Next Mega-Credit Problem Looming?

An economy already reeling from the sub-prime mortgage mess could be in for a big hit from another type of financial instrument, experts warn.

They say possible problems in the gargantuan "credit default swap" market could cause credit-tightening and interest rate-hiking ripple effects, making it harder for consumers and companies alike to obtain credit.

CBS News correspondent Kelly Wallace explains that credit default swaps constitute a shadow financial system, out of sight and unregulated, that greases the wheels of business.

The swaps are a form of insurance, Wallace observes, with "big players -- banks, pension and hedge funds -- engaging in a high-stakes crap-shoot, trying to protect themselves if companies fail."

"This is a big one," cautions Harvard Economics Professor Kenneth Rogoff. "If this one got into trouble, it would be a big problem."

Wallace points out that the market for the exotic financial instruments has leaped, by some measures, from $1 trillion to $45 trillion -- about twice the size of the entire United States stock market.

What could be scarier than a market about defaults when things go bad, Wallace asks, rhetorically? How far-reaching could the problem be if they all start going belly up?

"Remember," says Forbes magazine Associate Editor Matthew Mill, "that ... everything in the economy is tangled together."

And, Financial Times U.S. Managing Editor Chrystia Freeland told Early Show co-anchor Harry Smith Thursday, "An estimate from (one very bearish economist) this week was about $250 billion could be the hit from credit default swaps, which is similar to the hit from the sub-prime mortgage instruments."

Credit default swaps, Wallace says, could be the next financial domino to fall: If companies default on their obligations, buyers of credit default swaps would lose millions, banks would tighten credit, and interest rates on everything would go up.

Says Harvard's Rogoff, "We're going into a downturn now, so everybody holding this stuff is getting a little panicked, and we'll see how the market does."

There are already signs of trouble, Wallace notes: A recent government report warned of a significant increase in trading in swaps during the third quarter of last year, while the Federal Reserve Board this week downgraded its forecast for the economy, blaming the housing slump and credit crunch.

Freeland told Smith, "Part of what has been going on is financial institutions are discovering that they weren't that good at really understanding the value of lots of different things on their balance sheets.

"And if banks get worried that they're not quite sure what the value of their assets is -- the credit default swaps are interesting, because it's a form of insurance. That was supposed to protect people's assets.

"So, if you're not sure that insurance is going to work, suddenly how valuable is the stuff you have? So banks are getting worried about it."