Credit Default Swaps Explained

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From Economics Help --

Credit default swaps, which were essentially insurance policies taken out against risky loans, have been widely discussed throughout coverage of the financial crisis.  However, it's unclear exactly what their role was.  Did they exacerbate the problem, or are they simply a financial structure for mitigating risk that have nothing to do with the underlying debt problems?  Check out this quick explanation to help simplify this complicated financial structure.

“ The buyer of a credit default swap pays a premium for effectively insuring against a debt default. He receives a lump sum payment if the debt instrument is defaulted...Credit Default Swaps are unregulated and because they get traded so frequently there is uncertainty of who owns them and whether the holders can actually pay in the event of a negative credit event. ”