Credit Derivatives and the 2008 FinancialMeltdown

Abstract

This paper shows that credit derivatives, credit default swaps (CDS) in particular, contributed significantly to the implementation of a flawed home financing policy, enhanced and supervised by Fannie Mae and Freddie Mac, that ended up unraveling the mortgage market and destroying wealth at an unprecedented scale since WWII. A brief discussion of the origins of the crisis is presented followed by an extensive discussion on interest and credit derivatives. The contributions of these derivative instruments to the meltdown in the financial markets are documented here. The world financial system was so shaken that credit froze, mortgage markets failed, and massive intervention, in ever more ingenious ways, by the Fed and the US Treasury were implemented. Deregulation is not to blame. Indeed, inappropriate supervision of financial markets (including those of credit derivatives) and institutions, the interventions by government and governmental sponsored institutions to achieve political objectives, and flawed regulations like SOX have undermined the integrity of the financial markets.