December 06, 2008

Understanding CDS

This is a really good piece on the CDS market. While the conclusions reached (that these were horrible instruments) is wrong, the explanations are extremely good.


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CDS, when issued by a counterparty that actually has the capital to back the security, are a very good way of insuring performance on a credit. The problem here is that a lack of regulation meant that anyone could write CDS regardless of their capitalization and they didn't have to adequately reserve against future losses.

Couple this with an industry that was hellbent on larger and larger volumes of credits (in this case, mortgages) all of which were 'credit enhanced' with CDS and you have a situation where credit is issued without regard to creditworthiness which was OK because ultimately it was going to be backed up with CDS.

"We make the loans because we can insure the loans".

Posted by mcblogger at December 6, 2008 04:30 PM

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