Regulating Credit Default Swaps as Insurance: A Law and Economics Perspective

24 Pages Posted: 23 May 2009

See all articles by Matthew A. Zolnor

Matthew A. Zolnor

Florida State University - College of Law

Date Written: May 23, 2009

Abstract

Much of the debate regarding the current financial crisis revolves around the especially destructive role that credit default swaps (CDSs) had to play. It has become clear that the lax regulatory framework implemented in the latter part of the last century incentivized the very behavior that CDS regulation ought to proscribe. Market participants on both sides of CDS transactions faced incentives to ignore the systemic risk inherent in unchecked CDS transacting. When billions of dollars worth of CDS obligations came due, the financial institutions that issued them failed, which had an enormous impact on the economy as a whole.

In the wake of the current financial crisis, the State of New York has announced plans to subject a large portion of the CDS market to the regulatory oversight of the New York State Insurance Department. Using the Coase Theorem, I explain why this plan is ill advised. Although such a regulatory framework may force market participants to internalize systemic risk, it does not do so at the lowest cost when one properly considers the unique attributes of CDSs and the external pressures that influence state-based regulatory decision-making.

Keywords: Credit default swaps, insurance, regulation, AIG, law and economics

Suggested Citation

Zolnor, Matthew A., Regulating Credit Default Swaps as Insurance: A Law and Economics Perspective (May 23, 2009). Available at SSRN: https://ssrn.com/abstract=1409112 or http://dx.doi.org/10.2139/ssrn.1409112

Matthew A. Zolnor (Contact Author)

Florida State University - College of Law ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States

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