U.S. bill would restrict over-the-counter (OTC) derivatives with new regulations

July 30, 2009 by · Leave a Comment
Filed under: Industry News 

This is much needed.  In no way can we have financial instruments that equal ten times the globe’s GDP and not have it under strict regulation.  The reason is because these paper contracts were used to get more leverage which is fine when everything is stable but can be a total disaster when the economy goes south or the firms that have written these go bust and causes them to go to “full performance”.

These should not be on any off-balance-sheet transaction and any company holding them should have strict capital requirements just like any other form of insurance that protect the policyholder against the institution from defaulting.  If you read a book called “The New Monetarism” it has an interesting chart that shows an inverted pyramid with real assets at the bottom and OTC derivatives at the top and that represents global liquidity.   In this chart, these derivative instruments represented 75% of all the liquidity in the system.

News (Reuters):

U.S. financial regulators would gain the power to restrict holdings of over-the-counter derivatives under legislation to be considered this fall, the chairmen of two House committees said on Thursday.

Chairmen Barney Frank of the Financial Services Committee and Collin Peterson of the Agriculture Committee said antispeculation provisions would be part of legislation to bring the $450 trillion OTC derivatives market under federal regulation.

The bill also clamps down on a type of derivative called credit default swaps (CDS), which have been blamed for magnifying global economic distress by spreading losses from bets on risky mortgages and other debt.

The swaps are used to insure against debt defaults and speculate on borrower’s credit quality.

A key question for the OTC bill is whether to outright ban “naked” CDS, swaps for which the trader or investor does not hold the underlying asset being insured. The alternative is requiring regulators to monitor CDS trading and restrict the size of holdings — position limits — by dealers and large investors.

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