The money made by selling these derivatives is directly responsible for the huge profits and bonuses we now see on Wall Street. The money masters have reaped obscene profits from this scheme, but now they live in fear that it will all unravel and the gravy train will end. What these banks have done is to leverage the system to such an extreme, that the entire house of cards is threatened by a small country of only 11 million people. Greece could bring the entire world economy down. If a default was declared, the resulting payouts would start a chain reaction that would cause widespread worldwide bank failures, making the Lehman collapse look small by comparison.
Some observers question whether a Greek default would be that bad. According to a comment on Forbes on October 10, 2011:
[T]he gross notional value of Greek CDS contracts as of last week was --54.34 billion, according to the latest report from data repository Depository Trust & Clearing Corporation (DTCC). DTCC is able to undertake internal netting analysis due to having data on essentially all of the CDS market. And it reported that the net losses would be an order of magnitude lower, with the maximum amount of funds that would move from one bank to another in connection with the settlement of CDS claims in a default being just --2.68 billion, total. If DTCC's analysis is correct, the CDS market for Greek debt would not much magnify the consequences of a Greek default--unless it stimulated contagion that affected other European countries.
It is the "contagion," however, that seems to be the concern. Players who have hedged their bets by betting both ways cannot collect on their winning bets; and that means they cannot afford to pay their losing bets, causing other players to also default on their bets. The dominos go down in a cascade of cross-defaults that infects the whole banking industry and jeopardizes the global pyramid scheme. The potential for this sort of nuclear reaction was what prompted billionaire investor Warren Buffett to call derivatives "weapons of financial mass destruction." It is also why the banking system cannot let a major derivatives player--such as Bear Stearns or Lehman Brothers--go down. What is in jeopardy is the derivatives scheme itself. According to an article in The Wall Street Journal on January 20th:
Hanging in the balance is the reputation of CDS as an instrument for hedgers and speculators--a $32.4 trillion market as of June last year; the value that may be assigned to sovereign debt, and $2.9 trillion of sovereign CDS, if the protection isn't seen as reliable in eliciting payouts; as well as the impact a messy Greek default could have on the global banking system.
Players in the future may simply refuse to play. When the house is so obviously rigged, the legitimacy of the whole CDS scheme is called into question. As MF Global found out the hard way, there is no such thing as "risk-free speculation" protected with derivatives.