Bill Cara points with approval to this chart.

Me, I've never seen anything more ridiculous in my life.

The idea is that five years' worth of bubbles in various asset markets are being compared, and that the CDS bubble is vastly bigger than the bubble in, say, the Nasdaq in the five years to 2000.

Balderdash.

The other three indices are price indices – they measure how the price of a certain asset or index moves over time. The CDS numbers don't measure the price of anything, they just measure the total number of credit default swaps outstanding. This is a bit like comparing the number of cars in a parking lot to the number of cars on a freeway and saying that the parking lot must be much more dangerous because it's got more cars on it.

But actually it's even sillier than that. You see, a chart of CDSs outstanding is not like a chart of total bonds outstanding, or total equity free float. A CDS is an over-the-counter contract which can be entered into at no cost by any two parties: it's not a security which can be traded.

Let me repeat: credit default swaps are not securities. If I enter into a CDS contract with a certain counterparty, and then the following day I wish to unwind that contract, nine times out of ten I won't sell my CDS back to the counterparty. Instead, we'll just write a second, equal-and-opposite contract, which cancels out the first one.

So let's say that one hedge-fund trader is active in the CDS market, and another hedge-fund trader is active in the bond market. Let's say they're both trading a credit like Russia which isn't issuing new bonds. Both of them enter into, say, 50 trades per day, 250 days per year, and they both end the year completely netted out, with no prop book at all. At the end of the year, the total number of bonds outstanding will have grown by zero, while the total number of CDS contracts outstanding will have grown by 12,500. But there's no increase in risk in either case.

Yes, there are things to worry about when looking at the unregulated CDS market. But the size of the market, as measured in contracts outstanding, isn't one of them.

Has the Explosive Growth of Credit Derivatives Increased the Risk of a Systemic Crisis?