Credit Default Swaps – Impose A Tax On Bogus Insurance
By Ron Cohen, CPA, MST
Greenstein, Rogoff, Olsen & Co., LLP
Proposal to amend the U.S. Internal Revenue Code:
Any Seller, Buyer or Insured Party who enters into a Credit Default Swap (“CDS”)
contract insuring U.S. source risks will be subject to an excise tax of 10% of
the face amount of such CDS. Exception: If the CDS parties provide evidence
the Seller of the CDS maintains directly related and segregated liquid assets as
insurance reserves equal to 30% of the face value of the CDS, no excise tax will
Well, that should do it. A complete end to high-tech gambling with CDSs.
Congress can debate what the percentages should be, but you get the general idea.
In my opinion, there are good and bad Credit Default Swaps.
A GOOD CDS helps spread reasonable risk, provides credit to
worthy borrowers and assists economic growth.
However, a BAD CDS is an exercise in financial terrorism. Unworthy borrowers
get credit they do not deserve followed by a cascade of bubble and bust events.
These consequences include an exponential growth in the national debt…so large,
that many argue (not this author, but some I respect) federal debt defaults are
sure to come resulting in a dissolution of the U.S. central government…resulting
in the dissolution of the Republic, as states and cities desperately re-group to
All from bad CDS -- an insurance product that barely
existed 10 years ago.
So what is the difference between a GOOD and BAD CDS?
Let’s go back to basic principles:
Basic Principal of Insurance: Insurance spreads
risk from the “few” to the “many.” Everyone benefits. In order to successfully
spread risk, the insurance must be able to pay claims for actual
losses. The ability of a company to pay claims is dependent on highly-liquid
asset reserves the insurance company holds (obtained by charging premiums over
time). If the reserves are inadequate to pay claims, the insurance is bogus.
The Seller of the insurance is simply gambling the claims will never arrive.
Confirmation of this basic principal was proven by three
letters: A.I.G. They lost the gamble.
WHY NOT TURN TO REGULATORS versus the Tax Law?
Fair question. Let’s look at the Regulators and their history of
Federal Reserve: Alan Greenspan was, until
the bust, a cheerleader for BAD CDSs as a form of self-insurance and
self-regulation for the banking system. Yikes!
Securities & Exchange Commission: Good
at editing financial statements. Otherwise, they missed Enron, Worldcom and
Madoff. Let’s not even discuss the Sarbanes-Oxley. Note that Madoff received
various “clean opinions” under Sarbanes-Oxley audits.
Bank Regulators: Good at taking action after
disaster has struck.
CPA, GAAP Financial Auditors: We don’t detect fraud.
We can’t tell a client how to run their business. We can only complain and
comment and/or quit. BAD CDS transactions are completely legal.
The Internal Revenue Service:
Looking to this organization is useful. But not as a direct regulator, but as
a beneficiary of the “self-assessment” tax system in the U.S.
Economic parties truly focus and obsess over tax
liabilities and exposure to I.R.S. penalties and interest. Corporate behavior
does change and adapt to tax laws.
Tax returns are internally and externally reviewed by various auditors and
management. They verify the returns are correctly filed and the accounting
impact of current and future taxes are appropriately recorded on the books.
Board of Director’s meetings include large amounts of time
on tax compliance and planning. Directors and Officers understand the
personal liability they may have for errors in tax reporting. Lastly,
everyone understands the cash impact of sending money to the I.R.S. and other
tax authorities. Taxes are very REAL.
That’s why I propose we cut-through the confusion and
efforts of the inept, under-trained, under-resourced do-gooders at most
agencies, and use the tax system to change behavior to eliminate BAD CGS.
Impose an excise tax, and the BAD CGS will largely
disappear out of a natural desire to avoid incremental taxes. An army of
auditors can’t do that. A good excise tax is much more efficient and effective.
While I usually complain about added laws, regulations and taxes,
BAD CDS are a new and modern form of evil. We’d all happily accept a bit
more tax law if it could avoid the foreclosure wastelands we now find within
Stockton, California and Cleveland, Ohio…and all the related human suffering.
So that’s it. Have we saved the Republic? The whole idea
is about two pages. You folks have to take it from here.