Credit Default Swaps: $60 Trillion of Bullshit | Slog | The Stranger | Seattle's Only Newspaper:
Car insurance makes sense. If I drive or own a car, I better have some way to pay for repairs and healthcare if I fuck up.
And it makes sense that the insurance company better be tightly regulated—forced to keep enough liquid assets around to pay out claims. If the insurance company failed to pay up, it would be a nightmare for everyone.
Credit Default Swaps (CDS) started out as insurance for bonds. For a percent or two a year of the face value of the bond, you received a contract to pay the face value of a bond if the issuing company defaults. This is little different than life insurance, homeowners insurance or car insurance.
The trouble started in 2000, when the Commodity Futures Modernization Act explicitly banned the regulation of these sorts of contracts. Funny things started to happen; people took out CDS contracts on bonds they didn’t hold.
This would be like me insuring your car. Why on earth would I do that? It’s a bet. If you get in an accident, I get paid; I’m gambling on your failure.
I could be even more clever, and eliminate my risk entirely—at least on paper.
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