Credit default swaps: how they work
Here is a story connected with the Greek credit crisis that in fairly simple terms shows how credit default swaps work and why they are so dangerous…or better put, create a vicious circle of financing debt, repaying debt, and making it near impossible to repay. Headline: “Banks Bet Greece Defaults on Debt They Helped Hide”.
“These contracts, known as credit-default swaps, effectively let banks and hedge funds wager on the financial equivalent of a four-alarm fire: a default by a company or, in the case of Greece, an entire country. If Greece reneges on its debts, traders who own these swaps stand to profit.
“It’s like buying fire insurance on your neighbor’s house — you create an incentive to burn down the house,” said Philip Gisdakis, head of credit strategy at UniCredit in Munich.”