That was outstanding, thank you.

Calling credit default swaps = insurance is okay as long as it is an insurance company issuing the insurance. I thought that investment banks were prohibited from issuing insurance. And part of the problem was that investment banks, and not insurance companies, sold these "Credit Default Swaps" and didn't call them "insurance." A technicality I think that the investment bankers should be held accountable for. A pig is still a pig, no matter what you call it.

Nice introduction to how Credit Default Swaps are supposed to work, but you really don't go into detail on how they've been abused. That's what has caused the problem.

AIG sold far more CDS than they could effectively guarantee. Their models didn't allow for so many defaults or such a large decline in the value of underlying bonds. Their bad models allowed them to report unrealistically high profits in the good times, but wiped them out when things went bad. Of course the execs. already pocketed their bonuses from the good times and aren't giving them back now.

On the other side, you have firms buying their insurance on their bonds and not accounting for the risk of their counterparties failing. Again we have a derivative tool serves to boost profits on both sides of the trade, until it comes crashing down.

If CDSs account for a major portion of the distrust between banks that is in large part attributable to the credit market freeze, and the credit market freeze is the critical impact the financial crisis is bringing to the economy as whole, then why not eliminate this particular opacity on the bank's balance sheets.

If I can cancel an insurance policy whose premium has been paid through the remainder of the year, receiving a refund for the prorated price of the premium left in the year, then why can't CDS's purchasers receive a similar refund from the CDS sellers for that contract. If the world's governments mandated a liquidation of all CDSs in this way, if only on a temporary basis, the problem would shrink from a >50 trillion dollar problem to a

Thanks Paddy - VERY edifying.
It seems SO implausible that a CDO holder could AFFORD the COST of a CDS.
Would you please describe to what degree the ongoing premium COST of a CDS blunts the profitablity of buying and holding a typical (haha) CDO? thanks

That was really helpful. (As well as really infuriating!) Thank you.

I don't understand much about CDS, but using the word 'insurance' in the example ( as cited by previous posters here) is a way to get the message across.

HOWEVER.............legally, and this is where the real problem came in as I understand it, is that if you called it insurance, (as Paddy does) it would have fallen legally under close regulation by the each state, as the insurance industry is heavily regulated, transparent and held accountable for the correct capitalization of their coverages and potential losses.

Somewhere, somehow, these CDS were de-regulated or something, and while they functioned just like an 'insurance policy', they were allowed to fly under the regulatory radar of the word insurance, because legally they were called CDS and not insurance policies.

This is where the real shenanigans began...........Banks obtained CDS's and legally not insurance and were therefore no longer regulated and could give out loans without any scrutiny as they would have had to do were it still legally called insurance instead of CDS.

Paddy.................what took place legally and at the legislative branch that allowed banks to no longer have call their loans insurance and therefore avoid regulatory scrutiny?

It seem to me that somthing changed in the consternation process that allowed all of this to happen.

CDS became a funny wordplay game, that legally and technically made the word 'insurance' a moot point, because all of the sudden, banks could obtain CDS instead of having to get insurance for their bad loans.

For your next video tutoring session, why not explain the differences between CDS and the word insurance from a legal standpoint and how that allowed this mess to occur and when and where that legislation was introduced that Banks could now take advantage of and not face regulatory scrutiny as they had had to when taking out insurance on home loans.

Best laymans explanation I have seen yet.
Kudos to you

This is really helpful stuff.

Paddy Hirsch is a golden god!!

Marketplace rules!!!

A quick question. The general rule that governs most insurance contracts is that I cannot purchase an insurance contract unless I have an "insurable interest" is the subject matter of the contract. For example, I cannot buy a life insurance contract on the life of President Bush, because I have now monetary interest in his life. If I purchase such a policy without an insurable interest, the insurance contract is void under well-settled law.
I am curious why this principle doesn't apply to credit default swaps or does it? Is it possible that Court's will void this contracts as contrary to public policy?
As I recall, the policy against issuing insurance policies to someone who does not have an insurable interests is, in part, that the law views them as "gambling" contracts that are against public policy. It seems to me that that is exactly what these credit default swaps are.

Very interesting But who can this be untangled? This thing seems to be compliacted that the people eho manage this are tied to the respective cco. with retention bonuses. To create a financial instrument sso interwoven that it requires to retain the person(s) who create it is self destructing. Why?