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Tuesday, October 07, 2008

A Look At Wall Street's Shadow Market - Credit Default Swaps

A recap on what exactly is Credit Default Swaps,

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default or "credit event" in respect of a third party or "reference entity".

From the CBSNews video below, Greenberger, a law professor at the University of Maryland and a former director of trading and markets for the Commodities Futures Trading Commission, said

It is an insurance contract, but they've been very careful not to call it that because if it were insurance, it would be regulated. So they use a magic substitute word called a 'swap,' which by virtue of federal law is deregulated

These complex financial instruments and very structured were designed by mathematicians and physicists, who used algorithms and computer models to reconstitute the unreliable loans in a way that was supposed to eliminate and mitigate most of the underlying risk. They thought these will work but they turn out to be utterly darn wrong because human behaviour can never be modelled by mathematics.

A Look At Wall Street's Shadow Market [Text Version]

1 comment:

  1. Do you have a Private mortgage insurance (PMI) policy? If you do your PMI insurer has passed along their risk by buying a credit default swaps (CDS) to protect them in the event you have your home that your home is taken away from you. CDS and PMI are the same thing. Make people wanting to buy a home put at least 20% down if you don't like them.


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