This vote was on killing an amendment by Byron Dorgan, D-N.D., that would have prohibited trading what are known as “naked” credit default swaps, one of the more exotic financial instruments created in recent years and which partially helped fuel the 2008 economic meltdown. Chris Dodd, D-Conn., moved that the amendment be defeated.
The amendment was offered to a bill that aims to close gaps in financial regulations, strengthen oversight of consumer lending and more closely oversee exotic financial instruments.
A credit default swap is basically an insurance policy that the person who loaned money to help a bondholder purchase a bond buys in case that bondholder defaults on their payments. A naked credit default swap is, in essence, a bet that an uninvolved third party makes that the bond issuer is or isn’t going to default.
“They don’t have an insurable interest in the bonds; they just made a bet. They have said: We have not bought those bonds over there. But those bonds were issued, and we would like to make a wager. We think those bonds are probably going to default. Someone else says: I don’t think they will. So you have a naked credit default swap with no insurable interest in anything,” Dorgan said. “Why is that troublesome? Well, I can’t buy fire insurance on the house of the Presiding Officer in Alaska. Why would they not allow me to buy fire insurance on his house? Because I don’t have an interest in his house, and they don’t want about 10 or 15 people having a fire insurance policy on his house. The only way you can get fire insurance is if you have an insurable interest. I can’t buy a life insurance policy on someone else’s life because I don’t have an insurable interest.”
Dorgan said at the end of last year there was about $10.9 trillion in naked credit default swaps held by commercial banks, and that it’s estimated that as much as 80 percent o the credit default swap market is traded by firms that don’t own the underlying debt.
Chris Dodd, D-Conn., said Dorgan’s concern is well-taken but that his amendment goes a step too far “at this particular juncture.”
“I don’t know, nor can anyone say with absolute clarity, what are the implications and the unintended consequences if we have a total ban on the naked synthetic credit default swaps,” Dorgan said. “I happen to believe in certain instances what Senator Dorgan offers makes sense. My concern is I cannot tell you with certainty what the unintended consequences are. I cannot say with absolute certainty what Senator Dorgan is proposing actually will be doing what it claims or if there are broader implications to it.”
By a vote of 57-38, the motion to kill the amendment succeeded. All but two Republicans present voted to kill the amendment. Of Democrats present, 18 voted to kill the amendment and 35 voted against (including many of the most progressive members). The end result is that the amendment was killed, and the measure went forward without language that would have banned naked credit default swaps.