Mind boggling

If you're like me, you don't know much about credit default swaps. I like to think I'm pretty knowledgeable about finance matters, but these things were only invented about ten years ago, and they're pretty bizarre. Gretchen Morgenson has a really good article on them in today's NY Times that pealed the scales off my eyes.

The market for these things is not many times larger than the U.S. stock markets -- about $46 trillion. Banks, investors and speculators buy these things, which guarantee to pay off if a bank loan or a bond goes into default. But here's the crazy part. Both the insurer and the insured can trade their interest to others without telling the other party who they sold to. Thus, if you thought you had insurance and the bond goes into default, you may not be able to find out who is obligated to pay you. Furthermore, the amount of bonds insured is roughly ten times the amount of bonds around since speculators buy and sell these things just to gamble on whether a company is likely to go into default. The problem is that to collect in the event of default, you usually have to tender a real bond, so 9 out of 10 insureds may not actually be covered. To make matters worse, there is no regulation whatsoever.

Go read it and have your mind boggled.