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(FINANCE) financial instrument in which buyer is someone who needs insurance against the [possibility] that a borrower will default on a loan. In that case, the [counterparty] is whoever receives the [CDS] premiums, and pays out in the event of default. WHY IT'S BAD Loans are usually made by either commercial banks (in which a loan officer is supposed to make a [professional] assessment of risk of default before handing over the money), or by investment banks (which underwrite securities like bonds). If the borrower has a high risk of default, then the loan should not be made--period. Credit default swaps were a stupid method of supposedly turning a bad loan into a "risky" (and potentially high-yield) "investment"; they were in reality a strategy for fraud. Since portfolio managers knew they were bundling securitized loans that contained mostly crap, they would arrange credit default swaps and cash in when the borrowers defaulted.
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