The Heart of the Matter: What Are Swaps?

A look at what Warren Buffett calls 'financial weapons of mass destruction.'

Eric Jacobson 6 October, 2008 | 2:19PM
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OK, wait. Don't run away just yet. I promise to try and keep you from nodding off. The subject of bonds is frustrating enough, and the very mention of the word "swaps" has been known to cause eyes to glaze over.

Here's the thing, though. Swaps have become so ingrained in the global financial system that the way it evolves over the next few years will depend heavily on whether swaps remain popular among institutions, whether they continue to work the same way, and whether--and to what degree--they become more heavily regulated.

The story of swaps also bears similarity to other major innovations that triggered the growth and popping of past investment bubbles, leaving destruction in their wake. In many just cases, the value of what remained became clear only later. Billions of pound

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Eric Jacobson  is director of fixed-income research with Morningstar.