Two ways to think about this. First way, go back to the bursting of the tech bubble. Remember margin calls? This works the same way, but more work than just getting a quote. Second way, if you have a hot hand, the casino comps you; if you have a cool hand they comp you more; if you’re a loser they stop. The CDS world was a casino, built on betting systems disguised as hedging. Everyone got tips for playing. As the bubble expanded, the tips got bigger, but the action was benign–you were only ever a little ahead or a little behind. Until suddenly you were sool, and that last extravagant gesture that was going to make your numbers brought, instead, bleak, stark ruin. It wasn’t just Jerome who was playing at this game, it was the adult supervision all over the financial landscape that had lost the risk aversion gene from their corporate DNA. “If you can’t price the risk, don’t take it” is the mantra that has kept some firms in business. And pricing doesn’t mean what delusion you and your buddy on the other side are sharing that morning. Trouble with these wretched instruments was that there was no real market you could look at as a reality check. Not that any one who didn’t make it would have looked.
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