I love analogies, especially when it comes to understanding complex things that I just don’t get.  Yesterday I had the pleasure of sitting in on a presentation given by James Anderson, the President of SVB Analytics.  He was giving a presentation on the US economy to a group of fairly senior business executives and he really did give an engaging, at times humorous, and very informative presentation.  Here are two take aways that I enjoyed particular, and please note that I’m paraphrasing him.

America’s role in the world economy: Think of the world economy as a reality show set on an island with five players on a team. One player is tasked with building shelter, another with hunting food, another with starting a fire and the third with providing drinking water.  Those four are countries like China and India.  America is the fifth player and its job is to eat, and it has done its job very well but now the other members are ready to vote it off the island.

Credit default swaps: Think of the market as a $1 million Texas Hold ‘Em game being held in a Vegas casino with a room full of spectators.  All of the spectators start placing side bets on which player will win, and eventually the amount of money in the side betting is $70 million vs. the $1 million that’s at stake in the actual game.  Credit default swaps are the side bets.  Now compare this description to the definition of credit default swaps on Wikipedia:

A credit default swap (CDS) is a credit derivative contract between two counterparties, whereby the "buyer" or "fixed rate payer" pays periodic payments to the "seller" or "floating rate payer" in exchange for the right to a payoff if there is a default^[1] or "credit event" in respect of a third party or "reference entity".

If a credit event occurs, the typical contract either settles by delivery by the buyer to the seller of a (usually defaulted) debt obligation of the reference entity against a payment by the seller of the par value ("physical settlement") or the seller pays the buyer the difference between the par value and the market price of a specified debt obligation, typically determined in an auction ("cash settlement").

A credit default swap resembles an insurance policy, as it can be used by a debt holder to hedge, or insure against a default under the debt instrument. However, because there is no requirement to actually hold any asset or suffer a loss, a credit default swap can also be used for speculative purposes and is not generally considered insurance for regulatory purposes.

See what I mean?