Limits sought on credit-default swaps
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Kai Ryssdal: It’s tough to predict the next big thing in a story that’s moving as fast as this one is, but Friday’s looking good for a big development. That’s when the Lehman Brothers’ oustanding credit default swaps will be settled to the tune of $400 billion. Those are basically insurance that companies buy from one another without any regulation whatsoever. Perhaps not surprsingly, given the turn of events the past month, the Fed wants to impose some order on the credit default market. Which is why there’s a big tomorrow to try to hammer out the rules.
Marketplace’s Nancy Marshall Genzer reports.
Nancy Marshall Genzer: Credit default swaps are like bets. I want insurance in case a company fails — so I buy a swap. I’m betting it will fail. The person on the other end of the deal thinks the company will be just fine. If it is, they keep my money. If not, they’re supposed to pay up. Decision Economics senior economist Pierre Ellis says, it’s kind of like betting on a game with a buddy.
Pierre Ellis: You want to be sure that, should that person lose, they have the resources to pay off the bet, and that’s what a clearinghouse does.
The clearinghouse would be a referee. Ellis says it would standardize swap contracts and make sure the parties have enough cash to pay up. And the rules would still apply if the swaps were traded. Say, the company I bet against looks like it will go under — and I’ll win. If I need cash right away, I can sell my swap to someone else. Right now, the swap trading is unregulated. So everybody’s gotten tangled up. It’s like a big, sticky spiders web. Wayne State University law professor Peter Henning says Lehman Brothers was caught up in the web — then it failed.
Peter Henning: Of course, when one part of the web became unhinged, it affected everything else.
Milken Institute economist Jim Barth says a clearinghouse would bring all the swap traders under one roof. They could see the entire web, and minimize the damage.
Jim Barth: All the others parties are there that will fully understand that something has happened and will be able to collectively deal with that particular problem.
But do we really want to encourage credit default swaps? Barth says they’re just a tool. If used properly, they won’t cause chaos.
In Washington, I’m Nancy Marshall Genzer for Marketplace.
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