Over the weekend, Felix stole a bit of my thunder, arguing preemptively that insurance commissioners shouldn’t regulate CDS, that CDS aren’t insurance in the first place. (A similar argument was made on Economics of Contempt.) Personally, I like the idea of a little internecine warfare here at Reuters. I think that means Felix and I are doing our jobs. In fact, he makes some good points in his post, but his chief argument is fatally flawed. I can’t let him get away with it. (Oh, and I’ll explain the title of the post in a second)
Here’s Felix’s argument:
First, credit default swaps are not insurance, they’re swaps. A lot of journalists talk about them being “like an insurance contract” when they try to explain what they are, and that’s true, as far as it goes — they do share certain characteristics with insurance. But that doesn’t mean they are insurance. It doesn’t mean that some foolish law should be passed forcing buyers of protection to have an “insurable interest” in some underlying debt instrument, and it certainly doesn’t mean that all CDS should be regulated by some insurance commissioner somewhere.
Let’s be clear, I didn’t say CDS are “like” insurance. I said they are insurance. The fact that “insure” is the only verb capable of describing their function settles that argument pretty quickly. The insurable interest argument, which is the same one made by Economics of Contempt, is totally circular. Insurable interest isn’t a feature of insurance, it’s a feature of insurance law. All that needs to happen to make the insurable interest doctrine apply to CDS is for legislators to pass a law requiring it, which is essentially what Assemblyman Morelle would like to do.
The question is whether that makes sense. I argue it does. The reason we require buyers of insurance to demonstrate an interest in the insured property is to eliminate incentives to destroy that property.
(more…)
