A Credit Default Swap is an insurance policy on a loan. The seller of the CDS agrees to pay out the value of a loan if it goes bad. But the buyer of the CDS doesn’t have to be the person who owns the loan. In this situation, one side is betting that the loan is good; the other side is betting that it will go bad. And here’s the crazy bit. A bank that owns these dodgy mortgages can buy a CDS to insure themselves against them going bad, but also sell a CDS to another bank, effectively betting that the loans won’t go bad. Imagine a complex network of Credit Default Swaps, bought and sold by all the commercial banks and investment banks in financial centres all over the world, and all centred around toxic, sub-prime loans with a bogus AAA rating. It’s a house of cards. As soon as the loans start to go bad – and they will, because they are all based on mortgages worth more than the houses securing them – the whole thing tumbles down. And this is what happened. In a frighteningly short space of time, almost all the banks found themselves with no liquidity. Because of their reckless betting, their reserves were all dried up. They had no money to lend. They had no money to do anything. They were bust.