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Pathology in the Credit Default Swaps market

Credit Default Swaps, which originated as legitimate finance instruments that acted as a kind of insurance (offsetting risk in return for a premium), morphed into something more akin to high stakes gambling.

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The Global Financial Crisis
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Immediate triggers of the financial crisis?
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Pathology in the Credit Default Swaps market
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CDS market complex, unregulated and secretive
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Complex financial instruments that few understood
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Credit default swaps became divorced from underlying value
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Hedging/Netting contracts created web of vulnerability
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Monoline insurers struggling to meet guarantees
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Reckless securitisation on top of reckless lending
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Resources of regulators limited in comparsion to market players
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Speculative swaps grew to dwarf real insurance swaps
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Vast scale of rewards encouraged complicity with system
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Foreign governments fled US agency bonds
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Investment banks incentivised to move into riskier activities
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Agency Problem
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Bubble in US house prices collapsed
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Foreign governments fled US agency bonds
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France loses its AAA, Germany can't support € alone.
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Sudden evaporation of market confidence/trust
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