What We Really Need from a Bailout Bill: 58 Trillion Reasons

The CorporateCounsel.Net blog, Sept. 24, 2008:

Predictably, the bare-boned Treasury proposal for a bailout bill - frought with Constitutional problems - is receiving backlash on the Hill. Also predictable - given that elections are coming up - many key Republicans have come around to the notion that the bailout bill should include limits on executive pay (see this Washington Post article and NY Times' article).

However, the bailout plan is missing a strategy to fix the problems that caused all the problems that the market faces. Without a going-forward plan, I don't see an end to shoveling money to the bailout. Simply banning short sales ain't gonna do it. Yesterday, SEC Chairman Cox testified about some of these problems before the Senate Banking Committee - here is an excerpt:

"The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake. There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps - double the amount outstanding in 2006 - is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.
Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS. Whereas a person who owns a bond profits when its issuer is in a position to repay the bond, a short seller profits when, among other things, the bond goes into default. Importantly, CDS buyers do not have to own the bond or other debt instrument upon which a CDS contract is based. This means CDS buyers can “naked short” the debt of companies without restriction. This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern. As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets."