House of Representatives Agriculture Committee Chairman Collin Peterson of Minnesota circulated an updated draft bill yesterday that would ban credit-default swap trading unless investors owned the underlying bonds. The document, distributed by e-mail by the committee staff in Washington, would also force U.S. trading in the $684 trillion over-the-counter derivatives market to be processed by a clearinghouse.
As much as 80 percent of the credit-default swap market is traded by investors who don’t own the underlying bond.
Naked CDS are evil because they demultiply the effect of bad debt. 1x bad debt is bad enough but if many Nx people bet against bonds then you have Nx the impact of debt imploding. Apparently that ration is 80 to 20 or 4x. Of course there is some noise in there about a professor who think it is a bad idea and wants to see the bill dead but to me, both propositions are no-brainers and I will ignore this particular professor. JPgoldmorgmanstanley however make 40% of their profits on these OTC markets so expect some lobbying.