Dinallo Has Common Sense Solutions on CDS and Regulatory Issues

Includes: BAC, C, GS, JPM, MS
by: Tom Armistead

Eric Dinallo was on Bloomberg recently, talking about CDS and other regulatory issues. This clip is worth watching: he is the only politician or regulator who understands the dangers posed by CDS and inadequate regulation and is willing to talk about realistic solutions.

Dinallo, as former NY State Superintendent of Insurance has first hand knowledge of the issues involved, due to the problems he dealt with on AIG, MBIA (NYSE:MBI), Ambac (ABK) and other financial guarantors. He and NY Governor Paterson attempted to bring the CDS issue to a head by offering to regulate them as insurance, if the Federal government did not step in and do something. At the time, it seemed that Congress would be doing something, but more than a year later CDS regulation is still being debated and in the process whatever we get is going to be too watered down to resolve the issues. Dinallo makes some excellent points:

CDS should be regulated - as either insurance products or gambling products. Approximately 20% of CDS are supported by an insurable interest: they should be regulated as insurance with requirements for adequate capital. The other 80% of CDS are gambling contracts and should be regulated as such.

These views are in sharp distinction from those we see in Congress, where there is considerable weight given to the input from Goldman Sachs (NYSE:GS), Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), JP Morgan (NYSE:JPM) and CItigroup (NYSE:C). All of these "banks" make good money trading and steadfastly resist any efforts to regulate CDS in such a way as to prevent a recurrence of the debacle that required their rescue on the backs of over-burdened taxpayers.

CFMA, Graham-Leach-Bliley, Glass-Steagall - CFMA was the legislation that exempted CDS from regulation by either the CFTC or the SEC. Glass-Steagall enforced the separation of banks from other financial activities such as insurance, and Graham-Leach Bliley removed these important protections from the regulatory arsenal.

Dinallo's common sense analysis: depositary institutions must not be permitted to indulge in leveraged financial bets. That would include insurance companies such as AIG. Basically we need to repeal CFMA and Graham-Leach-Bliley, restoring the legal basis for adequate regulation of financial firms.

Compensation for TARP recipients - After noting that Wall St. seems to have trouble grasping the implications of the compensation issue, Dinallo adds that it's not just about the top executives. There are many operating employees (traders) making the big bucks. Obviously their compensation schemes motivate extreme risk taking, inappropriate with taxpayer support.

But he sees the solution as being improved regulation, not setting arbitrary limits on compensation. If CDS are limited to their proper function as insurance, issued by institutions that have adequate capital, the problem of excessive compensation will go away. If banks and insurance companies that are entrusted with people's savings and financial security are prohibited from gambling, the high rollers will go elsewhere, where they can't endanger the system, and their compensation will be paid by their gambling adversaries rather than taxpayers.

NY Attorney General - Dinallo is a candidate for this position. Noting that Elliot Spitzer was able to act as the "Sheriff of Wall Street" while serving as NY Attorney General, and that Dinallo makes sense on a lot of regulatory issues, there is potential for some reduction in Wild West capitalism.

Disclosure - No position in the firms mentioned.

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