After the dribs and dribbles of subprime lending and mortgage-backed securities we come to the juicy bits. A staggering $55 trillion could be lost in CDSs. Never heard of it? But you are going to pay for it.

After months of treading the murky depth of subprime loans, mortgage-backed securities and other unsavoury little beasties shunning the daylight of commonsense financial dealings, we all want to go forward. But we find the way forward doesn’t go up to dry ground, it goes down into even murkier depths. And in there lies another ugly monster in wait which we can’t yet see properly: The CDS.

It’s the advantage of all those neat, little abbreviations that you don’t have to think about what they really mean. But let’s bring this one out into the open. A CDS is a credit default swap. It functions quite similar to an insurance contract, but instead of insuring you against fire or accidents, it’s supposed to insure against debt defaults. Please take note of the rider.

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If a big lender wants protection against debt default of a company, he takes out a CDS on this company’s bonds. The CDS gives the lender the assurance that should the company default on its payments, compensation will be somewhere down the road. It is this ‘down the road’ bit that is causing headaches to everybody. Nobody really knows where ‘down the road’ is, or who is on it.

As CDSs have been used as objects of speculation by banks and hedge funds, there suddenly existed a market. Unlike a public exchange, it was an unofficial, very murky market buying and selling these CDSs over the counter. This means that nobody really knows where these contracts are now lying. And as it became possible for investors to get CDS protection against firms he had no lending exposure to, the market is estimated at a staggering $55 trillion.

Insuring against inexistent lending is as if you are taking out a live insurance against somebody else’s live. If this person dies, you get the money. It is common practice in American companies to take out such life insurances against the lives of their employees. It is called Dead Pawn insurance, bringing the company money when the pawn sticks his spoon in the wall while the insurance policy is still running. This might even be after the employee has left the company. And usually an insurance company hedges this risk with another insurance company. The same process is a work in CDSs.

A firm that has sold CDS protection will then hedge that risk against another bank or investor, who in turn does the same. And that is the road we are looking at plastered with many, many CDSs. In the case of a default, the pertaining CDS would be triggered. Being reinsured, it would trigger another CDS. If one party in this long chain of liabilities and counter liabilities can’t settle on their obligations, it’s Domino Day.

The risk of such a domino effect is very high. Lehman Brothers’ collapse alone is worth $200 billion in payouts due from CDS. And as the CDS sale is over the counter, nobody knows who is going to foot the bill, and if they will be able to pay up. If banks and insurers say that it is all no problem for them because they have hedged their exposure to CDSs with other banks or firms, then they are either overly optimistic or just lying through their teeth, because they can’t know if the bad apple is at the end of the chain. And firms are imploding everywhere, from the States to Iceland and beyond.

So after the little bubbles in the mud, we are hitting the big one. The billions so far spent by governments can easily put on a few zeros to become trillions to get rid of this toxic waste.