Global Financial Crisis and Credit Default Swap

Dazzling numbers, complicated trading rules, seemingly inexhaustible and exorbitant profits...These are the characteristics of Credit Default Swaps and other risky financial derivatives in their golden age.

But now, CDS has brought much havoc in the global financial market. Because of its skyrocketing prices, euro zone and the market that stems from the sovereign credit default crisis are to be getting worse, not to mention the fact that it is Goldman Sachs who helps the Greek government to hide the deficit tools. And then push forward the year before Lehman Brothers and American International Group (AIG) bankruptcy, CDS is also wrapped in a shroud to account.

This series of amazing damages make CDS's seem quite defective. The problem is that, as in numerous cases of financial history, "criminals" are usually shown in the first reaction is to shift the responsibility onto others, rather than to review their own problems. This time, speculators once again seem to act as the chief culprit in the tragedy of CDS.

These speculators should really be damned, right? Maybe, in a sense, they are just scapegoats. Since the invention of the CDS derivatives of the decision-makers had never reviewed their own problems.

Let's look at the terrible financial turmoil. Some financial institutions packaged subprime mortgages into a category of claims, covered with the prevailing official seal, and then sold to funds and other investors. After the completion of these steps, CDS debut, and these financial predators have begun to vigorously CDS product short-selling of these bonds, rating agencies are also cosmetic CDS prices are lower under the unrealistic given the high ratings.

However, lies there must have been exposed one day. Suddenly, these misdeeds brought to light, and the entire financial system into chaos followed. Lack of transparency in the market led to the frequent buying and selling of CDS. CDS changed hand very often and so almost all financial institutions had this bomb in their inventories. The lack of financial supervision and rapid amplification of this defect caused a "domino effect".

The regulator found that this disaster had come to a situation that could never be mended. CDS market has hundreds of millions of counterparty trading. Every single part of a problem debt will result in intensive chaos in financial markets.

This is a vicious circle.

Fortunately, after years of efforts, CDS Clearing House established in the United States finally made some progress. This will enable CDS market to improve transparency. Investors can clearly listed on the company's assets based on the situation, profitability levels to determine the value of securities, and to determine transaction prices.

But there is problem again. Because the counterparties are not limited, how to avoid a large number of pairs of gambling on the market phenomenon? If some financial institutions that hold CDS deliberately caused the underlying bond defaults to get the high CDS gains, what should we do?

Those who seek to want to change the nature of the lofty ideals of greed on Wall Street may be in a very distant land. They finally realized that CDS trading had turned out to be a 42-kilometer marathon, not the 100 meters sprint.

So, if someone thinks of the creation of new financial instruments to carry out arbitrage, at the beginning of the creation of a problem he must make sure: Once the outcome becomes out of control, how can he and everyone exit? The creation of financial derivatives is simple enough. But if the unfortunate risk variables lead to a systemic collapse, the outcome will be another global crisis.