The Global Economic Crisis

timer Asked: Jul 5th, 2013

Question description

Read the “Global Economic Crisis” story on p. 197. Discuss the credit default swaps and the effects it had on the financial crisis.

Insuring with Credit Default Swaps:  Let the Buyer Beware!

Recall that a credit default swap (CDS) is like an insurance policy.  The purchaser of the CDS agrees to make annual payments to a counterparty that agrees to pay if a particular bond defaults.  During the 2000s, investment banks often would purchase CDS for the mortgage-backed securities (MBS) they were creating in order to make the securities more attractive to investors.  But how good was this type of insurance?  As it turned out, not very.  For example, Lehman Brothers might have brought a CDS from AIG in order to sell a Lehman-created MBS to an investor.  But when the MBS began defaulting, neither Lehman nor AIG was capable of making full restitution to the investor.

Only need a 75-150 word discussion on this topic.



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