Credit Default Swaps (CDS) Explained

Untangling credit default swaps from Marketplace on Vimeo.

This is the best explanation I've received yet of what these CDS are, and why they are so deadly to the financial system.

If you watch all the way through, at the end he explains that no one understands how many of these things that there are.

Basically the CDS is like insurance, but there is nothing preventing an investor from insuring on losses on GM bonds for example multiple times.

So even though the investor may "lose" 50% on an investment and have that made up to them by the insurer, they can cash in on multiple policies. Which means that if the asset drops from $2 million to $1 million, that the person who insured the asset can collect on this $1 million dollar loss multiple times.

So let's say that the investor takes out 10 CDS policies (i.e. insurance plans) at a 10% premium. So the investor has to give up $1 million to the insurers, but if the asset collapses and is collected on, then in exchange for this $1 million in insurance premiums, the investor gets back $10 million.

This is the reason that even the slightest drop in asset values covered by these CDS sets off a chain reaction in which the immediate loss in the value of the asset is multiplied across the firms that have covered the lost through a CDS. So a $1 million default is transformed via these CDS into a loss 10 or 20 times that.

It seems at the very least that a policy prohibiting double payment is in order. Insurance should be a way to distribute risk through a market not a financial instrument used to make money at the insurer's expense.

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thx middle

folks reading this or the comments, we're all learning here so if you don't understand something, ask a question because we also do.

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selling unhedged risk or selling risk you don't understand

The seller needs to limit his risk. Restricting the buyer through regulation, is not much different when closing the exchange when everyone wants to sell. This is a repeated historic lesson. Control the risk. The sellers took two much risk....

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drive by kool-aid drinkers

Folks, the drive by anonymous comments trying to stand by some corporate press release you heard on FAUX news, such as regulation hurts markets, what can I say, I hope the propaganda poison wears off and you start using your brain once again. We're here to help you start thinking for yourself. Regulation is a set of enforced rules, ethics, behavior if you will. It's like societal laws for markets. It is ok to shoot your neighbor in a society? Of course not and the same is true for regulations. They are the financial cops to keep ethics, transactions within a set of agreed to guidelines, rules so one can trust the market.

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CDSs

The lack of morals is what has gotten us into this mess.It is about me making money but not at the financial risk of the very industry that I am making money from!

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