Publications: The New York State Insurance Department and Credit Default Swaps: Good Intentions, Bad Idea

Financial Services Group Chair Alton B. Harris co-authored the article, "The New York State Insurance Department and Credit Default Swaps: Good Intentions, Bad Idea," published in the January/February 2009 issue of the Journal of Taxation and Regulation of Financial Institutions.

To read the first page of the article, please see below.  To read the full article, please click the Related Files link.

Acting in the belief that the use and misuse of credit default swaps (CDSs) were in large part responsible for the extraordinary current financial crisis,¹ the New York State Insurance Department (NYID) on September 22, 2008, issued Circular Letter No. 19 (2008) (“Circular 19”) announcing that as of January 1, 2009, it would view CDSs as insurance contracts if they are purchased by persons with a “material interest” in the referenced bonds or assets (covered CDSs).² At the same time, the Governor of New York called on the federal government to regulate the rest of the massive $62 trillion credit derivatives market. ³

¹ With allegations that CDSs are at the root of the global financial crisis, gaps in CDS regulation have come into the spotlight. See Alex Blumberg, “Unregulated Credit Default Swaps Led to Weakness” (available at www.npr.org/templates/story/story. php?storyId=96395271); James B. Kelleher, “Buffett’s ‘time bomb’ goes off on Wall Street,” Reuters, September 18, 2008. Wolfgang Munchau, “Not Merely a Subprime Crisis,” Financial Times, January 14, 2008 (available at www.eurointelligence.com/index.php?id=581&type=98&tx_ttnews[tt_news]=1996). As Eric Dinallo, Superintendent, NYID, said in addressing CDSs:

The unregulated marketplace in credit derivatives was a central cause of a near systemic collapse of our financial system. Credit default swaps played a major role in the financial problems at AIG, Bear Stearns, Lehman and the bond insurance companies. A major cause of our current financial crisis is not the effectiveness of current regulation, but what we chose not to regulate.
“Testimony To The United States House Of Representatives Committee On Agriculture Hearing To Review The Role Of Credit Derivatives In The U.S. Economy” (by Eric Dinallo, Superintendent, New York State Insurance Department (November 20, 2008)) (www.ins.state.ny.us/speeches/pdf/sp0811201.pdf) (hereinafter “Dinallo Testimony”). See also Press Release, New York State Insurance Department, Recognizing Progress by Federal Government in Developing Oversight Framework for Credit Default Swaps, New York Will Stay Plan to Regulate Some Credit Default Swaps (November 20, 2008) (available at
www.ins.state.ny.us/press/2008/p0811201.htm).

² New York State Insurance Department, Circular Letter No. 19 (September 22, 2008) (available at www.ins.state.ny.us/circltr/2008/cl08_19.pdf) (hereinafter “Circular 19”).

³ Press Release, New York State Insurance Department, “Governor Paterson Announces Plan to Limit Harm to Markets from Damaging Speculation” (available at www.ins.state.ny.us/press/2008/p0809224.pdf) (hereinafter “Governor’s Press Release”).
“The absence of regulatory oversight is the principle cause of the Wall Street meltdown we are currently witnessing . . . .” “The primary goal of insurance regulation is to protect policyholders by ensuring that providers of insurance are solvent and able to pay claims on policies they issue. The goal of regulating these swaps is not to stop sensible economic transactions, but to ensure that sellers have sufficient capital and risk management policies in place to protect the buyers, who are in effect policyholders.” Id. “FGI policies on CDS have exposed FGIs to certain risks that they have proved ill-equipped to underwrite or otherwise address effectively. Recent experience has shown that guarantees of CDS for which the FGI uses an SPV as a nominal counterparty are not consistent with the prudent operation and regulation of an FGI.” Circular 19, at 7.