Wednesday, October 15, 2008

Explaining the financial crisis

I like this from Jim Manzi at National Review Online. He uses hunters and gatherers living in caves as the example of how a banking crisis - like the one we have now - might arise. Here's a paragraph on Credit Default Swaps, which are often explained in nearly incomprehensible terms.
While this is happening a couple of sharp operators might sit together in a dark corner of the cave, and make a wager about whether Og will default on his bond. In plain English, we would call this a side bet. Though if you wanted to sell this idea to a fairly gullible person who holds Og’s bond, you might make it sound kind of gee-whiz by calling it a Credit Default Swap. If I hold one of Og’s bonds and I take a bet that pays out if Og defaults, then I’ve just hedged my risk.
Read the whole thing.

For a good article on CDS's this one from Newsweek is pretty good. Provides interesting background too.