Monday, May 21, 2012

Sheila Bair: JP Morgan highlights need for credit default regulation

According to a Telegraph article, Sheila Bair observed

The multi-billion dollar losses that JPMorgan Chase has racked up underline the urgent need to better regulate credit default swaps.... 
Credit default swaps act like an insurance contract in which the buyer is paid if a company or country defaults on its debt, while the seller receives a regular stream of interest payments. 
"I'd push them (CDS's) off the planet," said Ms Bair, who was head of the Federal Deposit Insurance Corporation for five years before stepping down last summer. "The CDS market is very volatile and very opaque. From a safety and soundness point of view, I'm uncomfortable with that." 
The Dodd-Frank Act, the financial reform measures that Congress passed in the summer of 2010, has called for the majority of the $600 trillion derivative market, including credit default swaps, to be traded on exchanges and for transactions to go through clearing houses. The rules have yet to be finalised and enforced....
Reforms that when implemented will do nothing to address the opacity that effects safety and soundness.  To address safety and soundness requires the ability to answer who is holding the risk.

The answer to this question is easily found by requiring banks to provide ultra transparency and disclose on an on-going basis their current asset, liability and off-balance sheet exposure details.
The trades that backfired were placed by JPMorgan's chief investment office, which is tasked with investing the bank's excess deposits and helping to manage the company's overall risk exposure. Ms Bair said that the pressure on banks to generate returns on their excess deposits is something that should also be on regulators' radars. 
"I think it's a real issue," said the former FDIC head. "The Fed has been pumping all this liquidity into the system. You've got banks sitting on all this cheap money looking for returns."
Yet another negative unintended consequence of the Fed's zero interest rate policies.

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