Credit Default Swaps, Clearinghouses, and Exchanges

July 09, 2009

Report

More on:

Financial Markets

Inequality

United States

Overview

Credit default swaps (CDS) are contracts that provide protection against the risk of default by borrowers. The buyer of the CDS makes periodic payments to the seller, and in return the buyer will receive a payoff if the borrower defaults, analogous to an insurance contract. While credit default swaps can be a valuable tool for managing risk, they can also contribute to systemic risk. CDS contracts are currently traded over the counter rather than on exchange, raising concerns over counterparty risk. The failure of one important participant in the CDS market can destabilize the financial system by inflicting significant losses on many trading partners simultaneously. A clearinghouse could in theory reduce counterparty risk by standing between the buyer and seller of protection, insulating the counterparties’ exposure to each other’s default. This Working Paper, the fifth in the Squam Lake Working Group series distributed by the Center for Geoeconomic Studies, analyzes the market for credit default swaps and makes specific recommendations about appropriate roles for clearinghouses and about how they should be organized.

More on:

Financial Markets

Inequality

United States

Top Stories on CFR

China

As religious observance in China grows, the Chinese Communist Party continues to toughen oversight, increase religious persecution, and attempt to coopt state-sanctioned religious organizations.

Refugees and Displaced Persons

The United States has long accepted refugees from around the world, but President Trump’s sharp cuts to refugee resettlement have sparked debate over the program’s national security implications.

Ethiopia

Ethiopia’s new leader is seeking aggressive reforms to put an end to discord and build on the country’s progress in recent decades, but a towering set of challenges threatens his agenda.