Credit Default Swops [ CDS ] – Profiting from failure?

Today it was announced that American International Group (AIG) is to pay pre_arranged bonuses of some $165 million after announcing losses of $61.7 billion as taxpayers contribute some $170 billion, much of those bonuses being connected to credit default swap products.

What are Credit Default Swops [ CDS ] one must ask given their growth within financial Markets since being invented by a team working for J P Morgan in 1997 and signed into Public Law(106-554) by President Clinton on the 21 Dec 2000. Well in principle a CDS is similar to insurance except one does not insure oneself but others as to their risk in suffering financial  loss/failure in a period of time, to which premiums are paid. Think of it as going to the races and winning through placing bets on the horse least likely to see the finishing post!. Its akin also to someone else insuring YOUR CAR then predicting a time period in which you are involved in an accident to which they financially gain. As oppose to cars or horses the Financial Industry gambles on loans and bonds as instruments of failure through bankruptcy and other defaults.

In the context of Business and a CDS part of a Pension Fund “A” could become a 5 year loan to Business “B” to which “A” then buys a CDS from a derivative Bank “C” for the period and paying premiums. Now Business “B” could successfully return “A” at the end of the period OR default through Bankruptcy in which premiums cease and Bank “C” refunds the loan to “A” – that is unless Bank “C” faces bankruptcy too. Its important to note from the above that not only does the Pension Fund holder provide the loan but also must pay insurance for its successful return, the onus not being on the recipient to insure against repayment.

In the UK and before New Labour came to power one would have needed to show a means by which a long term loan be finally repayed by way of endowment Policies etc to interest only mortgages however New Labour deregulated the financial market whereby no forms of repayment be necessary as protection towards consumers. Given the scenario which now exists in the <?xml:namespace prefix = st1 />UK as to mortgage defaults and home repossessions was this foreseen and CDS’s applied prior?.

In gambling on success in the drive towards prosperity is one thing but to gamble on failure for profiteering surely is about eroding economies whereby they must eventually collapse!. If I were PM Brown I would be enquiring into Bank Accounts that show vast profits at the demise of a Nation which has become both homeless and pennyless.