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The visualization mentions credit default swaps, but then doesn't show how those, too, contributed to the cycle as all the investments were being unwound. My s

The visualization mentions credit default swaps, but then doesn't show how those, too, contributed to the cycle as all the investments were being unwound. My somewhat primitive understanding is that since the 'safe' tranche of the CDOs was 'insured' via a CDS, when the defaults actually happened, the banks had to pay back not only the amount they had borrowed, but also an additional CDS payout. This contributed to the bankruptcies too, I think.

johnbender 18y ago
Credit default swaps are a way for large financial institutions to pass risk of defaults along, you might have heard "spread the risk around", by getting their risk insured by other big firms. Those firms in turn do the same thing, and everyone was happy because it created lower risk and made loans easier to get. In theory. In practice this chain of risk management snapped when one company defaulted on their insurance of the risk and the whole thing came crashing down.
hardik 18y ago
The CDS were underwritten by other large financial institutions for relatively cheap premiums. These institutions thought that "safe" assets will never go out of money so the insured event will never occur. CDS is the reason AIG went bust. It gets trickier, they did not go busting having to make make payments for the CDSes that they had written but the likelihood of them having to pay increased in light of increased defaults, so the rating agencies cut the rating of AIG. Now, whenever CDS or similar derivatives are written they are done looking at the ratings of the parties involved and with caveats that any fall in ratings would translate into the parties making additional margin payments (money to safeguard against parties defaulting); getting back to the AIG story, when the ratings fell, they were obligated to pay additional margin money to the tune of billions.. which they did not have. A small facet of the big big story.

johnbender 18y ago

Credit default swaps are a way for large financial institutions to pass risk of defaults along, you might have heard "spread the risk around", by getting their risk insured by other big firms. Those firms in turn do the same thing, and everyone was happy because it created lower risk and made loans easier to get. In theory. In practice this chain of risk management snapped when one company defaulted on their insurance of the risk and the whole thing came crashing down.

hardik 18y ago

The CDS were underwritten by other large financial institutions for relatively cheap premiums. These institutions thought that "safe" assets will never go out of money so the insured event will never occur. CDS is the reason AIG went bust. It gets trickier, they did not go busting having to make make payments for the CDSes that they had written but the likelihood of them having to pay increased in light of increased defaults, so the rating agencies cut the rating of AIG. Now, whenever CDS or similar derivatives are written they are done looking at the ratings of the parties involved and with caveats that any fall in ratings would translate into the parties making additional margin payments (money to safeguard against parties defaulting); getting back to the AIG story, when the ratings fell, they were obligated to pay additional margin money to the tune of billions.. which they did not have. A small facet of the big big story.