, Maiden Lane is major street in the New York City financial district.