FINANCE: OTC and CDS

Some interesting information:

Structured Finance

OTC's are over the counter security sales.

CDS - credit default swaps: Time article & Businessweek

Bank of International Settlements

SWAPs in general

CDS's were made legal by the Commodity Futures Modernization Act of 2000. Which is apparently something Phil Gramm is still pretty proud of, according to the NYTimes...

In November 1999, senior Clinton administration officials, including Treasury Secretary Lawrence H. Summers, joined by the Federal Reserve chairman, Alan Greenspan, and Arthur Levitt Jr., the head of the Securities and Exchange Commission, issued a report that instead recommended legislation exempting many kinds of derivatives from federal oversight.

Mr. Gramm helped lead the charge in Congress. Demanding even more freedom from regulators than the financial industry had sought, he persuaded colleagues and negotiated with senior administration officials, pushing so hard that he nearly scuttled the deal. “When I get in the red zone, I like to score,” Mr. Gramm told reporters at the time.

Finally, he had extracted enough. In December 2000, the Commodity Futures Modernization Act was passed as part of a larger bill by unanimous consent after Mr. Gramm dominated the Senate debate.

“This legislation is important to every American investor,” he said at the time. “It will keep our markets modern, efficient and innovative, and it guarantees that the United States will maintain its global dominance of financial markets.”

But some critics worried that the lack of oversight would allow abuses that could threaten the economy.

Frank Partnoy, a law professor at the University of San Diego and an expert on derivatives, said, “No one, including regulators, could get an accurate picture of this market. The consequences of that is that it left us in the dark for the last eight years.” And, he added, “Bad things happen when it’s dark.”

In 2002, Mr. Gramm left Congress, joining UBS as a senior investment banker and head of the company’s lobbying operation.

That does seem a bit corrupt, doesn't it?

I've been wondering for a while why Banks and pension funds bought CDOs (especially the "toxic waste" - why would anyone buy something with that nickname?). This is an interesting bloomberg article on that point...

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Darrell Duffie, a professor of finance at the Stanford Graduate School of Business in Stanford, California, says he's concerned about public pension trustees' getting their CDO education from the banks that are selling the investment.