Says Tony Dwyer, a strategist at FTN Equity Capital Markets: "You have turned the buyer of stressed corporate debt from a buyer incentivized to make the company better and worth more, to a buyer with the goal of default. If the total cost of buying a bond and insuring it to par is less than par, it creates an arbitrage that ultimately destroys capital." Theoretically, an unlimited amount of credit-default swaps can be written and bought on any issuer, and there are incentives for buyers to make companies look sickly. If an investor buys a troubled issuer's deeply discounted corporate debt that has little chance of trading again at face value, and then buys CDS as protection, the investor could essentially want the issuer to default so the swaps pay off to the max.
In particular, John Paulson and his friends made a bundle on CDSs - http://www.freerepublic.com/focus/f-news/2186519/posts?page=36#36
Yes, he did, because he was one of the few people to both see that the whole thing was a crock, and act on it.