The idea that the contracts are balanced relies on each party being able to perform. If somewhere in the line of balances defaults, I don’t get paid, and then cannot pay out the whole chain unravels and no one gets paid. And this assumes that I ever had the ability to pay. One end of the CDS is mortgage or bond assets that may be worthless. The other is Joe CDS seller and his 2 or 3 hundred basis point premium to provide the swap. This is hardly going to cover a hundred million dollar loss.
Credit Default Swaps (CDS’s) are functionally like insurance, but with no retained asset requirements like a real insurance company. Some articles I have read put the amount of 43 trillion on garbage backed paper – you know CMO’s or marginal corporate bonds. This is the dirty little secret that will cause the FED to do everything it can to head off a financial “event”. The implications of a wide spread failure are staggering.