CREDIT DEFAULT SWAPS - THE INSANE PROBLEM AND THE RADICAL BUT SANE SOLUTION
September 25, 2008
By Chuck Simpson
The paramount reason for today's cancerous credit crisis is seldom even hinted and never explained.
First, a simple definition. A credit default swap is a form of insurance. A variant of mortgage insurance required of many home purchasers. An insurance policy that requires a company with financial strength to step up to the plate and pay the mortgage if for some reason the home buyer defaults.
A credit default swap is similar: If default occurs, an insurance company pays the income stream of the mortgage.
With one extremely important difference: Payments are made to the owner of the policy, not to the financial institution that stands to suffer a loss.
Financial institutions are allowed, through total lack of regulation, to buy and sell credit default swaps, or insurance they will be paid in event of default, on financial instruments in which they have no financial interest.