The point of financial markets is to support the real economy, not to allow investors a venue for gambling. Casinos serve that function. And BTW, casinos are better regulated in term of making sure the house can make good than the CDS market is.

Credit is essential to the functioning of an economy. No credit puts you at the barter stage. When I provide services and bill my clients, I am extending to credit, they have an account payable (my invoice) and I have an account receivable (what they owe me). You cannot have commerce on any scale without credit.

So we need to talk about productive versus unproductive uses of credit, not “lets’ get rid of credit.”

I can’t wait until we get AI computers running all this high-falootin’ finance for us.

The real issue is that CDS are not a capital market product; I suggest you read Chris Whalen on this topic. They are in no way, shape or from a derivative; they are not price in relationship to an “underlying”; none of the Black Scholes or related models apply here. They are an insurance product and should be treated as such.

And the comparison to short selling in equities is misguided. The volume of shorts in equities is a fraction, and not a large one, of total outstandings. In CDS, it is a significant multiple (4 times? maybe more) of the total value of the bond market. The side bets are vastly larger than the underlying useful economic activity.

As Keynes noted, “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” And Keynes was a very successful speculator. The capital market do not have any inherent right to exist, nor are they inherently virtuous, your ideology to the contrary.

But you could have a situation where 10 buyers each pay $1 per year to 10 sellers for $100 of protection.

Say in year 2 the reference entity explodes (who could have imagined?? LOL).

So the Buyers pay 10 x 2 x $1 = $20
The Buyers receive 10 x 100 = $1000

Buyers pay $20 and get $1000
Sellers get $20 and pay $1000

That $1000 didn’t exists, a priori, in a vault someplace. It was raised through hedges that worked or didn’t work, or from some other potentially destabilizing process that might demand liquidity when it’s least available.

Speculators (buyers in this case) win.

But how can you margin something like that, because you’d need some math to work the probabilities? And then you get judgment calls and lobbyists and wining and dining and cigars and night clubs and lap dances and etc. etc. And the probabilities would get slimmer and slimmer and slimmer until they’d disappear into a Black-Schole. Isn’t this sort of deja vu?

Eventually the math goes out the window while the money comes in — courtesy of U.S. middle-class taxpayers.

If they don’t want the credit risk, they should sell the damn bonds and leave “the populace” alone to our backyards and football games and dogs and cats and hunting and fishing and Sunday sermons and keg parties and garden clubs I don’t want to subsidize Wall Street’s “efficiency”. I want inefficiency, imagination, laziness, dreams, languidness, squalor and inebriation, lassitude and laying around, creativity, conscience, holisticism, wholeness, long weekends and evenings and mornings that last like days of dreams. To hell with “efficiency”. It’s a Godless Moron with three-heads, each one uglier than the next, and it will eat the world alive with its steel jaws.

“CDSs are “anti-social”, he goes on, because those who buy credit insurance often have an incentive to see companies fail. Rather than merely hedging their risks, they are actively hoping to profit from the demise of a target company.”

This scheme strategy plays out in same egregious pattern with CDS shorting mortgage debt. When viewed from perspective of a mortgaged homeowner, these CDS shorts become weapons of class destruction as well. Little do victims of mortgage servicing fraud realize that it was complicit mortgage servicers, subsidiaries of the mega banks who greased the skids, gaming lucrative CDS bets for their proprietary traders.

Furthermore, despite $27,349,230,000 committed to mortgage servicers as incentive payments for mortgage modifications as part of the administration’s HAMP program, servicers have been deincentivized from supporting this program because CDS payouts rigged on insider knowledge that servicers manufacture defaults are so much greater.

Short CDS holders want these credit events, they want these bogus defaults and illegal foreclosures so they can collect on highly leveraged bets. They don’t care that fraud is perpetrated in order to collect their winnings. They don’t give a rat’s ass about Main Street homeowners at all. They are actively hoping to profit from their demise. This extreme anti-social behavior is well on its way to pushing U.S. foreclosures well past 3 million this year.

I do take issue with your comment that “if you buy CDS on a company whose bond you don’t own, you CANNOT destroy that company” however.

Traders would buy CDS on a company’s bonds, they would then begin aggressive naked short selling of the company’s stock, the rapidly falling stock price would cause ratings agencies to lower their credit rating, and the firm’s creditors often had clauses that required additional collateral be posted if their credit ratings dropped, the additional collateral required caused a deterioration in their financials which increased the likelihood of default thus increasing the value of the CDS.

So one did not have to actually own the bond in order to “destroy the company” and profit from a CDS trade.

If you buy fire insurance on a house you own and then proceed to burn it down, the insurance claim offsets your financial loss in the house and you come out even. If you buy a policy on your neighbor’s house and then burn it down, you suffer no financial loss on the house and come out ahead by an amount equal to the insurance claim.

QED.