That’s why they are called swaps, not insurance. So they can get around the law requiring insurable interest. Note that there is legit bond insurance (e.g. PMI) that can be purchased.

I’ve often pointed out that swaps are like allowing life insurance policies to be taken out on other people without their knowledge. Not only is there the potential for insurance companies to bankrupt themselves overnight if they over-sell an entity; there is also the incentive to kill the person you took the policy out on.

I’m almost certain that the huge explosion of swaps was due to Nassim Taleb (the black swan guy). He made billions betting on so-called ‘once-in-a-lifetime’ financial events. I’m sure there are hundreds of thousands of hedge funds following in his footsteps.

Regarding participation; I think that the swaps market is only open to hedge funds and other private equity groups. You need millions of dollars to make the billion dollar plays these folks have. Some ETF vendors do use swaps to implement their long/short/leveraged ETF products, so that is one way the little guy can participate.

Anyways, swaps should be illegal and probably will be after the market in them collapses. The odds aren’t so great when you realize that there is absolutely no way many of these swaps can ever be paid off. Its like a lottery where the organizers embezzled the money from the ticket sales because they thought there was no chance anyone would win. Unfortunately for them (and the ticket holders), it turned out every ticket was a winner.

The good news is that *majority* of these bogus swaps are held by hedge funds, so it won’t affect the average Joe when they default (unless we have to bail them out as well). It’s in our best interest that they go away, as hedge funds will then be forced to invest in markets; vs. spending all their capital betting they collapse.