This is a good read on why credit default swaps are destroying our financial system.

The money quote:

These are deliberate flaws built into the game that include the lack of a central counterparty, no effective limit on dealer leverage and a schizophrenic pricing methodology that has nothing to do with the several different types of underlying risk contained in these contracts. It is a market designed by and for the seller, to the disadvantage of the buyer. But CDS may also be thought of as a poker game where the dealers have few chips on the table.

It comes down to excessive leverage, and the author, Christopher Whalen, is rather more of an optimist than I am about the outcome and how soon the mess will be straightened out.