Derivatives Regulation
Credit derivatives such as credit default swaps (CDS) can be thought of as insurance policies that protect a lender from the risk of default by the borrower. Party A pays a premium to Party B, who agrees to pay Party A in the event Party C defaults on its obligations, such as bonds. CDS can be used to hedge or can be used speculatively. Derivatives usage grew dramatically in the years preceding the crisis. The volume of CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. Total over-the-counter (OTC) derivative notional value rose to $683 trillion by June 2008.
Author Michael Lewis wrote that CDS enabled speculators to stack bets on the same mortgage bonds and CDO's. This is analogous to allowing many persons to buy insurance on the same house. Speculators that bought CDS insurance were betting that significant defaults would occur, while the sellers (such as AIG) bet they would not.
Read more about this topic: Subprime Mortgage Crisis Solutions Debate, Regulation
Famous quotes containing the word regulation:
“Lots of white people think black people are stupid. They are stupid themselves for thinking so, but regulation will not make them smarter.”
—Stephen Carter (b. 1954)