Wednesday, Feb 21, 2007
FINANCE:What exactly is a Credit Default Swap
Wikipedia: Credit Default Swaps
This little creature may be the financial instrument which brings the whole Anglo-Countries house of cards down.
Read more and find out what it is.
Posted by lvmreader @ 02:56 PM (383 views) Add Comment
7 Comments
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1. The Capitalist said...
Just like consumers taking mortgage protection insurance, so pension funds insure themselves if their investment turns sour. So the big question is, are corporations going to default? Well if you are in the sub-prime lending game you are on very thin ice, as consumers struggle to pay their debts. Assets (real estate) look overvalued and confidence collapses. Oh yes the new paradigm - human nature never learns!
2. Rimmer said...
Way over my head but there must be a point, even an explaination would be appreciated?
3. rich said...
There's a lot of jargon and equations in there. How about you just tell us why you think this is relevent?
4. lvmreader said...
Basically a credit default swap (CDS) allows someone to lend you money and then get someone else to insure the loan so if you cannot repay the loan, they'd still get their payments + interest.
Simple enough.
Good. Now can you see why this would lead to masses of sub-prime loans to companies (which can then lend to individuals)?
The fundamental problem is that the determination of creditworthiness has not necessarily been updated.
This basically means that banks could led to "Rodney the Hamster" and some other entity is insuring that risk. Who could that entity be - why the seller of CDS of course - other banks / financial institutions. Sometimes even the SAME bank. It is so circular they do not necessarily know. Risk Management is more of a "thing they'll get round to" / concept than a real practice.
So, with CDSs and CDOs (collaterised debt obligations) this merry-go-round gets bigger and bigger sucking more sub-prime toxic waste into the vortex. It all seems fine while the stock market is bullish, asset prices (esp houses) are high and cashflows remain stable.
The wheels come off when too many people default - when the "risk models" prove to be fantasy. This is when you will see the collapse of a major "big 4" bank.
This time, not even the BoE can help them.
Of course, house prices will rise forever, interest rates will be permanently low, inflation is a 2.5%, no-one ever defaults on their mortgages, reposessions are for the 1980s, not today.
So what is there to worry about.?
5. harold said...
lvmreader, good call.
6. Chillilizard said...
There was a related article a few days ago, except this time it was about the USA. Apparently what the lending insitutions do is sell mortgages, and before the ink is dry, sell the loan on the markets. They make profits from fees during both transactions and apparently lose all risk. They say it is a good thing as it puts the risk where it is most wanted; the high risk speculator. The problem here is that the banks want their fees and don't do a good job of ensuring that they lend to good borrowers. The way I see it, the risk cannot be gotten rid of, no matter how much you spread it out. My thinking is that the others are spreading their risk in the same manner your way.
It'll all end in tears.. If H5N1 doesn't get us first, or the hoodies on the tubes, or a million other things the modern media like to scare us with.
7. Brutal Deluxe said...
For an video explanation from that madman Cramer
Cramer on Financials -
http://www.cnbc.com/id/15840232?video=624755222&play=1