Everything You Ever Wanted to Know about Credit Default Swaps (via RGE Monitor)

Jim Mahar over at FinanceProfessor.com just linked to a fantastic explanation of Credit Default Swaps. Here's the opening lines:

Credit default swaps (CDSs) have been identified in media accounts and by various commentators as sources of risk for the institutions that use them, as potential contributors to systemic risk, and as the underlying reason for the bailouts of Bear Stearns and AIG. These assessments are seriously wide of the mark. They seem to reflect a misunderstanding of how CDSs work and how they contribute to risk management by banks and other intermediaries. In addition, the vigorous market that currently exists for CDSs is a significant source of market-based judgments on the credit conditions of large numbers of companies--information that is not publicly available anywhere else. Although the CDS market can be improved, excessive restrictions on it would create considerably more risk than it would eliminate.

It also has a very nice diagram of a typical CDS (and we professor types like diagrams we can use in class, eh?)

click to enlarge

Read the whole thing here

Comments

[PostIronAge:]

So, it is ponzie scheme, right?

Jan 27 11:51 PM

[Big Al45:]

Actually, the only thing you need to know is that about CDSs is that they suck. Unless you're shorting a stock and your short isn't working fast enough. So you use them to instill a little panic.

Jan 28 12:08 AM

[Ronald Pires:]

This was actually published last month by the American Enterprise Institute, where author Peter Wallison hangs his hat. In spite of Wallison's hard right economic philosophy, this article is mostly free of any ideology and is quite good. Worth reading if only for his explanation of notional value and the misuse of notional value numbers in the press.

Jan 28 02:00 PM