New York insurance regulator calls for regulation of credit default swap market

The Superintendent of the New York State Insurance Department has called on the United States federal government to regulate the credit default swap (CDS) market, after CDS played a major role in the financial unravelling of the American International Group (AIG).
“In an interview with the New York Times, [New York] Governor [David] Paterson called credit default swaps ‘gambling’ and noted they were a major cause of AIG’s problems,” Eric Dinallo testified at the U.S. House of Representatives Committee on Oversight and Government Reform on Oct. 7. “He told the paper that ‘when we peeled back the onion, we found that AIG had so many credit default swaps that we couldn’t calculate how much money they probably had’ lost.”
Dinallo called on the U.S. federal government to follow New York’s lead in calling for a stronger regulatory oversight of the credit default swap market.
A credit default swap is a contract between two parties, in which one party pays the other for protection in the event that a third-party bond issuer goes into default.
Some credit default swap arrangements are insurance contracts, protected by state insurance regulators, Dinallo noted. Others, called ‘naked’ default swaps, are not licensed insurance
contracts, and hence are not regulated, because the purchasers of the swaps do not own the underlying bonds.
“Having New York regulate just part of the credit default swap market [i.e. not the “naked” default swaps] is not an ideal solution,” Dinallo told the committee. “As the governor clearly stated, we would much prefer an effective solution for the entire market.
“But until there is, we will do our job and regulate that part of the market that is insurance.”