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Credit Default Swaps: Bad Enough to Ban?

There seems little doubt tighter regulation of esoteric financial derivatives that have played a major role in the financial crisis is on the way, but one influential lawmaker is weighing a more drastic measure: banning them outright.

Sen. Tom Harkin (D., Iowa), chairman of the Senate Agriculture Committee, which regulates derivatives and so has a claim to authority over credit default swaps, has repeatedly questioned whether the $60 trillion industry should be outlawed. The unregulated derivatives, which insure lenders against borrowers' default on debt, have been blamed for the financial meltdown of companies like American International Group (AIG - Get Report), which required a multi-billion government bailout last month.

"They've been touted as reducing risk, but as we have seen, it has actually increased the risk, the systemic risk, of the whole society," Harkin said during an Oct. 14 hearing exploring the need for greater regulation of the derivatives.

It is unclear how much support an outright ban of CDS would have in Congress and Harkin has not yet introduced legislation on the subject. Still, the debate has exposed the enormity of the gulf between a Democratic party that looks to have a significant mandate to regulate business for the first time in decades and a Wall Street community that is used to being left alone by Washington.

"People on trading desks don't really typically know how to interact with people who are making laws, because most of the stuff we do is unregulated," says a senior trader at a large bank, who declined to be identified.

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