A credit default swap (or CDS for short) is a kind of investment where you pay someone so they will pay you if a certain company gives up on paying its bonds, or defaults. A credit default swap is like insurance on bonds, but different from insurance in important ways:
- Insurance companies make sure you own the thing you're insuring, but you can buy credit default swaps for bonds you don't own.
- The government makes rules (called regulations) for insurance, but they don't make any yet for credit default swaps.
- Insurance companies have to have enough money in case lots of people need to collect insurance at the same time. Because there aren't many rules for CDS sellers, they don't have to be as careful.
Because nobody makes sure you have the bonds you get credit default swaps for, people can speculate on them by buying credit default swaps on companies they think will get in trouble.