Is a Credit Default Swap (”CDS”) a Contract of Insurance?

This question was resolved in the negative some ten years ago in both London and New York

Posted by jck at 8:10 am ET on October 9th, 2008 |

11 Responses to “ Is a Credit Default Swap (”CDS”) a Contract of Insurance? ”

  • # 1 barry Says:

    Almost 25 years ago (man time files), I was working at a large NYC bank that wanted to start trading in OTC currency options. We had to convince NY State regulators that such options were neither insurance poliices nor a form of gambling. Convincing the regulators proved more diffiuclut than our lawyers had anticipated. We won the day on the insurance argument by pointing out that we could ‘delta hedge’ (try explaining that to an insurance regulator) the options. We won the day on the gambling argument by pointing out that we didn’t have a fixed payout (we crossed our fingers that no one would ask about an option spread).

    What is the French say, “La plus la change, la plus de meme chose” or something.

  • # 2 jck Says:

    plus ca change, plus c’est la meme chose, eternal truth, the FT calls CDSs, a “kind of insurance” I call it a bet, that’s simpler.
    btw there is a very good book on gambling, banking, insurance etc called ” a world of chance” by brenner and aaron brown, check it out.

  • # 3 dd Says:

    I believe the New York Department of Insurance can reconsider opinions, clarify and issue new regulations. So, while the question was resolved for the moment it was not settled as a matter of law as that requires either clear legislation (although no matter how “clear” it is still subject to judicial review) or a judicial determination; both are preferable.
    As for other nations, their laws and opinions are not binding on the US unless someone comes up with a treaty obligation.

  • # 4 Kiers Says:

    it is nice for (m)ass media (actually a very cunning media) to call it insurance…as in …oh I just wanted to buy some ‘protection’ on this….
    very warm fuzzy feeling…

    jck is right…it is a bet, it is a replication of credit, it is a means to get hold of credit OTC, it is a way to short bonds…it is all BUT “insurance”.

    Did u see the 60 minutes interview with ISDA chief [last Sunday]..???
    remember the same ISDA would charge you $90 for a 10 page blue guide on suggested ‘boilerplate terms’ used in CDS contracts…! remember…

  • # 5 dd Says:

    Under traditional definitions CDS is insurance and the worst sort w/o reserves as learned in 1905 reserves are all. But Greenspan’s horn blew and states went quiet. If it is a bet it is worse as gambling is illegal in all states unless a license is issued.

  • # 6 dd Says:

    Options went through the same sort of labyrinth but Friedman and the UC managed to morph commodities type trading to an options forum but it was regulated, open and transparent. Even then the “portfolio insurance” almost melted equities and w/o Greenspan forcing Continental to bail out a strapped Bear disaster awaited. Then again Greenie was far better at enlightening interested parties about their interests.

  • # 7 kiers Says:

    my friend, dd, if you worked in ANY investment “bank”, in post 2000, you KNOW CDS is a BET.
    I-Banks even could take out CDS on themselves!!!!!! IT HAPPENED.

  • # 8 Charles Davi Says:

    Hi,

    I authored an article you posted on your site. Just thought I would point you too another article I wrote which answers this question, in the negative.

    http://derivativedribble.wordpress.com/2008/10/21/the-regulatory-gong-show-new-york-struts-and-frets-its-hour-upon-the-stage/

  • # 9 jck Says:

    Many thx, will read it soon, busy at the moment.

  • # 10 jck Says:

    Charles:
    Good blog, I have added to the sidebar and good articles, will make a post about your blog later.

  • # 11 Charles Davi Says:

    Thanks! I’ll be adding some more material very soon.

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