Testifying before the U.S. House Oversight and Government Reform Committee, New York State Insurance Superintendent Eric Dinallo faulted provisions of 2000’s Commodity Futures Modernization Act that exempted so-called “naked” credit default swaps -- those in which the holder has no direct exposure to the named credit event -- from state gaming laws. The bill was sponsored by then-Sen. Phil Gramm (R-Texas), who one year earlier spearheaded the landmark deregulation bill known as the Gramm-Leach-Bliley Act (GLBA).

Without direct oversight by securities, commodities or insurance regulators, the massive growth of the unregulated CDS market, from $900 billion in 2000 to an estimated $58 trillion today, lay at the heart of the financial crisis now gripping global markets, Dinallo said.

“We’ve allowed this to run completely unchecked to the point where it is larger than the entire economic output of the world annually,” Dinallo said. Last month, New York Gov. David Paterson announced that the state would begin treating CDS where the buyer has exposure to a default as insurance, starting January 1, but Dinallo noted that such “covered” CDS represent only about 10% of the total market of swaps.

Under questioning from Rep. Bruce L. Braley (D-Iowa) Dinallo also suggested that Congress should revisit 1999’s Gramm-Leach-Bliley law, which eliminated the barriers between banking and insurance under the Depression-era Glass-Steagall Act, to ensure that diversified financial services holding companies that include insurance policyholder reserves or bank deposits are subjected to appropriate oversight. “The ‘supermarket of financial services’ it created can cause problems for the whole place ‘when something smells in aisle six,’” he said.

But he stopped short of agreeing with Braley’s suggestion that the McCarran-Ferguson Act, under which the state-regulated business of insurance is exempted from federal antitrust laws, be repealed.

October 15, 2008