Credit Default Swaps (CDS) are a derivative that pays fixed payments to a third party who takes on the risk if a borrower defaults to a lender. CDS's were invented by JP Morgan around 1994 and originally were not regulated. The Dodd Frank Act was formed in 2009 to regulate CDS's after the banking crisis of 2007-2008. The CDS was very popular in the early 2000s before regulation. The value of CDS's in the marketplace reached into the trillions out pacing the investments in the stock market before regulation.

The biggest risk with Credit Default Swaps is that if the party's in involved default and then the scheduled payments are not made to the lender. This would include current payments to be made and future payments to be made. CDS's were highly used for mortgage back securities and fixed income bonds prior to 2008 but have since been not as popular as regulation advanced after the financial crisis i and the Dodd Frank Act. Two examples of the usage of Credit Default Swaps are the use with bonds and mortgage back securities.

A person might think that bonds with a government are secure although this might not be the current case with the Russian Government that has defaulted on their foreign debt due to sanctions imposed on them because of their war with Ukraine. There have been other governments who have defaulted over the years. They include Greece, Argentina, and Venezuela. All triggered default payments historically in the past years. The Greece bond market collapsed due to a massive country debt crisis after the financial crisis of 2007-2008. Argentina has defaulted nine times in history due to enormous debt and countless recessions over the years. Venezuela defaulted in 2017 due to an unstable government and massive debt and recessions. Although other countries and governments like Switzerland and Germany have a AAA bond rating and essentially very low risk. Although this shows that not all countries and governments are a no risk investment.

Another type of CDS and a common one is with mortgage back securities. These are essentially bonds made up of a bundle of mortgages sold by an originating mortgage lender to an investment bank that sells to the security to investors. This allows for the lending institution to free itself from the obligation and not have any risk while make a profitable transaction. If everything in the process is followed as planned this is a relatively good process. Although like we experienced in 2007 -2008 when the process is not followed as designed then there can be chaos. Essentially, the crisis was focused on lenders lending to unqualified buyers that ended up in massive defaults and a collapse of the banking lending system in the country. This also had a negative financial domino effect in Europe and other countries globally that were connected to the Mortgage Bank Securities crisis.

Even with chaos and collapsing examples historically there is still money to be made with bonds and Mortgage Backed Securities. Without default these processes are a win, win process. It all depends on the risk taken and good regulation to make it work like the way it was designed to.

Question: After reading the opinion above, what is your response? What may be some risks or drawbacks? Please be detailed in your opinion.