Did credit default swaps cause the financial crisis?

Did credit default swaps cause the financial crisis?

I conclude that credit default swaps did not cause the dramatic events of the credit crisis, that the over-the-counter credit default swaps market worked well during much of the crisis, and that exchange trading has both advantages and costs compared to over-the-counter trading.

Who bought the credit default swaps?

Lehman Brothers found itself at the center of this crisis. The firm owed $600 billion in debt. Of that, $400 billion was “covered” by credit default swaps. 2 Some of the companies that sold the swaps were American International Group (AIG), Pacific Investment Management Company, and the Citadel hedge fund.

How much were credit default swaps worth in 2008?

Before the financial crisis of 2008, there was more money invested in credit default swaps than in other pools. The value of credit default swaps stood at $45 trillion compared to $22 trillion invested in the stock market, $7.1 trillion in mortgages and $4.4 trillion in U.S. Treasuries.

Could CalPERS negotiate a credit default swap with AIG?

CalPERS could accomplish this by negotiating a $100 million, five-year credit default swap with AIG — which up until a month ago was a global, triple-A rated financial institution. Under the terms of the swap, CalPERS would make an annual swap payment to AIG equal to — for example — 1\% of the $100 million swap notional amount.

How did AIG get involved in the financial system?

But a few years ago, AIG got involved in a new aspect of the financial system: It joined in the selling of so-called credit default swaps. A credit default swap, or CDS, is essentially insurance on debt. Imagine a bank that has bought bonds from, say, the Port Authority of New York and New Jersey.

What happened to AIG’s derivatives portfolio?

As Buffett and others have suggested, the risk in the AIG derivatives portfolio was explosive — and ignored until it was too late.

What caused the AIG collapse?

While the general view of the AIG collapse is that it was a function of collapse of the mortgage-backed securities market, in truth it was a direct consequence of AIG’s CDS exposure. Four weeks ago, AIG was a triple-A rated insurance company.