In my earlier post I took a Free market advocates position while looking at the recent WSJ story. In this post the same story is viewed through a different lens which yields a pro-regulation conclusion.
For all the high falutin terminology and complexity, a CDS is just a bet placed with a bookie. The industry (even the article wrongly makes this argument) keeps likening it to insurance, fact is if you carry life insurance on a stranger/public personality (say a racing driver), that is not insurance, that is a bet that he will die! (soon?) In this case most of the buyers of the CDS did not hold the security so same deal, these are bets. Now any bookie knows that if enough bets are placed and the book gets skewed enough, the bets will produce the result not the other way around, (games, fights and races are rigged all the time for this very reason). That is the ugly reality of big money betting.
If you want to cleanup a game, you have to curb betting on it. By this argument, if you want to cleanup the ABS business you have to outlaw CDS purchase without proof of ownership. Just as I can’t buy auto insurance on a car I don’t own, a bank should have not be permitted to buy “insurance” on what they don’t own. So make it truly like insurance and regulate it the same way. Outlaw betting/gambling on wall street in line with federal law, which prohibits betting except on a game of chance (dice etc.). CDS on ABS, is a game of serious skill, not chance.
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