What is a credit default swap?

Tuesday, March 9, 2010

That's part of what Greece's prime minister, George Papandreou, blames for his country's financial crisis. A credit default swap is a form of insurance on bonds that investors buy and sell. When it looks like a bond issuer might have trouble paying, its CDS prices soar because the bonds are more risky. But since there are relatively few investors in this area, Papandreou and others say CDS prices can be easily manipulated, driving up a country's borrowing costs. Papandreou, who wants U.S. and European officials to regulate credit default swaps, compared them to home insurance:

"It is common sense, enforced by insurance regulators, that a person is not allowed to buy fire insurance on his neighbor's house -- and then burn it down to collect on that insurance. Yet that is exactly what is done in the market for credit default swaps."

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