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This would seem to explain the reason Bear Stearns was bailed out, and why the survival of these sort of institutions is so critical in our economy these days… It’s sick and twisted, in my opinion. I think I’d rather stick to buying lottery tickets than financial derivatives.

http://en.wikipedia.org/wiki/Credit_default_swap

“Warren Buffett famously described derivatives bought speculatively as “financial weapons of mass destruction.” In Berkshire Hathaway’s annual report to shareholders in 2002, he said “Unless derivatives contracts are collateralized or guaranteed, their ultimate value also depends on the creditworthiness of the counterparties to them. In the meantime, though, before a contract is settled, the counterparties record profits and losses -often huge in amount- in their current earnings statements without so much as a penny changing hands. The range of derivatives contracts is limited only by the imagination of man (or sometimes, so it seems, madmen).” The same report, however, also states that he uses derivatives to hedge, and that some of Berkshire Hathaway’s subsidiaries have sold and currently sell derivatives with notional amounts in the tens of billions of dollars.

“The market for credit derivatives is now so large, in many instances the amount of credit derivatives outstanding for an individual name are vastly greater than the bonds outstanding. For instance, company X may have $1 billion of outstanding debt and $10 billion of CDS contracts outstanding. If such a company were to default, and recovery is 40 cents on the dollar, then the loss to investors holding the bonds would be $600 million. However the loss to credit default swap sellers would be $6 billion. In addition to spreading risk, credit derivatives, in this case, also amplify it considerably.”