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In the beginning in a galaxy far far away and we were solvent ....
A CDS was designed as a type of insurance, for large corporations. These are designed for large financial vehicles.
First point is they are private and totally unregulated transactions, the example below would be legal
Say Donald buys a bond from GM, but he is concerned they might go out of hence losing his whole investment. He comes to me and tells me, so I say that ok I have a lot more cash than your bond is worth, I'll insure that for you. Pay me 2% of the value per year and if GM goes under I'll give you your money back and you give me the no possibly worthless bond.
So far no real problem, other than it being unregulated it is a fairly simple insurance transaction.
Did I mention this is all unregulated private transactions.
So now instead of Donald, its Ford and their have a $1B bond from Leehman Brothers, a year sounded like a real safe bet. The yearly fee for this CDS is now $20,000,000
So banks now create CDS depts. I mean there are people falling over themselves to insure their bonds and every on of the these greedy buggers wants their share of the fees.
Did I mention these are private unregulated transactions ? Ok I guess I did but why do I keep pounding on that ?
Well there is a reason. Somebody figured out that these are unregulated and realized something else ...
There is no actual reason you have to actually own the bond in the first place. That.s right you heard me correctly.
Basically around 2003 they figured this out and large corporations started gambling. One side is gambling a company will go bust and the other that it won't.
People started taking buying CDSs for bonds the did not own. Banks would do this because they wanted the fees. In fact they encouraged it.
The net result would be that 50 people may buy a CDS against that Lehman bond and only one of them actually owns it. Meanwhile the bank takes 50 x $20,000,000 in fees on that one item.
It all looked like a safe bet until the sub prime disaster.
It wasn't the sub prime loans that took down the banks. It was the bond defaults on outstanding CDS obligations.
Yeah, I picked Lehman Bros for a reason. Image the bank now on the hook for 50 x $1B for that one bond, then repeat that thousands of times.
The sub prime meltdown triggered the disaster but gambling with Credit Default Swaps is what actually killed most of the banks not bad loans. The bad loans just brought the house of cards down around their heads.
NPR did a slightly more in depth overview I suspect.
I imagine they did. I was hoping to find the clip, just to show that M$M doesn't report all the info to us just as our elected officals do not either.
Anymore it seems like the only people you can rely on for "hard hitting" news stories front themselves as comedy. I'm looking at you Weekend Update, Stewart, and Colbert!
And the essence of the discussion you're referencing is in that Meyers clip too.
NPR did a slightly more in depth overview I suspect.
IIRC, yes you did. The only additional difference was that the problem was there was no way to assess the risks, since all transactions were private. The SEC was considering regulating CDS, but was meeting strong resistance from everyone involved.
Basically, if everyone agreed to pay off, the system was fine. However, once one company couldn't pay off, due to the large and complex web of the CDS, they all started to fail.
The commentator I heard on it (it was actually last week on This American Life), stated that there wouldn't have been a problem if all the CDS were public, as everyone would have adjusted accordingly in order to ensure that no one company was overburdened in case of default (the risk factor would be reviewed). However, since they were all private, one fairly small company could get numerous CDS, and if a company like LB failed, there was no way they could pay out.
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