CDSs work like this: Imagine you buy a house, and then you take out fire insurance with AIG in case it burns down. You pay AIG a premium for the fire insurance. They pay you a large lump sum if the house burns down. Now imagine that AIG felt the risk of the house burning down was so low that they sold insurance policies on the same house to 100 people. They're making tons of money on premiums. And now imagine they did this for 100 different houses. They're raking in the profits, investors are loving it and AIG is doing well. And now imagine all the houses burned down at the same time...
We have created a system for growth that depended on our building more and more stores to sell more and more stuff made in more and more factories in China, powered by more and more coal that would cause more and more climate change but earn China more and more dollars to buy more and more U.S. T-bills so America would have more and more money to build more and more stores and sell more and more stuff that would employ more and more Chinese...
Our dealings with China is really not what has created the mess we're in right now. I hope Thomas Friedman didn't actually blame the crisis on our trade imbalance with China.
Considering that there still seems to be disagreement about the causes of the great depression, my guess would be that there are people who know, but nobody knows who they are.
Because I've been reading about this shit for nearly two years and I don't have a real good handle on it, particularly how CDS are involved.