The Big Short - shorting vs CDS
"To be able to truly short something you technically need to be able to borrow the security so you can sell it.  There needs to be a system for borrowing in place to be able to do this which is very robust for large U.S. stocks but doesn't exist for CDOs mainly due to the complex legal structures around them.   However, the word ""short"" is commonly used in finance to mean profiting from a loss of value of something.  So the use in the movie title, though a bit confusing, was fine. Credit Default Swaps are not technically insurance as you don't need own the thing you are ""insuring"" (and for a few other reasons).  However, I agree with the movie that thinking of them as insurance is a pretty good way to understand them.  As you are playing a monthly premium to for a contract that pays out when something goes very wrong.   However, the movie was a little fast a loose as CDS of various types were regularly traded well before the bubble even started.  Though maybe not that particular type of CDS.  So while they may have been ""expensive"" it was the easiest route and reasonable idea."
The point of short-selling as a separate instrument is that you can you do it when you can't sell the underlying asset... usually because you don't actually own any of it and in fact believe that it will go down. Shorting allows you to profit from a falling price. Another (non-speculative) possibility is that you don't have the underlying asset right now (and thus can't sell it) but will get it at a certain point in the future, e.g. because it's bonds that you've used to guarantee a loan... or grain that's still growing on your fields. "Someone told me that the main protagonist in Michael Lewis's, ""The Big Short,"" Dr. Michael Burry is shorting the student loan bubble.  I don't know if the investment banks have already set up student loan traunches  and if he's got CDSs on those, or if he's just shorted the Apollo companies, Strayers, etc." "Yes, CDOs certainly allow the investor to choose the tranche they want to invest in. As you said, lower risk higher priority tranches get paid first but also have a lower coupon rate. The higher risk lower priority (""junior"" or ""mezzanine"") tranches pay last, if it all, but have higher coupons." Short the Pound and other English financial items.  Because the English economy is tied to the EU, it will be hit as well.  You might prefer this over Euro denominated investments, since it's not exactly clear who your counterpart is if the Euro really crashes hard.  Meaning suppose you have a short position Euro's versus dollars, but the clearing house is taken down by the crash. Yeah this is what I thought too. The article referencing 'The Big Short' is kind of just fear mongering, the crisis was horrible and the movie did well to reflect that but the entire crux of the story was that credit ratings agencies weren't transparent and the market was being rigged. If regulation is good then there's no reason CDOs are a problem. "The default scenario that we're talking about in the Summer of 2011 is a discretionary situation where the government refuses to borrow money over a certain level and thus becomes insolvent. That's an important distinction, because the US has the best credit in the world and still carries enormous borrowing power -- so much so that the massive increases in borrowing over the last decade of war and malaise have not affected the nation's ability to borrow additional money. From a personal finance point of view, my guess is that after the ""drop dead date"" disclosed by the Treasury, you'd have a period of chaos and increasing liquidity issues after government runs out of gimmicks like ""borrowing"" from various internal accounts and ""selling"" assets to government authorities.  I don't think the markets believe that the Democrats and Republicans are really willing to destroy the country. If they are, the market doesn't like surprises." "In both cases, you have a bunch of assets that pay into a trust, and a set of rules determining how the payments are distributed to bond holders.    Typically, the bonds are split up by ""Seniority"" where any losses from the underlying assets gets recognized by the least senior bond holder first, and the most senior is protected until those below in seniority are wiped out.  In the case of mortgage backed securities, you have a lot of early payoffs (sales and refinances), and those payoffs tend to pay off the senior bonds first (though in practice, quite a bit more complicated than that)  CDOs tend to have bonds as assets that pay into the trust, and CMOs have mortgages.  CDOs used to be more likely to be things like corporate debt, or junk-rated debt.  But during the housing bubble you did have CDOs backed by some form of mortgage backed bonds.  If you build a CDO out of tranches of CMOs, you are going through multiple stages of tranching, and things 'get weird' when you have highly-correlated loss behavior in your underlying assets.  The Equity position or the residual, as it is sometimes called, is whatever money coming from the underlying assets isn't owed to any bond after all of the structuring rules are followed.  This would be interest received in excess to interest owed + money required to make up for lost principal.  Typically goes back to the issuing bank.  There is something called a NIM bond that gets carved out of the residual and pays to the investment bank, I gather.  Residuals and NIMs of mortgage bonds are pretty worthless in a high loss environment like this." Goldman Sachs saw credit default swaps as an investment option too. You have to realize they aren't really in the buy and hold game.  Them seeing an opportunity to make money off something doesn't mean it will necessarily go up in the future.  Also the US economy is the strongest it's been in almost 20 years.. Eroding? The answers provided already pretty much answer the differences and trade-offs, and I'd agree with recommending an online savings account like ING because the rate is just about the same as most CDs you'll find right now.  It's really a matter of when the CD rate is higher, and you can accept not accessing the money, then the CD is a better value, otherwise go with the savings account. However, here is an interesting option with CDs that helps with not being able to access the money: a CD ladder.  Basically, you get a CD every 3 months (or some other acceptable time frame), starting with 3, 6, 9, and 12-month CDs.  When the time is up for each of them, take that money and put it back into a new yearly CD.  Eventually you will get to the point when you have all of the CDs long-term, but you'll get some of the money every 3 months.  If you need the money, you'll have the option to use it, but you can always just keep it going, too.  The exact timing you use depends on your situation, but it's a great way to help get around not being able to access the money for a year or more. CDS spreads represent the premium for insuring some specific bonds against a default (as defined by the ISDA). I'm not sure how you can arrive at the claim that they have little to do with the already issued debt itself, except if you were to assume that this debt is not quoted on any market. There is a direct relationship between the level of the CDS spreads and the price of debt. I'm confused... Berkshire is entirely independent from AIG. Are you saying that Berkshire would have gone bankrupt had AIG gone under? That doesn't make any sense... AIG and Berkshire were performing the same function during the financial crisis - they were market makers for CDS/CDO's. AIG needed the money. Berkshire didn't.  Please explain. Shorting the Euro is the same as staying long the dollar, so if you're in the US you don't need to do anything. If you want to make some serious money you would want to either short specific European bank stocks, or buy puts on some of the European indices. This all depends on your timeline and net worth.  If you're short on time before you plan to start spending it or have a large net worth, parking some of your money in CDs is a good idea. If you have lots of time or not much net worth, then index funds are a better bet. Equity or dividend index funds are the way to go when you have 10+ years before you reach your goal. CDs major downside is that they don't beat inflation 1 - 3% a year. This is why you only use them when it's absolutely critical you hold onto every penny of the principal. The reason is because with CDs your 10k is actually losing its value (not the principal) the longer you leave it in CDs. I generally wouldn't recommend CDs unless you are in or approaching your 60s or have assets over 500k. Even still I would limit the use of CDs to no more than 20%. I would view them as catastrophic loss protection. "A **Synthetic CDO** is the devil incarnate.  From the CDS buyer (aka Insurance buyer's) point of view: if you want *protection* on some credit/debt-security/loan and **can't find a willing counterparty**, just get ""investors in a CDO"" to supply it, in small portions in mass!  The poor tranche buyers won't even be aware that their **""tranche LOSS""** constitutes final full default-recovery payment on the defaulted credit to the CDS buyer.   CDOs are making a come back (slowly but surely) b/c there's a lot of ""JUNK"" accumulated in the **""Levered Loan/Mezzanine Market""**. So industry finds it's favored vehicle to dispose of said junk, hiding behind two counterparties couched in different semantic cloaks: ""CDS BUYER"" on one side, and ""CDO INVESTOR"" on the other.  To boot, red-meat free-market publications like WSJ then say (asif) ""O, buyers are dying for yield, there's great demand"". LOL. This completely obfuscates fact that a humble cdo investor is **entering the INSURANCE BIZ** against some very dodgy ""assets"".  (would you insure stage IV cancer patients for $1mn at annual premium of, say $5000?)" Brokerage firms are required to report the number of shares being shorted.  This information is reported to the exchange (NYSE of NASDAQ) and is made public.  Most financial sites indicate the number of shares being shorted for a particular stock.  The image below from Yahoo finance shows 3.29 million shares of CMG were being shorted at the close of 9-28-2012.  This is over 12% of the total outstanding shares of CMG.  For naked short selling additional information is tracked.  If the brokerage is unable to borrow shares to deliver before the settlement date of a short sale then the transaction is recorded as fails-to-deliver.  No money or shares are exchanged since the brokerage is unable to deliver the shares that were agreed upon.  A large amount of fails-to-deliver transactions for a stock usually indicates an excessive amount of naked shorting.  When investors and brokerage firms start to aggressively short a stock they will do so without having borrowed the shares to sell.  This will result in a large amount of naked short selling.  When there are a large number of naked short sellers not all the sellers will be able to borrow the necessary shares before the settlement date and many fails-to-deliver transactions will be recorded. The SEC records the number of fails-to-deliver transactions. The table below summarizes the fails-to-deliver transactions from 1-1-2012 through 9-14-2012 (data obtained from here). The “Ext Amount” column shows the total dollar value of the transactions that failed ( i.e. Fail Qty * Share price ).  The “Volume” column is the total number of shares traded in the same time period.  The “% Volume” shows the percentage of shares that failed to deliver as a percentage of the total market volume. The table orders the data in descending order by the quantity of shares that were not delivered.  Most of the companies at the top of the list no longer exist.  For many of these companies, the quantity of shares that failed to deliver where many multiples of the number of shares traded during the same time period.  This indicates massive naked short selling as many brokerages where unable to find shares to borrow before the settlement date. More information here.