Credit default swaps. Icebergs for financial markets.

Credit Default Swap. PIMCO

(How a CDS works. From PIMCO.)

The financial rot has spread from subprime to other areas like credit card and auto loan debt and to Credit Default Swaps too.

CDS are where the issuer of a financial instrument pays an income stream to the buyer who in turn, guarantees it against default. It can’t be called insurance, although it clearly is, because only insurance companies can sell insurance.(Got that?) Yet another example of the sleazy dealings that have been allowed in the unregulated shadow banking system.

Not only is it clear that some buyers of CDS will not be able to pay, the dollar amount of them is beyond enormous.

The CDS market is worth about $45,000 billion. This is not an easy figure to imagine. It is more than three times the annual gross domestic product of the US.

Does your “enhanced” money market fund contain CDS? How about your pension fund? Or your local and state government funds?

It is not difficult at all to see how the CDS market has the potential to cause serious financial contagion. The subprime crisis came fairly close to destabilising the global financial system. A CDS crisis, under a pessimistic scenario, could produce a global financial meltdown.