"Credit Default Swaps" "souring" as I type this

[ensho]

http://onlinejournal.com/artman/publish/article_3356.shtml


Credit Default Swaps the next crisis -- subprime is just a ‘Vorspeise’


While attention has been focussed on the relatively tiny US "subprime“ home mortgage default crisis as the center of the current financial and credit crisis impacting the Anglo-Saxon banking world, a far larger problem is now coming into focus. Sub-prime or high-risk Collateralized Mortgage Obligations, CMOs as they are called, are only the tip of a colossal iceberg of dodgy credits instruments which are beginning to go sour. The next crisis is already beginning in the $62 trillion market for Credit Default Swaps. You never heard of them? It’s time to take a look, then.

The next phase of the unravelling crisis in the US-centered “revolution in finance” is emerging in the market for arcane instruments known as Credit Default Swaps or CDS. Wall Street bankers always have to have a short name for these things.

-snip containing "Blythe Masters"-

Credit Default Swaps resemble an insurance policy, as they can be used by debt owners to hedge, or insure, against a default on a debt. However, because there is no requirement to actually hold any asset or suffer a loss, Credit Default Swaps can also be used for speculative purposes.

Warren Buffett once described derivatives bought speculatively as "financial weapons of mass destruction."
-snip-
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note: it is impacting the "Anglo Saxon" banking world.

[whistle]

1. Can someone explain just exactly how this would work and who benefits and who loses?

[Yavin4]

5. I'll Try

Let's say that you purchased a bond from ABC company, and even though you're getting coupon payments from the bond, you're worried that it will default.

So, you go to a Swap dealer. For a premium, the Swap dealer will pay you a sum if your bond defaults, and the size of that sum depends on the premium that you pay.

The Swap dealer benefits if the bond does not default because they get to keep your premium.

You benefit because if the bond does indeed default, you will get something.

Now, the question here is that the risk has been shifted to the Swap dealer, so how does the Swap dealer protect him/herself.

Well, the Swap dealer makes similar arrangements with other players. They pay a premium to other dealers who are willing to take on the risks, and in exchange those dealers will pony up if the bond defaults.

Supposedly, through complex metrics are adjusted so that the risks to any one player is minimized.

As you can see, the risks get spread out over hundreds of players, and if everything defaults all at once (see the Subprime mess), then everyone goes down.

This is why Buffet called derivatives toxic.

[Selatius]

2. Why is it that bankers and speculators love to create stuff that doesn't exist in the real world?

Are they so bent on finding any money-making scheme that they're willing to create shit in space and sell it as real securities?

[jaksavage]

3. Because they have so much money

to invest they obsess on ways to make more.

[ensho]

4. ask Blythe

nt

[Yavin4]

6. We Live In A Culture Where Everyone Is Under The Gun To Be Rich

And there's very little wealth creation in simply trading securities. You may make a little money, but not the big money.

Financial engineering is where one can hit it big very quickly, and as a consequence, one can melt down the entire financial sector as well.