This is the third and concluding article in a series that covers the perverse government bailout of AIG. The first piece covered how the insurance industry operates and where problems can arise, the second dove into the moral hazard of the AIG bailout, and this third piece will address not only the risks, but the history of over-the-counter [OTC] trading and what should be done to resolve its weaknesses. I do not believe that OTC trading should go away entirely. OTC trading has served a purpose for specialized transactions or when specific financial instruments are first traded.
When discussing over-the-counter instruments we are not talking about stocks trading via pink sheets or OTC because their price has dropped below exchange listing criteria. We are addressing OTC derivatives such as interest rate swaps, total return swaps, credit default swaps, forwards, certain equity options and any other derivatives that are generally traded between investment banks and their clients.