CDS triggered by US action on Fannie, Freddie

Aline van Duyn at the FT has a piece of reporting on the effect of US intervention at Fannie and Freddie.

Apparently the act of being placed in "conservatorship" is equivalent to bankruptcy, and triggers many of these "insurance" contracts. The International Swaps and Derivatives Association (ISDA) is working on a protocol to address the situation.

This protocol will likely allow adherents to amend the documentation of their contracts, most likely (if past practice rules) to take advantage of some auction pricing mechanism.

Depending on the specific documentation (I haven't seen any) there could also be disputes over whether the "conservatorship" was actually a triggering event. Whether something actually constitutes a triggering event can be a notoriously tricky question.

Credit swaps again = insurance

Gretchen Morgenson has another story on the front page of the Sunday NY Times business section on credit derivatives, and those instruments are again described as "insurance contracts."  

I am really surprised there has not been a deluge of people writing in to nuance this description and assure regulators that, of course, these instruments may look like insurance (and are supposedly used like insurance), but are in no case whatsoever actually insurance.

The story, "First Comes the Swap.  Then It's the Knives," is a great read, and begins to reveal some of the dispute between investment bank Paramax and hedge fund UBS.

Share links to other CDO unwinding litigation in the comments....

Futures, I mean insurance, I mean futures...

The Sunday NY Times business section had two stories which had an interesting overlap.

First, Gretchen Morgenson, in reporting on how Fairfax Financial Holdings profited from credit derivatives, described those financial instruments as "insurance contracts that allow investors to bet for or against a corporation's bonds." (Good luck getting anyone in the financial industry to give you an opinion in writing calling a derivative "insurance.").

The second piece, by Nelson Schwartz, reported on Congressional efforts to control energy prices. Of note, Rep. John B. Larson proposed legislation that would ban unregulated (over the counter) trading in energy futures where the parties would not take delivery of the commodity, i.e. the positions would be settled in dollars. This proposal is fascinating in its own right, but where it gets very interesting, and how it really relates to the first article is in this quote from John Damguard, the president of the Futures Industry Association.

"The over-the-counter markets are a very important part of the way industry and institutions manage risk."

Well, he certainly makes over the counter deals sound a lot like insurance. Of course, most of the trades entered are not for true hedging purposes, e.g. futures purchased by airlines, but are instead large, heavily leveraged bets sold by traders and investment banks to investors seeking above market returns. And of course, if these deals were actually "insurance" as opposed to speculation, they (and the dealers who package and sell them) would fall under an entire class of regulation.

So, if we shouldn't regulate over the counter deals because they fill a important need of managing risk, then why aren't they regulated as insurance? It seems like the insurance industry should get on this one, and use a favorable bill to steal part of an industry away from Wall Street.