**** you, method of characteristics

[chequita guevara]

Innovation for its own sake isn't worth protecting. The fact that nothing has come in preventing the potential fraud, abuse, and pitfalls of Credit Default Swaps is an indication that the argument that innovation will be stifled is firmly unfounded in any fact.

at the thought that CDS are more prone to fraud and abuse than are joint stock companies.

They are if joint stock companies are regulated and CDSes aren't.

[KrazyHorse]

Asher caused the crisis.

[KrazyHorse]

They are if joint stock companies are regulated and CDSes aren't.

Joint stock companies are orders of magnitude more complex in their operations than are CDS, which are simple contracts obliging each party to fulfill certain specific and well-detailed obligations. Joint stock companies are subject only to the dispersed attention of their shareholders through the occasional board elections, causing tremendous agency problems. CDS are subject to the highly-interested and concentrated attention of the two parties. The case for regulating joint stock companies is OBVIOUS (and it's not to prevent stock bubbles/crashes!). The case for regulating a two-party contract simply because you can is NOT.

[KrazyHorse]

Go ahead and regulate them. More work for me to subvert the regulations.

[MRT144]

What strawman? You're obviously concerned with the prospect of abuse of CDS, but you're willing to live with the ever-present FACT of corp. misgovernance.

Your concern over CDS is almost certainly based on nothing more than a facile understanding of their terms and some sort of scare story you read in the WaPo/NYT/WSJ.

I can see the use of them, I just can't see the use in not having a capital requirement for the seller, or there being 4 to 5 times more CDS sold than the value of the underlying instrument or that one need not own the underlying instrument to enter into a CDS contract.

The problem in this specific instance was that Goldman got a payout from AIG on the Lehman bonds, well in excess of what AIG could pay out given their imminent default, and only through the magical hand of Uncle Sugar could Goldman be made whole. That strikes me as peculiar and wrong.

If you're willing, please explain how the contact between AIGFP and GS worked. It's my understanding that GS payed AIGFP a premium that would result in a payout in excess of the premium paid in the event of a default on the underlying bonds. What are you trying to say when that AIG get's the money back (when and how), and that the payouts are collateral on contracts. The time duration of the CDS hadn't lapsed, the default condition happened, right?

[MRT144]

Go ahead and regulate them. More work for me to subvert the regulations.

You'll fit right in at Goldman.

You're essentially saying, nothing should be done because the law will be broken anyway, except that tax payers bear the costs of the law breaking, either in prevention or restitution. Given the SEC's paltry budget and compromised abilities (I don't even want to use that word with them), why not at least TRY and prevent some stuff before it happens rather than after at greater cost?

[Drake Tungsten]

or that one need not own the underlying instrument to enter into a CDS contract.

I know that both KH and myself have explained the reasoning for this on several occasions.

[MRT144]

or that one need not own the underlying instrument to enter into a CDS contract.

I know that both KH and myself have explained the reasoning for this on several occasions.

There's reasons for it, no doubt, I just question the value of those reasons based on the exploitable nature of it.

[Drake Tungsten]

How is it exploitable?

[KrazyHorse]

You're essentially saying, nothing should be done because the law will be broken anyway

No, I'm saying that regulating them is just a bad idea. If given the opportunity I'll be happy to reverse the bad decision of the regulators via clever engineering.

[KrazyHorse]

Honestly, I hear all these scare stories about CDS. What I don't hear is evidence that they're actually being used nefariously, outside of the 1 or 2 cases I alluded to earlier.

[MRT144]

How is it exploitable?

1. Customer/Client withholds payment/withdraws capital to increase the likelihood of default and purchases CDS. Requiring that the purchaser of a CDS have some vested interest by being a bondholder would prevent this to some degree, especially if there was a limit as to the amount of CDS exposure you could have relative to the underlying bondholdings
2. Using CDS basis spread as a key metric of default likelihood encourages increased spread in basis, which triggers capital to leave which impairs the ability of the company to do business and increases the likelihood of default.

1. can be done and 2. can't be done.

[MRT144]

Honestly, I hear all these scare stories about CDS. What I don't hear is evidence that they're actually being used nefariously, outside of the 1 or 2 cases I alluded to earlier.

Why should taxpayers backstop an unregulated financial product? That's the problem.

Even better, why should taxpayers backstop a whole host of financial products? It follows that if you believe that Goldman has the ear of Uncle Sugar, their interest is going to be considered at the expense of others.

[KrazyHorse]

Customer/Client withholds payment/withdraws capital to increase the likelihood of default and purchases CDS.

This is precisely what I referred to. So far, I know of one instance of this. Any more instances?

If there truly has been only 1 or two cases of this, then shouldn't regulatory oversight be focused on areas where there are more problems?

Using CDS basis spread as a key metric of default likelihood encourages increased spread in basis, which triggers capital to leave which impairs the ability of the company to do business and increases the likelihood of default.

This simply doesn't make any sense.

[KrazyHorse]

Requiring that somebody own the underlying would be idiotic and demonstrates how ****ing little of this you understand. The WHOLE POINT of CDS is that it disaggregates default risk from other considerations, so that you can lay off GENERAL RISKS CORRELATED WITH THAT COMPANY'S DEFAULT. Requiring somebody to own the underlying in order to trade CDS is like requiring that somebody own the underlying to trade oil futures. It causes all sorts of transactions costs to appear.