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Regulate a $57 Trillion Industry? Yeah, That Sounds Like a Good Idea

Too big to fail? Maybe. Too big to regulate? Not according to some lawmakers.

Sens. Carl Levin (D-Mich.) and Susan Collins (R-Maine) introduced legislation today authorizing federal regulators to oversee the credit default swaps market — which has ballooned into a $57 trillion industry.

You remember credit default swaps. These babies — in essence, private insurance contracts in which one institution pays another when a third party defaults — are used to spread financial risk. They’re just one branch of the enormous swaps market. Yet the over-leveraging they allowed are thought by many experts to be among the primary factors leading to the global economic meltdown.

You might think that, considering the sheer size of the market, federal regulators would have been examining these swaps beneath a microscope. Think again. Current federal law actually prohibits the federal government from overseeing swaps at all.

Levin, who chairs the Senate Homeland Security and Governmental Affairs investigative subcommittee, and Collins, who also sits on the panel, are hoping to change that. Their proposal would remove the regulatory prohibitions on swaps while authorizing — though not requiring — the federal government to regulate the various swaps markets.

From Collin’s statement:

While local credit unions and small community banks are subject to safety-and-soundness regulation, enormous Wall Street financial institutions that have a far greater impact on our economy have not been subject to such regulation. This legislation would clear the way for federal financial regulators to oversee the swaps market. It is a critical component of the overall reform needed to restore confidence in our financial regulatory system.

The statement also lends a sense of just how huge the swaps markets have become:

Swaps are typically an agreement between two parties placing a bet on future cash flows. Some swaps bet on whether a stock price, interest rate, commodity price, or currency value will rise or fall; others bet on whether a company will default on payment of a bond. Stock price bets are referred to as equity swaps; bets on whether companies will pay their debts are referred to as credit default swaps.

According to the latest data compiled by the Bank of International Settlements, as of June 2008, worldwide swaps markets included credit default swaps with a total notional value of $57 trillion; commodity swaps with a notional value of $13 trillion; equity swaps with a notional value of $10 trillion; foreign currency swaps with a notional value of $62 trillion; and interest rate swaps with a notional value of $458 trillion.

The real question is, with so much at stake, why regulators have been banned from monitoring these transactions to begin with.

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