The problem with the CDS casino is the settlement/payment of these contracts only gets triggered when a company/entity defaults or declares bankruptcy. But CDSs involve the use of tremendous leverage. A hedge fund trader once told me that they insured/sold 50 times their capital in CDS with the counterparty being a very large, well-known investment bank.
When I asked him if he was worried about that kind of leverage, he responded by saying that is the bank's problem because if he is wrong about writing all these insurance policies (in the form of CDSs), they [the hedge fund] can only lose their investment capital in the fund. This is the ultimate moral hazard trade, in my opinion, and is a problem with the hedge fund industry right now.
Mark Bloudek on Minyanville Buzz & Banter, 9/12/08