By John Hintze
Naked credit default swaps appear to have gotten Congress's attention. Critics have long said that buying a naked CDS is akin to buying insurance on your neighbor's house and then hoping it burns down. The financial reform law passed earlier this summer could make that harder to do, depending on what the Commodities Futures Trading Commission decides to do.
Naked CDSs are used to buy insurance against the default of a bond or bond index without owning the underlying security, a common shorting technique of hedge funds. A similar practice—naked short selling—is illegal in the U.S. equity market.
Now a little-noticed provision of the financial reform legislation could have the same prohibiting effect on CDSs since it reempowers the CFTC to halt trading in derivatives contracts it deems contrary to the public interest.
The law specifically mentions derivatives that enable market participants to bet...