As pointed out several times by Steve Hsu recently, a major instigator of our current financial crisis is the Credit Default Swap (CDS). As far as financial instruments go, this one is almost understandable. Basically, it is an insurance policy that is exchanged between two firms. So, say you just loaned a bunch of money and you want to insure it. Well, you can buy a CDS for some fee from someone who will pay you some agreed upon amount if the loan goes bad. It is a zero sum game, which is why the amounts insured (notional amount) can be larger than the GDP of the entire world. Although the notional amounts of these CDS’s could be large, the big banks and hedge funds that traded them are often hedged so that the net gain or loss are manageable. The problem was that when Lehman Brothers went down, the whole network became unbalanced and some parties were exposed to huge losses. However, given that there is no market for these things, no one knows who is holding what. Steve drew a complex graph and an example to demonstrate how difficult it would be to unwind everything.