Demise of Aig

How AIG fell apart Adam Davidson Thu Sep 18, 2008 1:55pm EDT View bountiful Size (The Big Money) When you hear that the collapse of AIG or Lehman Bros. or convey Stearns might lead to a systemic collapse of the global monetary system, the feared culprit is, largely, that once-obscure (OK, still obscure) instrument known as a credit disrespect swap. So, what is a CDS, and why is it so dangerous? At first glance, a credit default swap seems like a perfectly sensible financial tool. It is, basic solelyy, insurance on bonds. Imagine a large cuss buys around bonds issued by General Electric. The swan expects to receive a steady stream of payments from GE over the years. Thats how bonds work: The issuer pays the bondholder some money every six months. But the bank figures at that places a chance that GE might go separate. Its a small chance, but not cypher, and if it happens, the bank doesnt get whatsoever more of those payments. The bank might decide to buy a CDS, a sort of insurance policy. If GE never goes bankrupt, the bank is out whatever premium it paid for the CDS. If GE goes bankrupt and stops paying its bondholders, the bank gets money from whoever sold the CDS. Who sells these CDSs? Banks, prorogue funds, and AIG. Its easy to see the attraction. Historically, bond issuers almost never go bankrupt.

So, many banks and hedge funds figured they could make a fortune by selling CDSs, keeping the premium, and almost never having to pay out anything. In fact, beginning in the slowly 90s, CDSs became a great way to make a bunch more money than was possible through traditional coronation methods. Lets say you think GE is rock solid, that it will never default on a bond, since it hasnt in novel memory. You could buy a GE bond and make, say, a hand-to-mouth(prenominal) 6 percent interest. Or you could just sell GE credit default swaps. You get money from other banks, and all you have to give is the promise to pay if something bad happens. Thats zero money down and a profit limited single by how many you can... If you want to get a salutary essay, order it on our website: Orderessay

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