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View Diary: Wall Street might not be growing tulips, but it's still spreading manure (153 comments)

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  •  Correction: origin of credit-default swaps (0+ / 0-)
    At the start of the market for Credit Default Swaps, there was a rather prosaic purpose to these instruments. They acted as private insurance, particularly for objects or events that might be tough to insure by normal means.

    No, that's wrong.  Credit-default swaps were illegitimate from the very beginning.  The insurance industry most certainly is set up to handle events that involve huge losses, but the problem with insurance is that it's a regulated industry. The insurance regulators want to make sure, for example, that in the event of a loss you can actually pay. Thus there is re-insurance to spread the risk around, so that the industry as a whole can handle losses on the order of thousands of oil spills.  The industry hires experts to accurately assess the risk, so they can safely beat the competition but still turn a profit and stay financially sound.

    The result is that insurance costs money, sometimes a lot of money if you're doing something risky. If, instead, you simply want to give people a false sense of security, you could do something else, and get someone to issue you a credit-default swap. That way, no regulator will check whether the losses, if they occur, can actually be paid off, or whether there are multiple CDS's issued on the same event, so that someone could profit massively by deliberately defaulting.  No one will check whether there's a conflict of interest.

    CDS's should simply be banned, and traditional insurance should be used instead.

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