In a “credit default swap” the investment bank pays the investor a fee which is like the margin on a loan. In return, the investor agrees to indemnify the bank against losses if the company fails to meet its obligations or goes bankrupt. If that occurs, then the investor pays the bank.
The payment is compensation to the investment bank for its losses on its loan when the company failed to pay.
The credit default swaps market is estimated to be a multi-trillion dollar problem. Even TIME Magazine is sounding the alarms on these products:
A meltdown in the CDS market has potentially even wider ramifications nationwide than the subprime crisis. If bond insurance disappears or becomes too costly, lenders will become even more cautious about making loans, and this could impact everyone from mortgage-seekers to municipalities that need money to fix roads and build schools.
One of the biggest issues of concern is some credit default swaps contracts are anonymous. This is a problem because one counterparty might not know what the risk exposure is on the other side of the transaction, which could potentially affect their ability to make good on payments.
Zamansky LLC is investigating several claims regarding credit default swaps. We offer free consultations.