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Credit default swaps are being thrust into the limelight, most especially due to the AIG disaster and hearings going on at Capitol Hill today.

Here is a (hopefully) simple explanation of what a credit default swap is:

Borrower Bill borrows $1,000 dollars from Loaner Jim. Loaner Jim wants to obtain insurance on that debt in the event that Borrower Bill goes bankrupt. Loaner Jim goes to Insurer Ida and asks for insurance on the $1,000 loan. Ida agrees and sets a figure of $50 per year to insure that loan.

Effectively, Insurer Ida is placing a bet that Borrower Bill will make the payments back to Loaner Jim. Insurer Ida even made sure to check Borrower Bill’s credit rating and determined that it was outstanding. What happened here? Insurer Ida wrote a credit default swap, which is an unregulated derivative. This derivative was created by JP Morgan way back in 1995.

Oh, but then some problems occur with Insurer Ida’s business and she isn’t even in a position to pay Loaner Jim the $1,000 in the event that Borrower Bill goes belly-up. Now, the premiums paid have vanished. Soon thereafter, credit agencies discover the problem and tell Insurer Ida to find some new infusion of cash or her credit rating will take a hit. When Insurer Ida can’t do this, her credit rating takes a direct and devastating hit and she goes bankrupt.

Now, Loaner Jim is in big trouble. The debt which was previously insured no longer is. Loaner Jim, as a result, gets downgraded by the credit agencies. Loaner Jim is in such bad shape that he now has to declare bankruptcy. Of course, by this time, Loaner Jim has gotten in on the credit default swap action, having written countless "policies" of his own on many debts owed to his friend, Buddy Bob. When Loaner Jim’s business collapses, pressure then falls on Buddy Bob and, like a snowball rolling down a very long hill, the cumulative effect is devastating.

How is it that things unfolded this way? Well, it would appear that the ratings used to assess each other’s debt-worthiness was farcical. Everyone took a chance, a gamble, an extreme risk and the proverbial chicken is coming home to roost… and not in a good way. Not good at all.

Where does AIG fall into this equation? Well, AIG apparently wrote $78,000,000,000 worth of credit default swaps.

Oh, but it’s not just AIG. Many financial and insurance companies used these derivatives not just to insure against defaults, but to bet on whether or not other companies would fail. These swaps were used to in an effort to make money and not simply as the insurance policy as originally intended.

From the Time Magazine article on March 17th, the scope of the issue is laid out in stark detail:

The CDS market exploded over the past decade to more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association. This is roughly twice the size of the U.S. stock market (which is valued at about $22 trillion and falling) and far exceeds the $7.1 trillion mortgage market and $4.4 trillion U.S. treasuries market, notes Harvey Miller, senior partner at Weil, Gotshal & Manges. "It could be another — I hate to use the expression — nail in the coffin," said Miller, when referring to how this troubled CDS market could impact the country’s credit crisis.

It cannot be ignored that this was allowed to happen by a government run by politicians whose bank accounts were fattened with the generous donations from big bankers and insurers. They looked the other way.

A default on simply 10% of the above detailed $45,000,000,000,000 would mean certain economic disaster. Even more scary news?  It’s all but certain to take place.

The scariest news of all?  The Bank for International Settlements recently reported that total derivatives trades exceeded one quadrillion dollars – that’s 1,000 trillion dollars. This was made possible by the fact that these "insurance policies" are unregulated.  So, the reason that all of this betting was permitted to go on was because there was nothing in place to stop them.  No regulation.  No oversight.  No nothing.  Considering that the gross domestic product of all the countries in the world is only about $60-trillion dollars, the potential for an economic disaster of epic proportions is far more likely than anyone cares to admit.

While everyone seems to have their sights set on AIG… the real culprits here are the people in Congress.  Congress made back room changes back in February which allowed the bonuses to be paid by AIG (which were known and permitted by members) despite all of the debate and discussion on Capitol Hill.  Now, everyone is denying responsibility, even those who are chairing the committees responsible for the changes.  The denials and finger-pointing are nauseating and we can only sit back and watch our pockets continue to be picked by all of those responsible for doing what happened and worse - allowing it to happen.

That’s right. Don’t rush. Don’t be in a hurry. We wouldn’t dare say don’t worry and don’t stress. We would say - don’t do it for long. Take the body blow, feel the pain, and then work to inhale deeply. Stand up straight, and get to work. Being unemployed can be harder work than being employed. The reward for working hard and working smart during an unexpected layoff can be great.

You are not alone. Millions of people across the country are receiving the same bad news, often in an emotionless, "all-business" fashion that leaves you with an instant emptiness in your stomach that is hard to forget, even long after it has gone. It’s not just a financial shock, it’s an emotional one, too. Don’t let it paralyze you to the point of inaction. Now is the time to bounce-back.

Much like filing for personal bankruptcy can feel like a personal failure, quite often, a job loss can come with the same feelings. Recognize this - absent misconduct or poor performance on your part - it was out of your control. "It’s just business." It’s all about the economy right now and everything is far from rosy and bright.

Find ways to keep your emotions in check. Lean on friends and family. Visit a spiritual advisor or consider seeking some personal counseling. However, don’t let much time lag between the layoff and getting down to the business of getting back in business. A couple of big tips that require urgent attention:

1. File for unemployment compensation right away.  The recent stimulus package has actually added $25.00 per week in unemployment benefits.
2. If you are paying child support - file for a modification as fast as you can.  In many states, child support orders can be retroactive to the date of filing.  Delays on your part could worsen your financial situation.

Next, you need to take action regarding your health care situation.  Can you go without?  Can you find and afford private coverage?  Should you go with COBRA? Did you know that the recent Federal Stimulus Package also has a provision that subsidizes COBRA premiums for an involuntary layoff?  It is possible to find less expensive coverage than what COBRA may afford you, however, you need to understand that changes may be required (doctors, pharmacy, hospital, etc.)  If you have less than perfect health or a pre-existing condition, private insurance is likely not a viable option, in which case, retaining the employer’s health insurance through COBRA may be your best bet.

Next up - it’s time to cut back.  Less income must translate into less spending.  Sacrifice the premium satellite television package.  Eliminate the "unlimited text messaging plan" or any other luxury services that your cell provider has persuaded you to purchase.  The idea here is we’re dealing with a short-term situation.  Don’t go out to dinner.  Reduce or eliminate adding more money to your investments.  Create a new budget!

Tapping the right resources to help manage your situation is critical.  Avoid the costly impact of hitting retirement or 401K accounts, along with their taxes and penalties.  These are mostly untouchable if you reach a point of bankruptcy proceedings.  If you have that emergency slush fund, manage it diligently, remember - this is a period of focusing on NEEDS and not wants.  Borrow if you can, consider a loan against the car you own free-and-clear.  This suggestion is here only because the interest rates are often smaller than credit cards (which should be avoided).

Doing the post-mortem on the job is important.  Recognizes areas where you were weak and work to improve them.  Whatever you do - leave the job on good terms!  You’re leaving a facility full of potential contacts, referrals, and pats-on-the-back for your next job opportunity.  Also, don’t rule out the possibility of being rehired.  It happens!

Forward-looking is forward-thinking.  Remember - there are still a lot of jobs available for you.  Don’t give up.  Don’t spend too much time watching television and playing video games.  If you treat your day like you’re at work, you’ll remain in the groove.  Get up like you normally do.  Shower.  Get active.  Even dress for work.  You’ll be surprised how it makes you feel and just think… you’ll be ready to go to an interview on a moment’s notice!  Stay active in your job search.

Additional tips:

• Remember that any job-hunting expenses, including but not limited to: mileage, travel, copying, mailing… are tax-deductible provided you’re staying in the same occupational field.
• Supplement your income.  Be creative.  Don’t rule out everything.  Consider offering baby-sitting services, do housecleaning, landscaping/yardwork, mow lawns, shovel driveways, consult work in your area of expertise.
• Increase your education!  Believe it or not, some state schools and community colleges have programs that offer FREE TUITION for people who are laid-off/unemployed.  Look into it.  This is another one of those proverbial "windows that open" when a "door closes."
• Check your state’s website for programs out there for assistance.  You will be surprised at the types of help you might find.

Good luck!

Now more than ever before, radio and television advertising is flooded with ads purporting to resolve your debt and credit issues.  Are these debt settlement firms a panacea or another pitfall?  If you’re not careful, you will find yourself not climbing out of the financial hole you’re in, but digging yourself deeper into debt.

Credit counseling is a good way to get started.  You will find most reputable agencies are working with clients to ensure that your income matches your expenses at a minimum.  Ideally, you want your income to exceed your expenses, but you need to get to break-even before taking the next step.  It starts with curbing your spending.  It moves onto establishing a solid budget in order to get income and expenses into balance.  Moving beyond that - the work begins to initiate meaningful savings plans.

For those in the most serious situations, many firms now offer a fee-based debt management system to help the client restructure and repay their obligations.  These are most often offered on a percentage basis or a monthly fee basis with you, the client, paying money to the debt management firm.  From that, they pay your obligations and take their cut.

So what’s the pitfall?   Too many people are still using their credit cards.  They’re not budgeting for anything.  They throwing good money after bad, bridging the gap on one end of the equation with the "help" of the debt management company while still supplementing their income with credit card spending.  Not good.

The lure of an attractive advertising campaign can be strong.  The television or radio extends its imaginary hand, promising to "eliminate your debt."  It’s hard, when you’re drowning in a financial morass, not to reach out and grab hold of that helping hand.  Truth be told… anyone claiming to be able to "eliminate your debt" is highly unlikely to back up that promise.  Negotiate new terms on your behalf?  Probably.  Consolidate your debt into "one manageable monthly payment?"  Sure, if you stop increasing your debt load.

Never forget, you can always go to your Better Business Bureau in order to ascertain the quality of the firm you are intending to use.  You will see the firms’ ratings with regard to overall level of service and customer complaints and are awarded a letter grade of A+ (being the best) to F (for failure).  You must use due diligence!

Other typical pitfalls and issues to avoid:

• Companies that offer you a document that claims to absolve you of all of your debt.
• Companies that charge fees "up-front" or fees that are unreasonable steep.
• Lenders can still sue you even though you’re hoping to settle.
• The process can take several years to accomplish, with the industry average being about 36-months.
• This will negatively impact your credit and debt interest will continue to accrue during the process.
• Companies that advise you to stop communicating with your lenders or stop making payments to your lenders.

Tips and information for you:

• Always communicate with your lenders.  The worst thing you can do is cut them off.
• Find a firm that is certified with the National Foundation for Credit Counseling.
• Lenders would rather get something instead of nothing.
• You will probably have to pay income tax on the amount of the forgiven debt.
• Do not sign any contracts or agreements until you’ve read and understood them completely.
• Check the laws in your state - some, for instance, prohibit the collection of fees earlier than "half-way" through the process.

Most importantly, client beware. As with any industry, there are plenty of bad apples out there who will make your situation potentially far worse.  Emails and websites tout a way to consolidate bills into one monthly payment without borrowing; stop credit harassment, foreclosures, repossessions, tax levies and garnishments; wipe out your debts; or rid bad credit. These offers often involve bankruptcy proceedings , but they rarely say so.

Proceed with caution.

ING Direct awarded 500 of its mortgage holders with one month’s mortgage payment. In response to the nation’s foreclosure crisis, the Dutch based ING Direct forwent its holiday party planning to conduct a contest geared to providing one month’s mortgage payment to its mortgage customers. Each participant wrote a 250 word essay sharing their reason to receive the one month’s mortgage payment. ING Direct used the over $800,000 office holiday party budget to fund the contest.

Recipients of the awards were varied from compelling stories of cancer survivorship to the financially responsible seeking relief. ING has over 83,000 mortgage customers, but only received 5500 essays for the contest. ING currently owns slightly less than 2% of the nation’s mortgages equaling $17 billion. In October, ING Direct received $14 billion dollars in aid from the Dutch government.

Federal regulators has approved an overwhelming reform act on the manner credit cards companies charge and collect its card holders interest and fees. Today’s economic crisis has led many card holders to defaulting status on consumer credit as foreclosure rates have climbed to record levels. With jobless and mortgage default rates climbing, many consumers have all but abandoned paying revolving consumer debt.

The new collection and fee tabulation changes will cost credit card issuers almost $10 billion a year but will not take affect until July 2010. Americans used nearly 700 million major credit cards in 2007. Consumer advocates have charged the collection efforts of credit cards to be unfair to the card holder for decades. The new regulations will also prevent credit card companies from raising interest rates on card holders without a 45 day notice. Additionally, card companies are restricted on raising interest rates on balances incurred when lower rates were in effect. Regulators hope to regain confidence of consumers in financial institutions and level the playing field for creditors and consumers.