Credit Default Swaps are like car insurance. Instead of buying insurance for a car you have bought, you buy insurance for a Bond you bought.  CDS are derivatives.

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The purpose of big bailouts was to prevent CDSwap explosions, risking a string of bombs to go off. The key aspect of CDSwap contracts is their hidden nature, with fuses intersecting in the dark.

The Credit Default Swaps can burn Hiroshima holes all over the US and European financial systems, resulting in an economic implosion in the US/EU from almost entirely eliminating bank and financial system structures. The process has only begun but in darkness.

The total size of this market is A STAGGERING $ 63 Trillion! CDS were used by Greece, Spain, Italy, etc., because they allowed the conversion of something like a bad bond or CCC into an AAA.

A premium is to be paid for the risk. The higher the risk, the higher the premium. Under normal circumstances, the risk for a bond issued by the American government is smaller than the risk for a bond issued by a company like General Motors.

If the risk occurs - either the interest or the Bond cannot be repaid, the Insurer compensates for the damage.  When does notional value become real value? Under what circumstance would a credit default swap require financing to 100% of its insurance undertaking? The answer is in default. This is why Greece won't be allowed to go into default, and we shall see Quantitative Easing to Infinity until the natural economic forces do what the politicians should do but do not have the balls for.

• Premiums are paid quarterly for the term of the contract but are decided upon at the moment the insurance is underwritten. The higher the risk, the more expensive the premium.

• Premiums for CDOs on Morgan Stanley used to be 2% ..now they are 8% to 10%

• The premium for CDOs on Washington Mutual was 5% and spiked to 40%.

• Premiums for Ford were 12%, and they spiked to 18%

• GM premiums rose from 10% to 25%Premiums for countries like Greece are astronomically high.

One of the companies that underwrote this kind of insurance (CDS) was AIG. They wrote credit default swaps on the CDO subprimes, Lehman, and other financials that went down…

Domino...domino...House of Cards: One of the major mistakes the American authorities made was letting Lehman go bankrupt, which triggered AIG's payment of huge amounts and its own default.

Credit derivatives only have ten major players (large banks like JPMorgan, Societe Generale, Bank of America/Merrill Lynch, Barclay's, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, UBS, BNP Paribas, Royal Bank of Scotland, Nomura, HSBC, ....: one goes down and it affects the other 9 players (domino effect).

Credit derivative insurers cannot be compared to life insurers. The reason is apparent: premiums in life insurance are calculated based on mortality tables. People tend to live an average of so many years. Credit Default Swaps premiums are/result from an extremely narrow market, misallocation of funds, abnormally low interest rates, and abnormally low premiums. In good times, when nothing happens, all insurers cash in the premiums and make a lot of bucks. In bad times, however, the whole sector suffers and the default of one insurer can become dramatic for another insurer or financial company: if the insurer of a Bond goes bankrupt, the Bond can become insolvent and the financial company carrying it on his books follows...Credit Default Swaps (like most derivatives) are a world where the market is completely in the hands and controlled by ten large banks: they decide whether a country or a company slides into bankruptcy or not. It is not hard to understand that such is a scary situation.

BASEL II regulations define the amount of capital banks must maintain in reserve. Here starts the irony. This is based on the quality of the bank's loan book. Unregulated Credit Default swaps allowed banks to get around the Basel rules.

BASEL III regulations try to adjust for the risk...but these ten banks and nobody else set the rules!

Because of a booming Real Estate market, subprime securities were insured for almost nothing. In those days, the mortgage default risk was very low; if it occurred, the value of the Estate was always high enough to cover the loss. Ironically, the insurer (ex., AIG) did not have to put up any capital as collateral because this kind of operation is not regulated. The only condition was to maintain a triple-A credit rating.

A computer model decided on the premium; profits could be booked after selling the swap. Under these conditions, any bank could (over) leverage itself to the full extent allowed under the Basel II regulations. The insurers could book millions of profit each year without worrying about the collateral. But the profits that were booked never materialized, and all of a sudden, the default rates on mortgages multiplied, and this is how certain securities labeled AAA were, in fact, worth less than the $ 1...the end of the game! The house of cards collapsed, and we saw a domino: AIG, Lehman, Merrill Lynch, Goldman Sachs, and a financial tsunami!

Countries like Greece used Credit Default Swaps to become members of the EU, and many municipalities and countries used them for additional income.

Conclusion:

1. Without the government's help, any major bank in the World would have gone bankrupt.
2. Without a credit default market, NO bank can report the correct state of its assets.
3. All banks would fail the Basel II regulations without a credit default market.
4. Replacing this massive credit-creating machine will lead us straight into Hyperinflation and deep depression—there is no doubt about this!

Credit Default Swaps traders and guarantors (the legislative and executive power)

Bank of America / Merrill Lynch Barclay's Citibank Credit Suisse Deutsche Bank Goldman Sachs JPMorgan Chase Bank, N.A. Morgan Stanley Société Générale BNP Paribas The Royal Bank of Scotland Nomura

ISDA (International swap and derivatives association)

In case of a default, the credit default swaps have to work…The ISDA defines a credit event and a default. Members of this association are large banks that have created the CDS, and there is no doubt they will push for more QE and NOT for Default.

On January 31, 2012, Greece set off a potential default, as only a maximum of 30% of the funds will be recovered. If Greece and Greek Swaps are declared a default, the five largest US banks will go bankrupt. Five large US banks (JP Morgan Chase, Wells Fargo, Bank of America… have issued 97% of all credit default swaps.  

However, if Greece is not declared a default, any other companies that use CDS to cover the risk will be in huge problems because they cannot exercise their insurance. People don’t understand the fragility of the system.  There will be more undercover, unadvertised QE or QE3,, and this is extremely bullish for equities in general.

This is how Goldman Sachs and Greece did it: