Wednesday, March 10, 2010

Insurance By Any Other Name

Now, the Euro zone and their American counterparts are blaming the CDS market for the troubles in Greece and in the Eurozone generally. What is a CDS? CDS stands for Credit Default Swap. That name is not very edifying. Try this. A CDS is a plain vanilla insurance contract. Yes, insurance. If you own a CDS contract on a Greek bond, then you get paid the full value of the Greek bond if it defaults. For this insurance protection you pay a quarterly premium. Whoever sold you this CDS is functioning like an insurance company. In fact, historically, insurance companies were the main supplier of CDS contracts. Think AIG.

Now ask yourself. If you abolish home insurance, which mainly insures homes against fire damage, would that eliminate fires? If you abolish car insurance, would that eliminate car wrecks? How about eliminating health insurance (which Obama seems dead set on doing), would that eliminate health problems? What the Euro and US regulators, including our friend Bernanke, are arguing is that abolishing the insurance market for Greek bonds will eliminate the likelihood of default for those bonds. Is that absurd or what?

You can't make this stuff up.

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