One Very Big Plus to the Waxman-Markey Climate Bill

It appears that the legislation, which creates a Co₂ cap and trade regime, also bans naked credit default swaps, and could be construed as banning all credit default swaps:

Here's the key passage from Waxman-Markey, buried on page 1,070 of the 1,428-page bill introduced in the Senate on July 6:

"It shall be unlawful for any person to enter into a credit default swap unless the person:

1) owns a credit instrument which is insured by the credit default swap;

2) would experience financial loss if an event that is the subject of the credit default swap occurs with respect to the credit instrument; and

3) meets . . . minimum capital adequacy standards…"

Basically, a credit default swap is an insurance policy on a financial instrument, and a naked swap is an insurance on a policy in which one has no interest in its continued existence.

This section of the bill is clearly intended to ban naked swaps, but some people are arguing that the specific language of the bill actually bans all CDS, because the person selling the swap does not have own, "a credit instrument which is insured by the credit default swap," but by selling the insurance they are "entering into" the CDS.

My guess is that the courts will not view this as a ban on all CDS instruments, and if Waxman-Markey bans nakes swaps, this is enough to justify support the bill on its own, as weak as it is.

By background, in insurance, it's forbidden to, for example, take out insurance on things like your neighbor's home, and has been for some time:

In 1746, Parliament passed the Marine Insurance Act, requiring anyone seeking to collect on an insurance contract to have an interest in the continued existence of the insured property. Thus was born the insured-interest doctrine. The indemnity doctrine, which precludes a buyer from insuring property for more than it’s worth, soon followed. The point of these rules is to limit insurance contracts to trading existing risks and not to create new risks by giving buyers of insurance incentive to destroy property. The doctrines have been part of insurance law in both England and the United States (which in 1746 were colonies under English common law) ever since.

Unfortunately, in the Greenspan/Rubin/Summers America, it was decided that this 263 year old lesson could be ignored, and so we have trillions of dollars in casino bets masquerading as insurance, but isn't insurance, because then the contracts for naked swaps would be unenforceable as insurance policies.

H/t Kevin Drum