Can anyone explain what an how Credit Default Swaps "are" and "how they "work?

To add to mbrcatz's answer: There are two reasons why this became such a big issue for AIG, resulting in that bailout. First, the risk was not properly assessed and the premiums did not accurately reflect the risk. The credit was rated by the credit rating agencies, who also didn't realize how risk this stuff actually was. Second, some of the people buying CDSs did not own any of the credits but still purchased these tools. It is kind of like insurance on a loan, if the borrower defaults, you get reimbursed. However, some people purchased these without owning the underlying credit for the purpose of speculation. I was similar to buying insurance on a house you didn't own, you just hope that the thing burns down. Hope that helps to supplement the already good answer.