"a vast, unregulated corner of Wall Street that has severely exacerbated the financial crisis. "

Interesting post in the Washington Post by David Cho and Zachary A. Goldfard about regulating Swaps:

"Originally, swaps acted like insurance policies for bond investors in case a company collapsed and could not pay back buyers of its bonds. To protect themselves against such defaults, bond investors could agree to pay a periodic fee to have another party cover the losses.

Unlike stocks and bonds, credit-default swaps fell outside the government's purview largely because they are private contracts. A law backed by leading Republicans and passed by Congress in 2000 specifically exempted swaps from oversight by the SEC and CFTC, which oversees commodity trading.

Since then, big hedge funds and other traders discovered that swaps could be traded and used to speculate on how close a company was to collapse. The market mushroomed. Its total value outgrew that of all publicly traded stocks combined. The swaps market began to affect the financial system in once unimagined ways.

The SEC grew concerned that traders were using swaps to manipulate stock prices."

What about AIG?:

"Last month, insurance giant American International Group nearly collapsed partly because it had issued $440 billion in swaps to traders around the world and was not going to be able to cover many of the promises it had made to cover defaults on debt. Government officials realized that swaps could pose a threat to the global financial system."

Okay, let's look at AIG. In this case, the problem is that AIG doesn't have the money to pay the insured parties who are claiming their insurance. In other words, it's a lack of capital. Now, how do you regulate this problem? How about raising the capital requirements?

"The clearinghouse, for a fee, would act as an intermediary that would guarantee transactions between swaps traders. In order to make those guarantees, the clearinghouse would require traders to maintain a sufficient amount of capital in their accounts. That would make it difficult to trade swaps without having the resources to cover a contract should a default happen."

So the clearinghouse idea solves the capital requirement problem and, hence, the payout problem. What about the trading of CDS's? Here is where I'm having a hard time understanding what the government wants to do and why.

"Lawmakers are divided on what should be done. Some want traders to meet strict capital requirements, referring to how much money an investor can borrow to buy a swaps contract. Others want to put all derivatives -- even those invented in the future -- under the oversight of the SEC, which could force traders to disclose detailed information to regulators on their activities."

Again, I understand the capital requirement idea, but what is the detailed information going to do?

"In a hearing last week, Sen. Michael D. Crapo (R-Idaho), who sits on the Senate Agriculture Committee, said that it was important to make "sure that we allow capital to move freely and efficiently in a market system," but also that the government must protect against "inappropriate manipulation of markets."

How does this inappropriate manipulation work? Here, I'm not sure yet what the problem is, so it's hard to judge a solution.