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In Light of Crisis, Common Trading Practice Looks Risky
Albert L. Lord says Sallie Mae is "liquid and well capitalized."
(Michael Nagle - Bloomberg News)
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That risk was on display when American International Group nearly collapsed last month. The insurance giant had provided tens of billions of insurance contracts in the form of credit-default swaps. The prospect of AIG defaulting on these obligations compelled the government to bail out the firm with a $85 billion loan.
There is no federal regulation of the credit-default swap market, but the Securities and Exchange Commission has asked Congress for that authority in what would be a sweeping extension of its responsibilities.
"This potential for unfettered naked shorting and the lack of regulation in this market are a cause for great concern," SEC chairman Christopher Cox said. Any change is not likely to happen until Congress returns in January.
In the meantime, regulators are searching for provisional ways to curb the market. The SEC announced that it would review credit-default trades as part of a broader investigation of possible market manipulation.
The State of New York said it would impose new rules Jan. 1 on some credit-default swaps under its existing authority to regulate insurance companies.
"We think there's a problem that the credit-default swap market is unregulated . . . and we were trying to make that point pretty strongly ," said David Neustadt, a spokesman for New York State Insurance Department. "When the price of credit-default swaps on some company's bonds gets way too high, people look at that and it affects the stock price, it affects their ability to borrow, it starts to affect their credit rating, and their rating affects the credit-default swap price in turn. It becomes a spiral."
For Sallie Mae, the annual cost of purchasing a credit-default swap insurance policy has roughly doubled in the past week to $1.6 million for every $10 million in bonds, according to Bloomberg. That price, according to Bloomberg, suggests a 74 percent chance that Sallie Mae will default on its debts within five years.
Yesterday Sallie Mae's chief executive Albert L. Lord sought to fight off the perception that his firm was on shaky ground. He said in a SEC filing that the firm is "liquid and well capitalized." He cited a new program put in place by the Education Department that not only guarantees the loans, but also directly funds them.
With the federal government behind the firm, Sallie Mae is reducing its reliance on private lenders to raise money to issue student loans.
Mark Kantrowitz, publisher of FinAid, a Web site that provides financial advice for students, said he did not understand why Sallie Mae's credit-default swaps soared this week. But the firm faces problems, he said.
The rising cost of borrowing because of the turmoil in the credit markets is squeezing its profits. If these rates continue to stay high, he said, Sallie Mae may struggle to pay its debts.
