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Toxic Assets – Credit Default Swaps

Why the banks are upside down.

Simple explanation of a credit default swap (perhaps oversimplified):

I lend you 400,000.00 dollars, I ask my neighbor Joe to guarantee the 400,000.00 dollar loan to you in the event you default. Joe says OK, takes the bet and guarantees your loan for a cost to me of 4,000.00.

You now default on the 400,000.00 dollar loan to me. I go to Joe and ask him to make good on his guarantee, give me the 400,000.00 that he “insured”. Joe doesn’t have the 400,000.00 dollars, in fact he never did.

Blow up.

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October 4, 2008 - Posted by | General |

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