W.M.D.? What W.M.D.?

Blythe Masters would like you to know that the credit default swaps market is working just fine, thank you very much.

Masters, who is now head of global commodities at J.P. Morgan, was one of the bankers in the early 1990s that helped create the credit derivatives market that has exploded into a $58 trillion murky mess at the heart of this credit crisis. (Read Jesse Eisinger's account of this here.) Credit default swaps were designed to offload risk from a bank's balance sheet by letting other investors bet on the default risk of those loans.

Warren Buffett famously called derivatives "financial weapons of mass destruction" before the subprime crisis set off alarm bells elsewhere in the market. Concerns about the implications of the instruments eventually triggered the massive federal bailouts of Bear Stearns and A.I.G.

But Masters, who spoke this morning at the annual meeting of SIFMA, the securities association she chairs, said that credit default swaps aren't what needs regulation. Rather, it's the people who use them who should be regulated.

SIFMA is calling for a financial markets stability regulator who would oversee all the various market participants, from hedge funds to insurance companies. Masters says this increased regulation, in combination with a clearing facility for the swaps, would be sufficient to address the systemic risk posed by the massive credit derivatives market.

"Ironically, the C.D.S. product has been performing exactly as it was intended to," she said.

Last week's unwinding of Lehman default swaps provided some evidence this is true. While some were worried that the settlements would create chaos in the market, exactly the opposite occurred. All swaps were settled smoothly with just about $5 billion in net payments made, because most sellers of the swaps had hedged their positions to avoid potentially huge payments.

Meanwhile, the federal government is eager to rein in the market in order to avoid future bailouts. The Federal Reserve is requesting proposals on how best to regulate the credit derivatives market from the two biggest futures markets, CME Group and Intercontinental Exchange.

by Megan Barnett