Browsing through John Taplin’s blog, I came across the following reference:

RTFA: http://www.nytimes.com/2009/01/25/business/25gret….

Mr. Raynes’s resolution is more radical: unwinding all outstanding credit-default swaps through a process he calls inversion.

Under this plan, insurance premiums would be refunded to buyers of credit protection from the entity that wrote the initial contract. And the seller would no longer be under any obligation to pay if a default occurred.

The premium repayments would be made over the same period and at the same rate that they were paid out. If a contract was struck three years ago and charged quarterly premiums, the premiums would then be refunded quarterly over the next three years.

Mr. Raynes’s proposal would treat hedgers – buyers who bought C.D.S.’s to protect themselves because they actually hold the underlying debt – differently from speculators who bought C.D.S.’s simply to bet against a troubled company.

Those guys, the gamblers, would receive only the premiums they paid to an insurer. Hedgers would have their premiums refunded, in addition to the difference between the underlying debt’s face value and an independent assessment of its intrinsic value.

For mortgage-related securities, this value would be ascertained by third-party analyses using loan servicing data on delinquencies, defaults and performing mortgages.

“If you stop the clock and reverse it, then the entire system will be able to breathe again,” Mr. Raynes said. “And over time, at the same speed that you got into the mess, you get out of it.”

Taplin has the following to say about it:

I like this idea because it unwinds a completely dangerous business that is used by speculators to launch their bear raids on banks using little or no collateral. Estimates are that half of the $30 trillion in CDS contracts would cancel each other out (offsetting bets). That still leaves $15 Trillion that no one has. Raynes idea of simply cancelling the contracts and returning the premiums is the only way out.

I’m not sure why this is the only way out, but there is a certain straightforward elegance to the proposal that really appeals to me. Essentially, the more that can be driven algorithmically, the less that can be short-sold by speculators. FTA, this all comes down to companies insuring debt-defaults for way less than they should have. After all, does it really matter if you can pay the claim later when you’ve gotten the money up front? In this case, the answer is no: plan B is the bailout.