[palmer]

The ideal world sounds nice, but you should add few real world scenarios. Bob issues CDS on BuggywhipCorpX and BuggywhipCorpY. Both default due to an unforeseen inventions, Bob only expected one or the other to default and Bob runs out of money. Govt bails Bob out.

Bob uses his "AAA" from other parts of his business to obtain credit lines for the CDS. Sam wants to compete with Bob but with his more expensive credit lines, Sam changes his default assumptions and offers the same or better price for his CDS as Bob (there are no regulations on them). Sam ultimately defaults on the CDS he issued.

Bob prices CDS assuming there would not be a recession. Alice thinks there will be recession and buys lots of Bob's and other issuers' CDS as a speculative investment. In one case there is a recession, Bob is out of money, govt bails him out. In another case there is no recession, but Alice is unable to pay her CDS obligations and Bob is forced to write them off leading Alice to default on her obligations in a systemic meltdown.

[Moonman62]

So, how exactly would the government bail Bob out?