You all know it means nothing because it really does mean nothing...,
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Peter R. Orszag is my new hero, because all my heroes are dead...,
other people's jargon:
Let me get this straight.
Credit default swaps are a kinda-sorta insurance policy on debt. You buy a CDS on some sort of debt instrument, you pay a quarterly premium, and if the bond or mortgage back security or whatever goes into default, you collect on the coverage you paid for.
You can buy these policies on bonds, mortgages, auto loans, student loans, credit card debt, hey what the fuck. Out of fear of what I might discover, I haven't attempted to find out if banks are selling swaps against one's own credit card balance, but that seems to be what somebody is doing.
The CDS is "traded" on a market. Apparently they're not really bought and sold, just handed off to third parties, cancelled, or covered. If I sell you a CDS policy, I might offset the risk of paying on it by going out and buying my own CDS policy, and so covering the risk of my paying on your insurance policy with my own insurance. In a way you can think of the CDS market as a dice game that's turned into one big circle jerk.
There are $62.2 trillion dollars in credit default swaps. Now, wikipedia tells me, the international bond market is worth some $45 trillion, about $25T of that in US bonds. Wikipedia says that figure includes our $11 trillion in mortgages, as well as corporate bonds, the US public debt, and the rest of the lot.
Now, I'm just a caveman, but if I were an eight year old who sat down one partly sunny day and just dreamed up our financial system out of the clouds, and looked at it with my simple ganglia, I guess I would say "we are over-insured".
Some $4 trillion - I think that's Roubini's figure - in real estate asset value is disappearing, some fraction of that value is held in mortgage backed securities, some fraction of which will go into default because it's disappearing, some fraction of the defaulting MBS is covered by these credit default swaps, so some fraction of the cost of the defaults will shift to other institutions. And that last part is what will doom us all, but only since last weekend, before which everything was pure awesome?
update: If you've followed this far - and I think I followed it correctly - Robert Waldmann helpfully explains the rest.