The Truth about Credit Default Swaps and the United States Financial Crisis
Veneri, Ryan M.
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The profound events of 2007 and 2008 revealed fundamental flaws in the U.S. financial system. Unlike previous dips that are an intrinsic part of a free market economy, the catastrophe of the current financial crisis has substantially affected nearly every citizen and community across the U.S. It is of the highest priority to identify these fundamental flaws in order to prevent further recession in the U.S. economy. Some scholars and economists have blamed credit default swaps (CDSs) for the near collapse of the U.S. financial system. However, this argument oversimplifies the true nature of the events prior to 2007. Human action and inaction in regards to the housing bubble and managing risk created an unprecedented amount of volatility in the global financial system. The use of CDSs prior to 2007 exacerbated the financial crisis; however, they are not the source. CDSs have proven to be an effective risk management tool that facilitates the availability of credit throughout the financial system. In an attempt to reform the U.S. financial system, policymakers have singled out CDSs for more stringent regulation. While some of these regulations will provide a better infrastructure for transactions, other provisions will restrict the availability of credit. In terms of the global economic recession, it is of paramount importance that individuals and institutions have access to credit. The temptation for more stringent regulation will not stimulate the economy out of recession. Policymakers need to create a better regulatory framework that allows derivatives such as CDSs to enhance economic welfare.