Do you think we should have regulated exchanges on things like [credit-default swaps?

HoughtonAndAtkeson answered one year ago …

We believe the guts of the problem are that there's too much leverage. Consider that the total corporate debt in America is about $3.7 trillion. Credit default swap (CDS) "insurance" contracts on that debt are $53 trillion.

There's also no visibility regarding who owes what because of the off-balance sheet nature of CDS contracts. Think Enron.

There's no confidence in banks, insurance companies and other financial market participants because no one knows who will be next to blow-up overnight based on huge amounts of CDS contracts that might come due.

With too much leverage, no visibility and no confidence, there is no commercial paper market because market participants have to hoard cash in case of unexpected CDS calls -- because if they lend cash, even on an overnight basis, it may not be returned.

If we were in charge we would fix these problems by:

• Immediately terminating the CDS market and call all existing contracts null and void. We would do this under the authority of national security/emergency powers.

• Immediately start a regulated debt insurance market for those lenders or owners of debt who wish to buy debt default protection. As a regulated insurance market, $1 dollar of debt could only have $1 dollar of insurance written on it instead of $14 dollars as is currently the case.

This would help U.S. economy and "Main Street." With the time-bomb of CDS liability removed, counter-party risk between lending parties would be vastly reduced.
This would also help unfreeze the commercial-paper markets. Regular operating companies could once again access cash to continue normal business activities.
We'd also expect a significant increase in the Dow—several thousand points or more, and no tax payers would be at risk.

Now, of course, if we did that, those who bought CDS contracts would have paid premium and receive nothing for it. Premiums could be re-paid by the underwriters of CDS contracts to alleviate this problem. In addition, bond holders who are concerned about remaining insured would have to buy replacement insurance possibly at higher prices.

The bottom line is that most of the current CDS obligations will never be paid because the amount owed is many times beyond the capacity of the underwriters to pay. Writing the CDS market off now is calling a spade a spade and removing the pressures that are driving our institutions out of business and raising economic uncertainty to historic levels.