Are Credit Default Swaps to Blame?
Credit default swaps (CDS) have been widely blamed by politicians, regulators and the media for their role in the ongoing crisis. What was their original purpose, and how have they contributed to the turmoil in the economy? A credit default swap is a credit derivative; this is a financial instrument whose value depends on an underlying or reference asset, such as a bond, bank loan, mortgage, etc. Credit derivatives enable financial institutions to hedge the risk of losses to their portfolios due to events such as bankruptcy or ratings downgrades. Credit default swaps were introduced by Wall Street in the mid-1990s as a form of insurance against credit risk. A CDS is an agreement between a protection buyer and a protection seller in which the buyer makes a regular series of payments in exchange for a settlement in the event of a credit loss by a reference asset. Due to their flexibility, the popularity of credit default swaps grew rapidly, giving rise to more complex variations. One of
