What is the nightmare scenario for the CDS market?

The sheer size of the market for credit default swaps makes people nervous. But what is the nightmare scenario? What would bring the market to its knees? You might think it would be wave of defaults. But Moody's argues that the biggest danger to the market stems from the potential for failure of a major investment bank. Financial News Online notes participants tend to run flat books, basically offsetting most of their position risks. But if a big counterparty bank were to fail it would rock the system. Havoc might ensure as people wondered if the contracts were at all binding. The lack of a clearing mechanism certainly wouldn't help if people tried to exit positions en masse.  

For more:
- here's the Financial News Online article

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